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Valuation Biases, Error Measures, and the Conglomerate Discount

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  • Dittmann, I.
  • Maug, E.G.

Abstract

We document the importance of the choice of error measure (percentage vs. logarithmic errors) for the comparison of alternative valuation procedures. We demonstrate for several multiple valuation methods (averaging with the arithmetic mean, harmonic mean, median, geometric mean) that the ranking of valuation methods is largely a function of the error measure chosen. Percentage errors give a higher weight to relative overestimates than to underestimates, and all established multiple valuation methods exhibit a positive bias according to this measure. Percentage errors lead to consequences that are not intuitive: E.g. setting company values equal to their book values often becomes the best valuation method. Logarithmic errors give equal weight to relative overestimates and underestimates and avoid unwanted consequences. With logarithmic errors, median and geometric mean are unbiased while the arithmetic mean is biased upward as much as the harmonic mean is biased downward. Measuring the diversification discount with the arithmetic mean generates a discount about twice as large as with the geometric mean or the median, whereas the harmonic mean leads to a diversification premium.

Suggested Citation

  • Dittmann, I. & Maug, E.G., 2006. "Valuation Biases, Error Measures, and the Conglomerate Discount," ERIM Report Series Research in Management ERS-2006-011-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    • Handle: RePEc:ems:eureri:7592
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    Cited by:

    1. Rudolph, Christin & Schwetzler, Bernhard, 2014. "Mountain or molehill? Downward biases in the conglomerate discount measure," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 420-431.

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    More about this item

    Keywords

    Conglomerate Discount; Financial Ratios; Valuation;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • G3 - Financial Economics - - Corporate Finance and Governance
    • M - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics

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