Question

Why is Arms length transaction the most preferred when determing fair value? please explain im detail

Answer 1

Arm’s length transaction is most preferred when determining fair value. This is because of the fact that arm’s length transaction is based on the principle of both the involved parties acting in an independent manner and in their self-interest. As such arm’s length transaction closely matches the fair value of the consideration.

I can explain my above point in a better manner through an example. Suppose that the two parties in a transaction are a buyer and a seller. The two parties are acting independently and also they do not know each other. Thus the objective of both the parties will be to find a price at which their welfare is maximized. So in such a situation the buyer will provide a bid which will be as low as possible while on the other hand the seller will provide a sale offer price that will be as high as possible. This will be followed by bargaining between the two parties using the information that is available to them. The two parties will eventually reach an agreement. In this manner the price point at which the buyer and seller both agree to would be very close or would even match the fair market value of the transaction.