Oncewehaveidentifiedthefactorsthatdeterminecomplexity
andhavecategorizedthembasedontheirimportance,wecan
construct complexity scores for firms. These complexity
scoresshouldallowustodistinguishbetweenmorecomplex
andlesscomplexfirms,andtoadjustvalueforcomplexity(if
necessary).Appendix16.2containsonesuchattempttocome
up with a complexity score.
CONSEQUENCES OF COMPLEXITY
When financial statements are not transparent, we cannot
estimatethefundamentalinputsthatweneedtoexaminein
ordertovalueafirm.Forinstance,afirm’sexpectedgrowth
shouldbeafunctionofhowmuchitreinvests(reinvestment
rate)andhowwellitreinvests(itsreturnoncapital).Iffirms
funneltheirinvestmentsthroughholdingcompaniesthatare
hiddenfrominvestors,wecannotassesseitheroftheseinputs.
Toevaluateafirm’s costofcapital,weneedtoknowhow
muchdebtisowedbythefirm,aswellasthecostofthisdebt.
Forfirmsthathideasignificantportionoftheirdebt,wewill
underestimatethedefaultrisktowhichthefirmisexposed,
and consequently, its cost of capital.
Doesthis mean that thevalue of a complex firmis more
difficultto estimatethan thevalue of a simple firm? The
answerisyes,butitdoesnotnecessarilyfollowthatinvestors
will discount the value of complex firms because of this
uncertainty.In fact,companies like GeneralElectric, IBM,
andTycoprosperedinthe1990s,evenastheybecamemore
complex.Whilesomewouldarguethattheincreaseinvalue
cameinspiteoftheircomplexity,thereareotherswhowould
presentthecasethatitwasbecauseofit.Inthissection,we