differencesacrossfirmsonfundamentals,thesefundamentals
tendtobefinancial(risk,growth,andcashflows)andalmost
neverrelatetocomplexity.AswithDCFvaluation,whenwe
doadjust,wegivecomplexfirms anadvantagebyarguing
thattheyshouldtradeathighermultiplesofearningsorbook
value because they are more diversified and less risky.
In this chapter, we argue and present evidence that most
investorswouldvaluethesimplerfirmmorehighlythanthe
complexfirm,thusdiscountingthelatterfirm’svalueforboth
itscomplexityanditsopaquefinancialstatements.Arethey
being irrational or are we missing an importantaspect of
valueinvaluationmodels?Webelieveitisthelatterandwe
willpresentwaysinwhichwecanmeasurecomplexityand
incorporate it into our valuation models.
DEFINING COMPLEXITY
Withatransparentfirm,theinformationthatweneedinorder
to valuethefirmnotonly isavailable andaccessibleona
timelybasis,butalsoisrelativelysimpletointerpretanduse
in valuation models. If we define a complex firm as one
whereconvertinginformationtovaluationinputsisdifficult,
wecanalreadyseethatdefiningcomplexityiscomplicated.It
cannot be definedin termsof thequantity of information,
where transparent firms are defined as those that provide
moreinformation.Afterall,theinformationhastobecredible
andusabletohavevalue.Infact,complexityinthecontextof
valuation can take two different forms. In the first, the
informationneededtovaluethefirmeitherisnotavailableor
isgarbled,whichisaninformationdisclosureproblem.Note
that this problem can be created either by the absence of
relevant information or by the presence of extraneous