Therefore, the only price agreeable to both buyer and seller in a fair value transaction is the fair value of the marketable security without any DLOM.
Because the cost of hedging the nonmarketable security is the current price of the marketable security, it follows that applying a DLOM creates an opportunity to make risk-free profits, or arbitrage.
Not so with FLP interests, and this is the basis for the DLOM
Both parts of the decision are troubling-the Tax Court's acceptance of the argument that the DLOM inherent in restricted stock studies is only 12%, and that the court accepted without much reasoning or computation of the likelihood of liquidation, that the partnership would be dissolved upon the request of a limited partner simply because the dissolution would pose little economic risk to the remaining partners.
Another critic of restricted stock studies (and pre-IPO studies), Mukesh Bajaj, attempted to isolate the DLOM.
In such a setting, two issues arise: whether such strongly illiquid stocks have market value, and, if so, what would the DLOM represent.
In the end, the in-exchange value of stocks is determined by the discounted value of cash flows that are expected to accrue on them, and the DLOM reflects the difference between the value of an illiquid stake (the present value of all expected payoff) compared to the value that they would have if they were traded on the public exchanges (highest and best use based valuation given the pro rata distributions of equity payoffs).
Two general types of empirical studies provide evidence for the existence and magnitude of the DLOM.
Great care and judgment must be exercised in using the results of these studies to estimate the DLOM of a small, privately held company.
Also not uncommon in tax valuation cases, the Tax Court disagreed with both appraisers and determined its own DLOM