On the Myth of Size Premiums in Corporate Valuation: Some Empirical Evidence from the German Stock Market

Abstract

It is common practice in corporate valuation with discounted cash flow models to refer to the Capital Asset Pricing Model (CAPM) to estimate the rate of return required by investors. However, based on empirical studies of the US stock market, primarily Ibbotson and Morningstar (2008) and Grabowski and King (2008), there is growing debate in Germany about whether to adjust the discount rate by adding a size premium for smaller companies, as valuation advisors already partially do in the US and several other countries. Since a relatively small size premium leads to an enormous collapse in value, the discussion of whether to adjust for size is all but negligible. Finding contradicting empirical results for the German stock market between 1995 and 2008, this paper questions the size adjustment in corporate valuation. However, it is not just empirical evidence that casts doubt on size premiums. There are also conceptual aspects that conflict with adjusting the CAPM through simply adding an additional risk premium. This paper tries to give a more comprehensive but critical view on corporate valuation with respect to size.