shouldbereplacedwithsmallerdiscounts.Inrecentyears,the
courtshavebeguntolookfavorablyatthesearguments.Ina
2003 case,
66 theInternalRevenueService,oftenattheshortendofthe
illiquiditydiscountargument,wasabletoconvincethejudge
thattheconventionalrestrictedstockdiscountwastoolarge
and to accept a smaller discount.
Firm-Specific Discount
Much of the theoretical and empirical discussion in this
chapter supports the view that illiquidity discounts should
varyacrossassetsandbusinesses.Inparticular,withaprivate
company,youwouldexpecttheilliquiditydiscounttobea
functionofthesizeandthetypeofassetsthatthecompany
owns. In this section,we considerthe determinantsof the
illiquidity discount and practical ways of estimating it.
Determinants of Illiquidity Discounts
Withanyasset,theilliquiditydiscountshouldbeafunctionof
thenumberofpotentialbuyersfortheassetandtheeasewith
which thatasset canbesold. Thus,theilliquidity discount
should be smaller for an asset with a large number of
potentialbuyers(suchasrealestate)thanforanassetwitha
relativelysmallnumberofbuyers(anexpensivecollectible).
Withprivate businesses,theilliquidity discountislikelyto
vary across both firms and buyers,which renders rules of
thumbuseless.Letusconsiderfivefactorsthatmaycausethe
discount to vary across firms.
- Liquidity of assets ownedby the firm. Thefact that a
privatefirmisdifficulttosellmayberenderedmootifits