An evaluation of the use of professional judgement in corporate valuations in South Africa

Abstract

Corporate valuations can be considered the heart of finance with sensible financial and investment decisions depending largely on the value of a firm. Investment analysts rely on corporate valuation estimates to make investment decisions while financial managers use these corporate valuations for capital budgeting as well as merger and acquisition activities. Global merger and acquisition and capital market activity has increased over the last decade with a significant number of deals being concluded on an annual basis. While the number of deals in South Africa make up a minority portion of the total global deals, foreign investors have shown an interest to invest in South Africa. Whilst finance research makes extensive reference to firm value, the professional judgement that is applied in its calculation has not been interrogated within the South African market. The focus of this research study was to examine the use of professional judgement within valuations in the South African context. The research aims at identifying aspects in corporate valuations requiring professional judgement and understanding why this professional judgement is necessary. Explanatory sequential design is the mixed method research technique that was employed to conduct this research. According to this design, the researcher begins by conducting a quantitative study and follows up with subsequent qualitative techniques to help explain the quantitative results.

The research was carried out in four parts. Part one involved collecting data from respondents by means of a survey. A sample of 30 experts were used. The small population size in terms of the number of professionals performing valuations in South Africa made it difficult to select a larger sample. Part two involved descriptive statistical analysis of the survey responses. The content of the surveys was summarised using descriptive statistics and were used to inform further questions for the semi-structured interviews.

Part three involved semi-structured interviews to add richness, reliability and to corroborate the trends identified. The researcher employed a phenomenological methodology to identify the perception of valuation experts regarding the judgement that they are required to apply when performing corporate valuations. The data collected was analysed by identifying common themes and arriving at a description relating to the phenomenon based on their experience. A sample of six valuation practitioners from the original survey sample were interviewed. While a larger sample would provide a broader range of data, obtaining a detailed account of the experience of the six valuation practitioners was sufficient to uncover the core elements of the professional judgment applied in the corporate valuations that they perform. 7 During part four, the results and findings were interpreted to answer the research question and identify areas of future research. The results of this research indicate that professional judgement is needed when determining which valuation models to apply, when calculating or applying certain inputs within the theoretical models and when considering adjustments that are processed to the valuation models. Industry nuances is a key reason for why professional judgement in necessary in South African valuations. This along with the limited number of companies listed on the Johannesburg Stock Exchange, make it more difficult to identity directly comparable companies which can be used for input estimation within the valuation models. In an emerging economy like South Africa, there is uncertainty associated with future growth and market conditions. Richness of market information and suitable benchmarks are also challenges faced in the South African economy. Market information and future growth are key inputs within a corporate valuation model. The challenges and uncertainties around these inputs requires the valuation practitioner to apply their professional judgement. Despite the challenges and uncertainties around valuation inputs, valuation practitioners are all in agreement that having a standard valuation model structure in place is beneficial and creates consistency in the approach to performing corporate valuations. Unfortunately, the level of professional judgement applied within these corporate valuation models can have a material impact on the final value and ultimately impact the management decisions which are made based on these valuations. Based on this, we can conclude that estimating valuation parameters is a key aspect that needs to be considered by both valuation practitioners and academics.

This research report contributes by identifying challenges and uncertainties which necessitate the use of professional judgement within corporate valuations. Identification of these challenges and uncertainties can assist valuation practitioners to place more emphasis on the inputs which have a large level of uncertainty associated with them. The report can further assist valuations practitioners to understand what is considered best practice for corporate valuations in South Africa. Identifying “best practices” and standardising the estimation practices will be beneficial to valuation practitioners by reducing the differences in corporate valuations. More accurate valuations will result in better information, assisting with more accurate and informed financial decisions being made