themorecomplexa financialstatementbecomes,themore
difficultitistogetbasicinformationweneedtocompletea
valuation.Wehavealsoshownsomeevidence,thoughnone
of it is conclusive, that complexity does affect value
negatively.Inthissection,webeginbylookingatwhysome
or manyanalysts do not considerthe complexityof firms
when valuing them and why this may lead to biased
valuations. We then consider ways of incorporating
complexity into firm value.
A Case for ignoring Complexity
Conventional valuation models have generally ignored
complexityonthesimplepremisethatwhatwedonotknow
aboutfirms cannothurtin theaggregatebecauseitcanbe
diversifiedaway.Inotherwords,wetrustthemanagersofthe
firmtotellusthetruthaboutwhattheyearn,whattheyown,
andwhattheyowe.Whywouldtheydothis?Ifmanagersare
long-terminvestorsinthecompany,itisargued,theywould
notrisktheirlong-termcredibilityandvalueforthesakeofa
short-term price gain (obtained by providing misleading
information).While there might be informationthat isnot
available to investors aboutthese invisible assets, the risk
shouldbediversifiableandthusshouldnothaveaneffecton
value.
29
Thisviewoftheworldisnotirrationalbutitdoesruninto
two fundamental problems. First, managers can take
substantial short-term profits by manipulating thenumbers
(andthenexercisingoptions andsellingtheirstock),which
may well overwhelm whatever concerns they have about
long-termvalueandcredibility.Second,evenmanagerswho