Did Adoption of Forward-Looking Valuation Methods Improve Valuation Accuracy in Shareholder Litigation?

Abstract

Prior to 1984, Delaware judges relied exclusively on the Delaware Block method - an appraisal formula based on trailing earnings and liquidation value - to price shares in shareholder litigation. In 1984, the Delaware Supreme Court changed the law to permit its judges to use any valuation method they deem appropriate. As a result, judges and litigants began switching away from the Block method and adopting forward-looking valuation techniques based on cash flow and earnings forecasts. While the use of forward-looking methods potentially improves valuation accuracy by incorporating forecast information, the use of forecasts allows more room for subjective manipulation. Did the adoption of forward-looking methods improve or reduce valuation accuracy in shareholder litigation? We address these questions using a comprehensive hand-collected sample of all Delaware corporate appraisal-remedy cases published between 1966 and 2002 in Lexis-Nexis. The sample identifies, on a case-by-case basis, the plaintiff's, the defendant's, and the judge's valuation methods and resulting valuation estimates. We show that the adoption of forward-looking valuation methods improves litigants' valuation accuracy on average.

Keywords: equity valuation, earnings forecasts, Delaware, shareholder litigation

JEL Classification: G12, G34, K00, M41