Measuring business interruption losses and other commercial damages: an economic approach

539 Pages·2020·3.577 MB·English

by  Gaughan, Patrick A

Measuring Business
Interruption Losses and 
Other Commercial Damages:
an Economic Approach
I wish to thank Sheck Cho, my editor at John Wiley & Sons, for all of his
support over the years.
Measuring Business
Interruption Losses and
Other Commercial Damages:
an Economic Approach
Third Edition
PATRICK A. GAUGHAN
This edition first published 2020
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10 9 8 7 6 5 4 3 2 1
Contents
CHAPTER 1 Introduction 1
Development of the Field of Litigation Economics 2
Development of the Field of Forensic Accounting 3
Qualifications of an Economic Expert 5
Qualifications of an Accounting Expert on Damages 8
Interdisciplinary Nature of Commercial Damages
Analysis 8
Difference Between Disciplines of Economics
and Finance 10
Finding a Damages Expert 11
Critically Reviewing a Potential Expert’s Curriculum
Vitae 12
Getting the Damages Expert on Board Early Enough 18
Courts’ Position on Experts on Economic Damages 19
Standards for Admissibility of Expert Testimony 21
Exclusion of Experts 25
Trends in Daubert Challenges to Financial Experts 25
Expert Reports 28
Defense Expert as a Testifying Expert, Not Just
a Consultant 33
Quantitative Research Evidence on the Benefits
of Calling a Defense Expert 35
Treatment of the Relevant Case Law 36
Legal Damage Principles 36
Other Types of Damages Cases 42
Summary 46
References 46
v
vi Contents
CHAPTER 2 Economic Framework for the Lost Profits
Estimation Process 51
Foundation for Damages Testimony 51
Role of Assumptions in Damages Analysis 52
Hearsay 53
Approaches to Proving Damages 55
Causality and Damages 59
Using Demonstrative Evidence to Help the Client
Understand Its Losses or Lack of Losses 67
Causality and Loss of Customers 68
Graphical Sales Analysis and Causality 69
Causality and the Special Case of Damages Resulting
from Adverse Publicity 71
Length of Loss Period: Business Interruption Case 72
Length of Loss Period: Plaintiff Goes Out of Business 77
Length of Loss Period: Breach of Contract 78
Methodological Framework 79
Summary 82
References 83
CHAPTER 3 Economic Analysis in Business Interruption
Loss Analysis 85
Economic Fluctuations and the Volume of Litigation 85
Macroeconomic Analysis 86
Definition of a Recession 86
Measuring Economic Growth and Performance 87
Business Cycles and the Movement of GDP Components 90
Business Cycles and Economic Damages 95
Varying Responses to Business Cycles Across Industries 97
Using More Narrowly Defined Economic Aggregates 99
Quantifying the Strength of the Relationship Between
Selected Economic Aggregates and Firm Performance 101
Implementing Inflationary Adjustments 104
Regional Economic Trends 108
Quality and Timeliness of Regional Economic Data 109
International Economic Analysis 111
Globalization of Supply and Demand 113
Summary 115
References 116
Contents vii
CHAPTER 4 Industry Analysis 119
Sources of Industry Data 119
North American Industry Classification System 125
Retaining an Industry Expert 132
Conducting an Industry Analysis 133
Relating Industry Growth to the Plaintiff’s Growth 136
Other Industry Factors 138
Yardstick Approach and Industry Analysis 141
Summary 144
References 145
CHAPTER 5 Projecting Lost Revenues 147
Projections Versus Forecasts: Economic Versus
Accounting Terminology 147
Using Graphical Analysis as an Aid in the Forecasting
Process 148
Methods of Projecting Lost Revenues 153
Curve‐Fitting Methods and Econometric Models 158
Understanding Regression Output and Diagnostics 161
Common Problems Affecting Regression Models 162
Confidence in Forecasted Values 167
Frequency of the Use of Econometric Techniques
in Commercial Litigation 169
Seasonality and the Forecasting Process 177
Capacity Constraints and Forecasts 179
Sensibility Check for the Forecasted Values 180
Projecting Lost Sales for a New Business 181
Projecting Losses for an Unestablished Business 186
Summary 188
Appendix 189
References 197
CHAPTER 6 Cost Analysis and Profitability 199
Presentation of Costs on the Company’s Financial
Statements 200
Measures of Costs 201
Profit Margins and Profitability 201
Appropriate Measure of Profitability for a Lost
Profits Analysis 202
viii Contents
Burden of Proof for Demonstrating Costs 206
Fixed Versus Variable Costs 207
Using Regression Analysis to Estimate Costs
as Opposed to More Basic Methods 212
Pitfalls of Using Regression Analysis to Measure
Incremental Costs 212
Possible Nonlinear Nature of Total Costs 213
Limitations of Using Unadjusted Accounting Data
for Measuring Incremental Costs 217
Treatment of Overhead Costs 220
Must a Plaintiff Be a Profitable Business to Recover
Damages? 224
Mitigation of Damages 225
Cash Flows Versus Net Income: Effects
on the Discounting Process 230
Recasted Profits 232
Firm‐Specific Financial Analysis 238
Cross‐Sectional Versus Time Series Analysis 240
Summary 240
References 241
CHAPTER 7 Time Value of Money Considerations 245
Determination of Interest Rates 246
Types of Interest Rates 246
Financial Markets: Money Market Versus Capital Market 247
Money Market Securities and Interest Rates 247
Capital Market 249
Real Versus Nominal Interest Rates 250
Determinants of Interest Rates 255
Prejudgment Losses 261
Components of the Cost of Capital 263
Discounting Projected Future Profits 269
Should the Risk‐Free Rate Be Normalized? 272
Common Errors Made in Discounting by Damages
“Experts” 276
Summary 282
References 283
Contents ix
CHAPTER 8 Business Valuations 287
Legal Standard for Business Valuations in Business
Interruption and Business Failure Lawsuits 287
Lost Profits Versus Lost Business Value 290
Business Valuation Framework 292
Public Versus Private Companies 293
Business Valuation Parameters 294
Revenue Ruling 59–60 and Factors to Consider
in Valuation 294
Valuation Concepts 298
Capitalization of Earnings 304
Adjustments and Discounts 308
Summary 314
References 316
CHAPTER 9 Intellectual Property 319
Patents 319
Computation of Damages for Patent Infringement 325
Legal Requirements Necessary to Prove Lost Profits 325
Royalty Arrangements 333
Copyrights 341
Measurement of Damages for Copyright Infringement 344
Trademarks 347
Trade Secrets 352
Summary 355
References 357
CHAPTER 10 Securities‐Related Damages 361
Key Securities Laws 361
Damages in Securities Litigation 366
Fraud‐on‐the‐Market 367
Comparable Index Approach 380
Event Study Approach 383
Examining the Variation in Abnormal Returns 386
Limitations of the Event Study Model 391
Broker Raiding Cases 394