VALUE ADJUSTMENT OR RISK ADJUSTMENT? PREMIUMS ANDDISCOUNTS IN CORPORATE VALUATION: THE CASE OF BROKERAGERECOMMENDATIONS

Abstract

Corporate valuation is one of those areas of finance where the precision
of a quantitative model must be supplemented by the analyst’s professional judgment. The value of a company is not solely the result of the mechanical application of the income, comparable, or transaction-based methods. It is also the result of interpreting characteristics of the entity being valued, such as the liquidity of its shares, the size of the company, its ownership structure,

The literature on the subject indicates that premiums and discounts are among the more complex, yet subjectively prone, elements of the valuation process. Prusak (2014) emphasises that their application depends on the level of value being estimated, particularly on whether a controlling, minority, freely tradable, or transfer-restricted stake is being valued. Similarly, Damodaran (2005) points out that illiquidity can affect a company’s value both through a direct discount and by increasing the required rate of return. This means that the mere identification of risk does not yet determine how it should be accounted for in the valuation.

The distinction between a discount and a risk premium is particularly significant. In this article, a discount is understood as an adjustment that directly reduces the value of the company, equity, or a specific block of shares. This primarily applies to discounts arising from 29 illiquidity, lack of control, holding-company status, and legal or economic constraints. Risk
premiums are of a different nature; they do not increase the company's value but raise the discount rate, thereby reducing the present value of future cash flows. This group includes, among others, the size premium, the specific risk premium, the country risk premium, and the
regulatory risk premium. This approach is consistent with the practice of estimating the cost of capital, in which a company’s additional risks may be accounted for by adjusting the cost of equity or the weighted average cost of capital (Grabowski, 2018; Harrington et al., 2021).

The research problem of this article thus boils down to how premiums and discounts are applied in brokerage recommendations and whether the manner of their recognition corresponds to the classifications presented in the literature on the subject. The aim of this article is to identify and organize the premiums and discounts used in corporate valuation, and
subsequently to compare theoretical findings with the practice of analytical reports concerning Polish and foreign companies.

The empirical basis of the study is an original compilation of brokerage
recommendations and analytical reports prepared in an Excel spreadsheet. The compilation includes the company name, country, report date, author of the analysis, type of adjustment applied, mechanism of its impact on the valuation, location within the model, amount of the adjustment, the analyst’s justification, and a link to the source report. This allows an assessment of whether the adjustments applied by analysts constitute a direct discount to value, a premium that increases the discount rate, or a qualitative adjustment incorporated into scenarios, forecasts, or multiples.

The article consists of three parts. The first part presents the theoretical foundations for the use of premiums and discounts in corporate valuation. The second part provides an empirical analysis of the reports included in the Excel spreadsheet. The third part assesses the alignment of market practice with the literature and identifies the main methodological issues,
particularly the risk of double-counting the same risk factors.