Government Regulation and Business Value

It its simples form, the value of any business is a function of its cash flows and the risks of realizing those cash flows. Generally speaking, the lower the perceived risk, the higher the value of the business. The converse also holds true.

In the process of estimating the value of an existing business, the risk assessment process is a key factor. Every company is exposed to risk. For example, a company with a high debt level is generally more risky than companies with low or no debt. Companies that have only a few customers that represent a high percentage of total sales are generally deemed more risky than companies that have many customers that generate the same sales volume. Companies that are highly regulated by government agencies may also face high risk levels due to frequent legislation that effects their operations and future cash flows. The auto industry, airline industry, and healthcare, are examples of highly regulated industries.

Successful business owners identify risks and proactively adopt strategies to reduce and minimize risks. Cultivating a diverse customer base is a deliberate action to reduce business risk. Hedging is a strategy often used to reduce risk. The purchase of insurance policies reduces risk of loss through casualty or otherwise.

Government regulations, for most business owners, can present uncontrollable risks. They can appear suddenly, the result of current events and the political pressure to “do something”.

From a valuation perspective, the recent announcement on the prospect of increasing the minimum wage could decrease the value of businesses that rely on low skill employees, those that are earning at or near the minimum wage. The decrease in business value is a result of potentially lower cash flows due to higher labor costs. In today’s fragile economy, a business owner would be hesitant to automatically increase prices based on a forced increase in labor costs. This could result in loss sales to competitors. Most likely, the business owner would cut back in total labor employed so that overall costs remain the same. What happens in this scenario is that fewer people are employed under the guise of helping the low skilled worker earn more.

There have been numerous studies that contradict the politically popular thinking that mandating minimum wage law is good for the economy and good for the low skilled worker.

A more effective approach is for policymakers to focus on policies that generate faster economic growth. A growing economy benefits all workers, while minimum wage policies disproportionately affect low-skilled workers. While I understand that politicians and policy makers believe they are helping workers, research shows the opposite is true. (1)




(1)Richard V. Burkhauser and Joseph J. Sabia, “The Effectiveness of Minimum Wage Increases in Reducing Poverty: Past, Present, and Future, Contemporary Economic Policy 25, no. 2 (April 2007).
Richard V. Burkhauser and Joseph J. Sabia, “Minimum Wages and Poverty: Will a $9.50 Federal Minimum Wage Really Help the Working Poor?” Southern Economic Journal 77, no. 3 (January 2010).