The Existence and Explanations for the Private Company Discount*

In this study, we seek to establish the existence and examine explanations for the private company discount applied by investors when they value the controlling interest in a private firm. Our four main findings are summarized as follows. First, we show the existence and estimate the magnitude of the PCD actually applied by investors when they acquire a private company. Employing both a univariate and a multivariate approach that controls for differences in industry, time, firm size and growth our results suggest a range of PCD estimates between 34% and 38%. Second, we find greater income-increasing accruals for private as opposed to public firms in the most recent annual fiscal period prior to their acquisition, consistent with private firms engaging in greater earnings management. Third, we present evidence that price multiples are weakly related to whether the financial statements have been audited by a Big 5 auditor, which provides modest but more direct support for the link between information risk and the private company discount. Last, we find that in regressions of purchase price paid on net income, book value and other fundamentals, the coefficient on net income is significantly lower for private firms. This result provides triangulating evidence consistent with the notion that earnings quality is indeed lower for private firms.