areconcernedaboutlong-termvaluemaydeludethemselves
into believing their own forecasts, optimistic though they
mightbe. It isnot surprising,therefore, thatfirms become
sloppyduringperiodsofsustainedeconomicgrowth.Secure
in thenotionthattherewillneverbe anotherrecession(at
leastnotinthenearfuture),theyadoptaggressiveaccounting
practices that overstate earnings. Investors, lulled by the
rewardsthattheygeneratebyinvestinginstocksduringthese
periods, accept these practices with few questions.
Thedownsideoftrustingmanagersisobvious.Ifmanagers
arenottrustworthyandfirmsmanipulateearnings,investors
whobuystockincomplexcompaniesaremorelikelytobe
confrontedwithnegativesurprisesthanpositiveones.Thisis
because managers who hide information deliberately from
investorsaremorelikelytohidebadnewsthangoodnews.
Whilethesenegativesurprisescanoccuratanytime,theyare
morelikelytooccurwhenoveralleconomicgrowthslows(a
recession!)and are oftenprecipitatedby a shock. In early
2002, the fall of Enron and the exposé of its accounting
practiceshada dominoeffectonthestock pricesofTyco,
Williams Energy, and even GE, all viewed as complex
companies.
30
Ways of Adjusting Value for Complexity
Canwevalueassetsincomplexcompanieswhileconsidering
thepotentialformanagerstomisleadmarkets?Inthissection,
we present four practical waysin which we canadjust a
discountedcashflowvaluationforthecomplexityoffinancial
statements.Theyarenotnecessarilymutuallyexclusiveand
represent solutions to different types of disclosure problems.