had,onaverage,a 1 percenthighercostofcapitalthanthe
most transparent firms (bottom 20 percent).
4.Ifthecomplexityisnotontheassetsideofthebalance
sheetbutontheliabilityside—significantoff-balance-sheet
borrowingthatisnotfootnotedorisreferencedobliquely,for
instance—wecouldadjustthedebt-to-equityratiotoreflect
thetrueleverageofthefirm(includingtheoff-balance-sheet
debt).Thiswouldresultinahigherleveredbeta(andcostof
equity)andahigherassessmentofdefaultrisk(resultingina
higher cost of debt).
Adjustingthediscountrateto reflectcomplexitymakesthe
mostsenseforfirmswherethecomplexityisobscuringthe
riskinessofthebusinessesthatthefirmisinvolvedinand/or
the financial leverage of the firm.
Adjust Expected Growth/Length of the Growth Period
Invaluinganyfirm,twokeyinputsthatdeterminevalueare
thelengthofthegrowthperiodandtheexpectedgrowthrate
duringtheperiod.Morefundamentally,itistheassumptions
aboutexcessreturns onnewinvestmentsmadebythefirm
duringtheperiodthatdrivevalue.Whatistherelationship
betweencomplexity andtheseinputs?Sincewederive our
estimatesofreturnoncapitalandexcessreturnsfromexisting
financialstatements,wewouldarguethatitismoredifficult
bothtoestimatethereturnoncapitalatcomplexfirmsandto
makejudgmentsonwhetherthesereturnscanbemaintained.
Onewaytoadjustthevalueofcomplexcompanies,then,isto
assumealower returnoncapitalonfutureinvestmentsand
assumethattheseexcessreturnswillfademuchmorequickly.
Inpracticalterms,thelowerexpectedgrowthrateandshorter