Damodaran on Valuation

16.9. CONCLUSION

Are complex firms worth less than otherwise similar simple firms? In some cases, they are and we have examined both the sources of complexity in financial statements and the appropriate responses in valuation. Complexity is the result of business decisions made by the firm (they can diversify and make the business mix more complex), structuring decisions on how the firm is organized (holding structures and consolidation), and disclosure decisions (on how to reveal information to financial markets). Thus, firms can have complex financial statements even if they are in simple businesses because of accounting decisions they make. We developed a number of potential measures of complexity, ranging from a measure of opacity (developed by Price Waterhouse) to our complexity score in Appendix 16.2 (developed by asking a series of questions about companies).

If we trust managers to be unbiased in what information they reveal to markets and when they reveal this information, we could argue that complexity by itself is not a problem since the additional uncertainty created is essentially firm-specific and diversifiable. If, however, managers are more likely to use complexity to hide unpleasant or bad news (losses or debt), complexity will result in more negative surprises than positive ones. In this case, it is appropriate to discount value for complexity. The discounting can occur in one of the inputs to a discounted cash flow value model—cash flows, growth rates, or discount ...