Corporate valuation methodologies during an uncertain economic climate in Malta : evidence from COVID-19

Abstract

PURPOSE: This study attempted to build on previous studies by conceptualising the effect of economic downturns on this practice. Firstly, the study aims (i) to evaluate any shifts in the value relevance of earnings and book values underpinning valuations; (ii) to assess changes that occurred to the conventional valuation methods; (iii) to investigate the usage of real options and other risk identification instruments as a means to gauge fundamental firm uncertainty. DESIGN: To comprehensively address these objectives, this research employed a mixed-methods approach. A multiple regression model was utilised to comprehend the payoffs that recessions exert on accounting numbers’ utility. Twelve (12) semi-structured interviews with valuers, stockbrokers, and CFOs were conducted to attain a holistic understanding of the ramifications of other aspects of the valuation process. FINDINGS: The statistical facet highlights the low utility levels offered by annual reported financial statements for local equity valuations, with neither earnings nor book values indicative of value creation amidst a turbulent economic climate. The findings further elicit that enhanced investor scepticism, earnings manipulation, and diminished earnings sustainability contribute to this lack of significance. Additionally, conventional valuation models endured significant fluctuations in their constituents, with the market and asset approaches facing reduced credibility due to volatile financial data, while the income model suffered from greater valuer discretion and subjectivity. Essentially, the income model prevailed among local practitioners during shock events. Furthermore, unawareness, complexity and resource constraints impeded analysts from implementing real options and simulations, with stress testing and narrative reporting emerging as the most prevalent risk identification technique implemented during this time. CONCLUSIONS: The study concludes that a recessionary environment establishes a more arduous environment for valuers. Essentially, accounting fundamentals detach from firms’ economic reality, as valuers must adjust the fundamentals of valuation models and consider other performance indicators. Despite being inherently influenced by economic shocks, these methods remain the pediment for valuers in their appraisals. Thus, local valuers tend to conform to an approach of model stability based upon the most simplistic assumptions and risk-measuring instruments, hindering the application of novel methods, with a preference towards satisficing rather than precision. Ultimately, external influences play a key role with the level of professional guidance and scrutiny highly correlated with the accuracy of firm values during macroeconomic imbalances. VALUE: This study is of significant value as it bridges the disciplines of economics and accounting, providing crucial insights into the impact of economic downturns on corporate valuation practices. By doing so, it enriches the knowledge base, equipping the valuation community with a comprehensive analysis of the external economic environment, thereby enhancing their decision-making capabilities.