Trustworthiness of firm valuations: Bias and market perception in compliance with capital market regulations

Abstract

Capital market and accounting regulations stipulate that firms’ market prices should be preferred over expert valuations as the latter are more susceptible to subjective assertions or judgments by the management and/or appraiser. As a result of this regulatory requirement, companies' subsidiaries that are (not) publicly traded are generally included in their financial reports according to market (expert) value. However, we show that (1) for private firms, expert valuations are systematically upward biased, whereas, for public firms, they are not; (2) private firms' expert valuations are non-informative, whereas, for public firms, they are not only informative but more so than the market values; and (3) market participants consider the public companies' expert valuations reliable and useful. It appears that market participants are able to see through the inherent possibility of an intentional or unintentional bias in firm valuations that rely on future projections and still find valuations valuable. Our results should be of interest to regulators, investors, managers, financial analysts, and various other capital market participants. Acknowledging regulatory limitations can benefit market participants even in the presence of imperfect regulations.