Economic Foundations of Valuation Discounts

This paper develops and analyzes two models of asset valuation from which the appropriate discounts for lack of marketability, blockage, and minority ownership are derived. The analysis of the first model shows that a lack of prospective buyers is a necessary but not sufficient condition for a discount for lack of marketability. Heterogeneous beliefs among prospective buyers regarding the value of the asset are also required. A consequence of this result is that the proper marketability discount for an interest in a partnership that holds easily valued investment assets is zero. Analysis of the second model shows that a discount for owning a minority interest reflects the ability of a majority owner to indirectly transfer wealth to himself at the expense of the minority owner. If a discount exists, it is decreasing in the cost of the transfer to the corporation and decreasing in the ownership interest of the majority shareholder.