growthperiodthatemergewillresultinalowervalueforthe
firm.
Apply a Complexity Discount
We could do a conventional valuation of a firm, using
unadjustedcashflows,growthrates,anddiscountrates,and
thenapplyadiscounttothisvaluetoreflectthecomplexityof
its financial statements. But how would we quantify this
complexity discount? There are several options:
1.Oneistodeveloparuleofthumbsimilartothoseusedby
analystswhovalueprivatecompaniestoestimatetheeffectof
illiquidity.Theproblemwiththeserulesofthumbisthatthey
notonlyarearbitrary,butthesamediscountisappliedtoall
complex firms.
2.Aslightlymoresophisticatedoptionistouseacomplexity
scoring system, similar to the one described in Appendix
16.2, to measure the complexity of a firm’s financial
statementsandtorelatethecomplexityscoretothesizeofthe
discount.
3.Wecouldcomparethevaluationsofcomplexfirmstothe
valuationofsimplefirmsinthesamebusiness,andestimate
thediscountbeingappliedbymarketsforcomplexity.Sinceit
isdifficulttofindotherwisesimilarfirms, wecanestimate
thisdiscountbylookingatalargesampleoftradedfirmsand
relatingastandardmultipleofvalue(sayprice-to-bookratios)
to financial fundamentals (such as risk, growth, and cash
flows) and some measure of complexity (such as the
complexityscore).Wedidthisonalimitedbasisforthe 100
largestmarketcapitalizationfirmsandrelatedprice-earnings