Damodaran on Valuation

16.8. CURES FOR COMPLEXITY

To preserve the integrity of financial markets, we must push to make the financial statements of firms both truthful and transparent. In this section, we consider some of the ways in which we can make this a reality.

16.8.1. Legislation

In the aftermath of accounting scandals in the United States, legislation has inevitably followed. After the Great Depression and evidence of financial skulduggery, the Glass-Steagall Act was passed restricting banks from investment activity, and the Securities and Exchange Commission was created to regulate the trading of securities. In the aftermath of the collapse of the savings and loans in the 1980s, we saw increased regulation of financial services firms in general. The latest crisis in accounting, precipitated by the implosion of Enron, has resulted in new laws designed to prevent a recurrence. While the motivation for legislation is usually noble, laws are blunt instruments that often create new problems in the process of solving old ones. Restrictions on the granting of options to employees may prevent their abuse in compensation systems but they also undercut attempts to make managers have a stake in the company's success in financial markets. Restrictions on special purpose entities may take away legitimate avenues for firms to reduce their cost of borrowing.

16.8.2. Auditing and Accounting Integrity

Accounting standards and rules are usually rewritten in response to corporate failures. No matter how strict ...