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The Existence of, and Earnings Quality Explanations for, the Private Company Discount
Gus De Franco, University of Toronto
Ilanit Gavious, Ben - Gurion University
Justin Jin, University of Toronto
Gordon D. Richardson, University of Toronto
ABSTRACT. We seek to establish the existence of, and examine earnings quality explanations for, the private company discount (PCD) applied by acquiring firms when they value the controlling interest of a private firm. First, we show the existence and estimate the magnitude of the PCD actually applied by acquirers when they purchase a private firm. Employing both a univariate and a multivariate approach that controls for differences in industry, time, firm size and growth, we find a range of PCD estimates between 34% and 38%. Second, we find positive abnormal and total accruals are greater for private firms than for public target firms in the annual fiscal period prior to the acquisition, consistent with private firms’ accruals being of lower quality. Third, we present evidence that valuation multiples are increasing in whether the firm is audited by a Big 5 auditor and leverage. These factors proxy for audit quality and creditor demand for quality financial information.
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