| Liquidity is a relatively broad and elusive concept that generally denotes the ability to trade large quantities quickly, at low cost, and without moving the price. In practice, a clear distinction between marketability and liqudity appears to be missing. In the appraisal industry, our practioners have frequently used the terms for marketability and liquidity interchangeably. Dr. Abbott's work helps us clarify that ... and provides a way to determine or quantify the discount better.
Dr. Ashok Abbott, an Affiliate of the Minnesota Business Group, has developed a proprietary method to examine these liquidity and marketability issues. MBVG is proud to facilitate the examination of these important questions and provide this important tool for use by other appraisers and valuation professionals. The amount of discount has become contentious in the courts in the past few years.
MBVG believes that the present debate will continue with respect to ascertaining the appropriate discount rate to use for smaller holdings of privately-held securities. Besides the difficulty of referring to empirical studies, which cover a very wide range of possible discounts, appraisal procedures for narrowing the range by using factors have left appraisers with no comparable statistical or empirical support.
The Quantitative Marketability Discount Model (QMDM) was an excellent step in the right direction of explaining why the discounts exist for smaller holdings. But the analyst still must make several specific judgments about holding period, etc. that are difficult to support.
MBVG and Dr. Abbott are not proposing doing away with any of the appraisal tools that are presently used. Instead, we propose that the tool that Dr. Abbott has developed can be used to substantiate and support the other procedures and methods. We think that not only will the Abbott Index provide a way to make the discount for lack of liquidity more precise, but also more defensible.
Dr. Abbott believes that the first error appraisers make is to assume that "marketability" and "liquidity" mean the same thing. They don't. Dr. Abbott explains that "marketability" really relates to whether an investment has been registered for public trading. It does not also include a measure for liquidity for a block of stock beyond that registration. This aspect of selling the stock Dr. Abbott terms "liquidity".
Dr. Abbott's studies of publicly held common stocks display, with a high degree of correlation, that the ability to sell a particular block of common stock is directly explained by certain key variables that relate to the subject company. Dr. Abbott uses historical data on publicly traded common stocks obtained from the Center for Research in Security Prices (CRSP), a well-known financial research center that is part of the University of Chicago, Graduate School of Business. He has ascertained with a high degree of statistical confidence that the "liquidity" of specific amounts of common stock traded within a company can be explained with some certainty with a few identifiable variables within a company. He identified and determined these variables using regression analysis, a tool that also enables others to replicate his findings.
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