The Discount Rate ‘Controversy’ – Much Ado About Nothing Part 2

Business_Finance_14079I have been attacked by the opposing expert for not using the yield of Treasury Bonds. Using short-term Treasury securities (T-Bills) is justified to remove inflation/interest rate risk that may occur with longer term Treasuries (bonds). It is not usually financially prudent to ‘lock-in’ to a Treasury Bond yield when future interest rates are expected to rise due to inflation. Further, the yield on Treasuries can change from the time when the report was written to the conclusion of trial. Using some historic average of shorter-term Treasuries provides this needed flexibility.

Moreover, for approximately one and a half years (Nov 2005 to May 2007) the yield curve flattened and then became inverted for the most part. What this means is that the yield on long term Treasuries (bonds) was actually less than that of the short-term T-Bills. This rarely happens and when it does it makes the business news. In the Nov 3rd 2006 issue of Value Line, the yield on a 10-year Treasury was 4.76%, while the yield of a 3-month Treasury was 5.11%. In the May 18th 2007 issue of Value Line, those figures are 4.66% and 4.85%, respectively.

Typically, the longer the date to maturity the higher the yield because of the economic principle of forgoing liquidity and undertaking interest rate risk. But, one can see from the preceding paragraph, sometimes this is not the case.

In actual fact, it is really the net discount rate that ultimately matters most (discount rate minus growth rate of wages). To justify my use of Treasury Bill yields and net discount rate, I offer the following case law for now. More case law and  brief literature review will be in Part Three of this article.

The courts have not set the appropriate method for determining the discount rate. The parties normally receive a fairly wide latitude in arguing how future damages should be reduced to their present value. [e.g., Noble v. Tweedy (1949) 90 Cal.App.2d 738, 747-748, 203 P.2d 778, 783] But until evidence is taken on this present value issue (or comparable judicial notice), no present value instruction may be rendered. [Wilson v. Gilbert (1972) 25 Cal.App.3d 607, 102 Cal.Rptr. 31]

Which party has the burden of proof? No known reported court decision has firmly resolved which side has the burden of proving the appropriate reduction to present value. The courts have determined that a risk-free rate is the appropriate rate. The argument then turns to determining which is the appropriate risk-free rate.

About George Jouganatos, Ph.D.

Professor of economics for over 18 years, taught economics, finance, and quantitative analysis at UC Davis and Santa Cruz, California State University, Sacramento, and University of San Francisco. Has written many economic impact, efficiency, cost, and feasibility studies; designed economic models, strategic plans, and performance measures. Has written and conducted seminars in the field of economics of development, political economy, economic history, environmental economics, public policy, operational analysis, and economic modeling and forecasting. Over 25 years of consulting services providing economic and statistical analysis for the private and public sectors. Specialties include, but not limited to, personal injury, wrongful death, wrongful termination, housing discrimination, employment discrimination, economic loss, business valuations, lost profits, divorce, general economic and public finance issues. Consultation and testimony for numerous attorneys in California, New York, Nevada, Iowa, Montana, British Columbia, Oregon, New Mexico, and Hawaii. Expert witness and article contributor for

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