valuebusinesses(andthereturnstheyearn)atdifferentstages
of the life cycle.
62 Theyconcludethattheprivatecompanydiscountisonly
11 percentforlatestageinvestmentsbutcanbeashighas 80
percentforearlystagebusinesses.Theperilsofconcluding
that these discounts are for marketability aremanifold. In
additiontoilliquidity, privateequityinvestorsoftenarenot
diversified,andsomeoftheadditionalreturnmayrepresenta
premium for this nondiversification. In addition, private
equityinvestorsalsoexercisesomeorevensignificantcontrol
over the firms they invest in, resulting in higher cash flows.
Real Assets
Ifilliquidityisaproblemwithfinancialassets,itshouldbe
doublysowheninvestinginrealassets.Afterall,sellinga
realassetisoftenmoredifficultandexpensive(intermsof
transactionscosts)thansellinga financialasset.Whileitis
difficulttoquantifytheilliquiditydiscountinmostrealasset
markets,therehavebeenattemptstodosointherealestate
market. Krainer, Spiegel, and Yamori (2004) attempted to
measure illiquidity in the Japanese real estate market by
measuringhowquickly realestatepricesadjusted afterthe
1990 stock market crash. They present a model and
supportive evidence that illiquidity increases after a price
decline and that it(surprisingly) increases more for assets
withmorepredictablecashflows.Intheirtests,thepricesof
commercialrealestate(with itslower variancecash flows)
declinedfurtherandfasterthanresidentialrealestateinJapan
after 1990.
63
DEALING WITH ILLIQUIDITY IN VALUATION