Damodaran on Valuation

16.2. DEFINING COMPLEXITY

With a transparent firm, the information that we need in order to value the firm not only is available and accessible on a timely basis, but also is relatively simple to interpret and use in valuation models. If we define a complex firm as one where converting information to valuation inputs is difficult, we can already see that defining complexity is complicated. It cannot be defined in terms of the quantity of information, where transparent firms are defined as those that provide more information. After all, the information has to be credible and usable to have value. In fact, complexity in the context of valuation can take two different forms. In the first, the information needed to value the firm either is not available or is garbled, which is an information disclosure problem. Note that this problem can be created either by the absence of relevant information or by the presence of extraneous information. In the second, the information may be available, but the firm itself is so complex (either because of its organizational structure or because of its business interests) that valuing it becomes difficult to do.

By separating the two complexity factors, we can already see that increasing and tightening disclosure laws may reduce the first problem, though regulators have to weigh the benefits of requiring more disclosure against the costs of creating more complicated financial statements, but regulation can do little about the second. In this chapter, ...