Boards look to fairness opinions*

Boards have been concerned for decades they weren’t getting enough expert, third-party financial advice. But now they are actively seeking independent opinions

*This is an expanded version of a summary that first appeared in the April 2007 issue of CAmagazine.

By Helen Mallovy-Hicks

Boards have never been under so much pressure – whether it be from new regulations or stakeholders. One way to meet the new demands is to get better independent financial advice through fairness opinions.

Financial advisers provide fairness opinions to help boards or independent committees determine if the price in a proposed transaction is fair. Separate teams of advisers can also perform due diligence on important financial decisions such as mergers and acquisitions.

The popularity of fairness opinions has grown in recent years and the trend is likely to continue. Boards have been concerned for decades they weren’t getting enough expert, third-party financial advice. They’re asking for more advice now and it’s a wise move. Boards that consider credible financial advice from a greater number of sources can make better financial decisions. Better decisions lead to better performance and better returns for shareholders.

How the process works
Boards often establish an independent transaction advisory committee when considering a proposed transaction. That committee may turn to a financial adviser to assess the fairness of the proposed transaction from a financial point of view.

In the past, boards and committees often turned to their investment banker -- who may also be acting as deal adviser -- to provide a fairness opinion. But due to an increased focus on corporate governance and independence, it is becoming more common to seek fairness opinions from an independent financial adviser who was not involved in the deal negotiation. This could include a business valuation firm that has no financial interest in—or fees contingent on—the outcome of the proposed transaction. The expectation is that an independent opinion provider delivers a more reliable fairness opinion for use by the independent committee—and the board of directors.

What boards should expect
So what should boards of directors and independent committees expect in a fairness opinion? They should expect that the opinion provider substantiate their opinion and explain how the conclusion was reached. Boards should be prepared to question and challenge the fairness opinion provider so they can reach a point where they are comfortable in relying on the opinion. This is one factor among many that will be considered by the committee when evaluating and deciding on the proposed transaction. Although fairness opinion providers will not comment on whether a transaction is barely or extremely fair, they will present their view to the boards and committees. If the answer is barely fair, the board may face a tougher decision on how to proceed in the decision process.

Concerns with litigation
Boards also need to ward off the ever-present threat of costly litigation. To comply with existing and proposed legislation such as Bill 198 and Sarbanes-Oxley, boards need to show they’ve weighed advice from credible, objective and independent sources. Fully independent valuation advice can provide more legitimacy for board decisions involving value—both in fact and appearance—and stand up in court if necessary.

Independence issues to consider
It is no longer favoured practice to comply with existing legislation at the expense of independence issues associated with opinion providers, given the considerable focus on better corporate governance and proposed disclosure requirements. Today, boards of directors commissioning fairness opinions are placing more focus on fee structures and disclosure of independence.

Independence—both in fact and appearance—is a key issue to consider when soliciting a fairness opinion. The perception that a deal that is endorsed by a board and management will inevitably get a positive fairness opinion from a friendly adviser can be costly. There can also be a perceived conflict if an adviser is paid a contingency or success fee. Some people argue that someone who knows the company is well-positioned to determine whether an offer is fair. Even if this is accurate, the advantage of a second opinion from an independent opinion provider is that it can bolster the case, particularly if the person who is close to the company is acting as the deal adviser.

In our experience at PwC, we have seen more and more companies engage independent advisers and valuators to conduct fairness opinions over the years, and we expect that on larger and more complex transactions multiple fairness opinions (including one by an independent financial adviser) will be become more predominant.

Small organizations and fairness opinions
In today’s regulatory environment, seeking fairness opinions isn’t limited to large companies. Smaller organizations, including private companies and quasi-governmental organizations, have also been doing this recently. This is interesting because there are no regulations that require fairness opinions for these companies. This shows just how much the ground of corporate governance in Canada has shifted—and why boards need to keep moving with the times to stay on their feet.

Valuation has become critical in the governance of corporations. The use of fully independent expert valuation advice provides comfort—both in fact and appearance—in the corporate governance process for boards of directors and independent committees. In these times of heightened shareholder activism, and demands for strong corporate governance, the use of credible, independent valuation advice can be a strong tool for boards.

Helen Mallovy Hicks is a partner in PricewaterhouseCoopers LLP's valuation & strategy advisory practice. She is a Chartered Business Valuator with more than 19 years of independent expert business valuation, litigation support, and related financial advisory experience in Canada, the US and UK.