Spectrum offers a number of continuing education programs for its clients, including: Statistics for Litigators; Measuring Lost Profits; Introduction to Business Valuation; Taking The Economist=s Deposition; Daubert Challenges to Economic Testimony; Personal Injury Damages - A Primer; and FELA Damages. These programs have previously been qualified for CLE credit in Missouri and Kansas and we have the paperwork necessary for submission to other states.
If you are interested in an in-house training session or sponsoring a seminar in your area, please call, write or e-mail Chris or Eric. The cost of a program is minimal and even that is frequently waived for established clients or for opportunities to introduce ourselves to potential clients.
There is a lot of fascinating new technology available for managing the paper generated in a professional practice. We have decided to experiment with the technology here at Spectrum and have installed Adobe Acrobat, other OCR software, gigs of new disk space, a high resolution / high speed scanner and all sorts of other neat stuff. Over the next six months, we will move to a paperless environment in which all case documents are scanned and stored on disk or CD, reports are linked to underlying documents and our expert deposition and report, question data banks, and research files are fully text searchable. It is our hope to continue to improve both our productivity and the quality of our work product through these innovations. Stay tuned for updates.
As former teachers and students of corporation finance and investments, we are constantly surprised by the loose standards that apply to the calculation of business damages. Many litigators and "experts" seem to proceed willy-nilly in the misinformed belief that there is no body of science or technology applicable to analyzing harm to a business as the result of a contract breach or tort. This is simply not the case; there is a standard, even if it is more observed in the breach than the performance.
Calculation of lost profits should follow the model of "capital investment decision analysis" as taught in courses in Corporation Finance and Managerial Economics. The "actual" and "but for" scenarios can either be separately analyzed and damages computed as the difference in the net present values or the net present value of the annual differences can be used. In either case, the appropriate measure is the present value of future cash flows. This can be done on either a before or after tax basis. If done after tax, the tax consequences of the award should be added to damages. Seldom appreciated is the fact that the choice of before or after-tax modeling can be important, especially in cases where the actual and but for scenarios have different net investment consequences.
The selection of a discount rate to apply to the cash flow streams is also governed by theory, not by whim. The best choice is the after-tax marginal cost of capital. In the case of large, publicly traded firms, this rate can be observed in the markets. For smaller firms, a proxy rate can be calculated. In other cases, the analyst can use the firm’s own hurdle rate (typically found in internal studies). In no case, is it economically and financially correct to use a US Treasury security rate to discount business damages. Furthermore, in cases where a venture is particularly risky or safe (relative to the rest of a firm’s undertakings), an adjusted rate should be used which better comports with the risk of the enterprise analyzed. For example, a new product venture or entry into an untried market might call for the use of a venture capital rate of return. In any case, there is a very large body of literature on these issues which should guide the analyst.
In this day when courts are less reluctant to exercise gatekeeper prerogatives, expert witnesses should make sure that their work product comports with the standards of their professions. We are very surprised that more challenges are not being leveled against junk science in business litigation. However, the tide is changing and this Spring we helped a client exclude expert damages testimony in Pietro Culotta v. Southern Pacific RR. Perhaps the courts are finally heeding Judge Posner’s admonition that, "post hoc ergo proctor hoc simply will not do."
No, The Net Rate Isn’t Stable Either
In the current issue of Litigation Economics Review, an article by Chris, Steve and Eric demonstrates that the real interest rate is not stable and that the most accurate way to estimate future interest rates is to use a consensus forecast. In an effort to avoid reality and keep their numbers high, some economists have asserted that, even if the real interest rate is not stable, the difference between it and the rate of earnings growth is. This is simply not true.
There have been several articles in recent years in the Journal of Forensic Economics (JFE) that have demonstrated that the difference between the interest rate and rate of wage growth is not stable. We have recently revisited this issue in a paper which we have posted on our web page and will submit for publication in the near future. There is, however, some "fog" in the air. An article by Gilbert in the JFE purports to show that the rate is stable. Another article in that same Journal by Peláez reaches essentially the same conclusion based on faulty logic. You may find "experts" citing these articles in support of using a historical net rate approach.
The article by Gilbert is foolish and, incredibly, is based on an algebraic error. Gilbert assumes that since the ratio of the real interest rate to the real rate of wage growth, i/g, is stable, the geometric difference (1+i)/(1+g) is also stable. This is clearly not true; this article would not have been published had it been subjected to reasonable peer-review.
Peláez found in one article that the difference i-g is not stable, hence the net rate is not stable. He opines in another that though the annual net rates are not stable, the geometric average of the previous years’ net rates will be stable. This then would be a justification for using historical average rates. This is both illogical and numerically vacuous. If the annual net rate is a "random walk" there is no reason to believe that the geometric average of the past net rates is not also a random walk. Peláez’ method is simply mathematical fog.
A critical question in many personal injury cases is how large a drop in earnings may result from an injury. Many expert reports claim a loss that seems inconsistent with the severity of the injury.
Important components of expected earnings are the probability of being in the labor force and the expected rate of employment (opposite of unemployment). If these are underestimated for the disabled individual, earnings will also be underestimated and vice versa.
Spectrum has been researching the expected earnings of the disabled. This research has looked at the labor force participation and employment rates of the disabled as they are defined in the census. We have found widespread misapplication of these data by expert witnesses, especially those testifying for plaintiffs.
The March Supplement to the annual Current Population Survey (CPS) focuses on disabilities. Earnings, the probability of being in the labor force and of being employed for those not disabled, all disabled and the severely disabled are found in the well-known summary tables from this Survey. From these summary data, one can solve for the characteristics of those not severely disabled using a little bit of algebra.
It would seem logical to select from the Census Bureau summary tables the appropriate probabilities given the severity of an individual's disability. Many "experts", however, lump both not severely and severely disabled individuals together to estimate probability of labor force participation and employment. This biases the estimate of economic loss.
Part of Spectrum's on-going work on disability involves using the original data on which the Census Bureau's summary tables are based. From the original data and the definitions of the levels of disability,we have estimated the probability of labor force participation by age, sex, marital status, education and other demographic characteristics. It is instructive to compare the results of using the statistical technique with the probabilities used by Vocational Economics in which all disabled are lumped together irrespective of severity of disability. The following graph provides the comparison.
The top line is the age probability profile for those not disabled, the second line is the profile for those not severely disabled and the bottom line is the profile for those severely disabled. Clearly, in terms of the age probability profiles, those not severely disabled have much more in common with those not disabled than they do with the severely disabled. This emphasizes the importance of differentiating the not severely disabled from the severely disabled when estimating expected lost earnings. To dramatize this point, the third line in the graph depicts the age-probability profile used by Vocational Economics.
We have used the results of our research in several recent matters. Since our estimates are based on well-accepted statistical procedures with known error rates, they conform with requirements under Daubert. We are also in the process of preparing an article on our results for our web site.
In 1991, Patrick Gaughan, President of Economatrix in New York, went to members of the Board of Directors of the National Association of Forensic Economists and secured affidavits from four stating that the concept of hedonic damages was generally recognized in the field of Forensic Economics. These affidavits were then used by purveyors of this silliness to suggest that the NAFE as an organization supported hedonic damages. Subsequently in 1997, NAFE board member Tom Ireland secured affidavits from three of the original four stating that it was not their intention to suggest that the NAFE membership endorsed hedonic damages. In May the board of that organization voted that it is the policy of the board not to take positions on controversial issues. Of course, the fact that so many board members took such a position in the first place regarding a concept which has been dismissed as gibberish by prominent academic and the courts speaks loudly as to the bias of the NAFE. We have a paper on the biases of the NAFE authored by Dr. Ireland.