Damodaran on Valuation

16.3. SOURCES OF COMPLEXITY

Using the broad definition of complexity laid out in the preceding section, we can start looking at the sources of complexity. Some complexity can be attributed to external forces—regulatory authorities and accounting standards boards—but most can be traced back to the firm. In other words, firms with complex and difficult-to-use financial statements have no one to blame but themselves for most of the complexity.

16.3.1. Regulatory Framework

Since we defined complexity to include both the absence of relevant information and the presence of extraneous information, some of the responsibility for complexity has to be borne by the regulatory authorities governing financial disclosure. The financial statements of firms in many emerging markets are often incomplete and leave out large chunks of relevant information, largely as a consequence of lax regulatory requirements. Berglof and Pajuste (2005) examine the financial statements of 370 Central and East European firms and find widespread nondisclosure of basic information on governance and performance.^[] However, they also find that disclosure policies depend more upon the legal framework and practice in the country in which a company is incorporated, rather than the company's characteristics. It stands to reason that companies that operate in markets where poor disclosure policies are condoned will have little incentive to improve their practices.

^[] E. Berglof and A. Pajuste, "What Do Firms Disclose and ...