Forensic Economics in International Cases Presentation to the Dade County Defense Bar Association July 18, 2007 Manuel Lasaga Ph.D. StratInfo Miami, Fl
Introduction • An economist is an economic expert not an attorney. – Advice the economist on the legal rules affecting calculation of damages. • Calculation of economic losses is a multi-step process. • Basic model for calculation of economic losses in the case of: – Personal Injury & Wrongful Death (PI&WD) – Commercial Losses • Application of basic model to international cases. Manuel Lasaga Ph.D. Manuel Lasaga Ph.D. www.StratInfo.com www.StratInfo.com 2 2
Personal Injury and Wrongful Death (PI&WD) Generic Model: Income Income Income = + + + PV ... 1 2 n + + + ( 1 i ) ( 1 i ) ( 1 i ) 2 n 1 2 n Income i represents the loss of income. This estimate includes among other things the following calculations based on available information: • Base salary & growth of salary (for PI need income before & after) • Benefits • May include adjustments for survival and employment probabilities • Less taxes • Less personal consumption (in case of wrongful death) • “n” is the period of loss NOTE: Because this is a simple version of the model used for illustration purposes, it may exclude other variables. The discount rate “i” should be a risk-free rate Manuel Lasaga Ph.D. www.StratInfo.com 3
Commercial Losses Generic Model: CF CF CF = + + + PV ... ( 1 2 n + + + k k k ( 1 ) ( 1 ) 2 1 ) n e 1 e 2 en CF i represents the cash flow loss to the business. For valuations, CF n would be substituted with the terminal / residual value. This estimate includes among other things the following calculations based on available information (see Note in previous slide): • Revenues / sales (cost of goods sold) & growth • Administrative costs • Less taxes • Add back non cash-flow expenses (i.e. depreciation) • Add changes in long-term debt • Subtract actual capital expenditures and change in working capital • n is the period of loss In this case the discount rate “k e ” is the cost of equity which should be adjusted for risk. Other discount rates could apply depending on definition of CF. Manuel Lasaga Ph.D. www.StratInfo.com 4
Steps in Calculating Economic Damages Identify key input Generate factors & assumptions: projection of losses Establish Methodology: Macro & Micro economic and PV Model factors discount to PV Quantitative & Qualitative Information Assess sensitivity of estimates to key factors Manuel Lasaga Ph.D. www.StratInfo.com 5
The Time Line of Economic Losses Today T T + n years T – x years 2007 2025 2003 Date of End Date Date of Loss For Losses Analysis Event Some All information Information needs to be Is based on projected Actual values Manuel Lasaga Ph.D. www.StratInfo.com 6
Economic Losses from an international perspective • This presentation will focus on cases involving PI&WD. • Importance of cross-country issues. • The process for calculating economic damages in the international context: – Determining the input factors / assumptions – Generating the output from the model – Sensitivity of PV to determining variables Manuel Lasaga Ph.D. www.StratInfo.com 7
Economist Should Address Specific Country Issues • The methodology based on the PV model is the same for every country, but is applied to each country differently. – Each country has its own unique characteristics. – Developed versus Emerging Markets. – Different economic structures: currencies, markets, institutions, culture, demographics, etc. – Availability of information differs widely across countries. Manuel Lasaga Ph.D. www.StratInfo.com 8
• Estimation of economic losses in international cases involves the following country specific process: – Use of relevant information – Consistency of analysis – Reasonableness of assumptions – Appropriate use of the model – Generated output makes economic sense in the country context. Manuel Lasaga Ph.D. www.StratInfo.com 9
Analysis of Input Factors: I. Macro / Economy-wide Variables The following input variables may be useful if available: Inflation • CPI, PPI Interest Rates • Short- and long-term rates • Nominal and real interest rates Exchange Rates • Use the spot rate or forecast the exchange rate? Economic Growth (GDP) • Importance of informal economy Industry Growth Income Growth • Personal income, wages, etc. Taxes Manuel Lasaga Ph.D. Manuel Lasaga Ph.D. www.StratInfo.com www.StratInfo.com 10 10
Sources of information for Macro Variables: – Country sources include: 1. Central Bank 2. National Statistical Institute 3. Ministry of Finance – International sources include: 1. IMF 2. World Bank 3. UN / OECD Manuel Lasaga Ph.D. www.StratInfo.com 11
Forecasting the Macro variables: – Projections based on past values 1. Use of past values depends on length of economic cycle. Rely on experience over long periods that are representative of the economic/business cycle. 2. Analyze growth rates and historical volatility. – Take into account reasonable relationships between variables. For example, GDP measures total output in the economy; thus it has a direct impact on the output of a particular industry, which in turn has a direct impact on the output of a particular business within that industry, which in turn has a direct impact on the growth of income of a person working in that particular business. – Compare to forecasts produced by others such as IMF, World Bank, Consensus Economics. Manuel Lasaga Ph.D. www.StratInfo.com 12
II. Micro / Individual Variables The following input variables may be useful if available: Life Expectancy Level of Income prior to loss & projected Income growth 1. Nominal growth; or 2. Real growth (inflation adjusted) 3. Growth rate is dependent on individual’s past performance as well as industry and economy-wide characteristics. 4. When available, refer to statistics on earnings in that industry. Information on comparable occupations may also be useful. – Note: for PI you need to project the level of income that the individual would have earned if the loss had not occurred and the income after the loss; the economic loss is the difference between the two. Value of services Personal consumption (WD) Life care plan (PI) Manuel Lasaga Ph.D. Manuel Lasaga Ph.D. www.StratInfo.com www.StratInfo.com 13 13
Sensitivity of PV (output) to Input Values Sensitivity to Assumptions: Hypothetical Venezuelan Case Projection period 20 years FX rate: Bs2,147/US$ Lower Lower Higher Base case Inflation Growth Disc rate Inflation 17.5% 15.5% 17.5% 17.5% Income Growth (nominal) 20.5% 20.5% 18.5% 20.5% Discount Rate (after Tax) 19.00% 19.0% 19.0% 21.0% Present Value of Losses $225,000 $189,732 $189,007 $186,658 % change versus Base -15.7% -16.0% -17.0% Memorandum: If no offset in Disc rate $221,785 Note: these are all hypothetical values used for illustrative purposes only. Manuel Lasaga Ph.D. www.StratInfo.com 14
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