ESG and impact on company value
Although the general perception is that ESG disclosures are generally non-financial in nature and have no financial impact, this view fails to recognize that ESG represents a multitude of factors in assessing long-term financial viability. term and sustainability of a business. . According to the International Valuation Standards Council (IVSC), ESG is characterized more as pre-financial information and should be integrated into valuation practice and standards as part of a systematic approach.
Although this emerging trend is becoming more widespread, there is still some opacity about the relationship between ESG performance and company value; namely which ESG elements have the greatest impact on value, and whether companies with good ESG performance attract a premium.
The lack of global ESG reporting standards has resulted in a lack of standardization when calculating and reporting ESG performance, although standardization developments are still ongoing, including the development of global ESG reporting standards under the aegis of the International Sustainability Standards Board. At the same time, ESG ratings provided by various third-party agencies provide a useful proxy for understanding and comparing companies’ ESG performance. However, each of these third-party agencies use their own proprietary methodologies and lack alignment. Research found that the average correlation of ESG scores for seven of the largest ESG rating providers is just 0.45, compared to an average of 0.99 for credit ratings from major agencies. Despite their shortcomings, ESG ratings are now widely used by a range of stakeholders to assess ESG performance.
In a recent Deloitte publication (“Does ESG impact company valuations? An Australian perspective”, April 2022), relating to the Australian market, Deloitte’s analysis of companies on the ASX200 (as a proxy for the Australian listed market) on three -year from 2019 to 2021, highlighted the following key information:
- There is a “size effect”. Large companies have better ESG ratings, despite similar reporting scope coverage.
- There appears to be a reasonable positive correlation between total shareholder return (TSR) and improved ESG scores over a three-year horizon. This holds for surplus (adjusted for industry) as well as absolute TSR.
- Improvements in ESG scores are also positively correlated with improvements in valuation multiples (EV/EBITDA, EV/Revenue and P/E) over this horizon.
Among the three ESG pillars, the Environment or “E” score seems to be the most convincing when it comes to excess TSR, while the Social or “S” score corresponds best to multiple improvements in earnings.
Despite survey data suggesting a lower cost of capital for companies that improve their ESG measures, with evidence of greater capital weight seeking “ESG-friendly” investments, Deloitte’s analysis of the Australian listed market does not show such a relationship.
So what can companies do to improve their ESG performance to generate more value? The question remains whether ESG-related outperformance represents a market inefficiency that will eventually disappear over the longer term. However, in the meantime, it is essential that companies and private equity firms prioritize the following:
- Have an informed understanding of ESG issues relevant to their business and/or portfolio companies, value chain and key stakeholders
- Disclose performance data relating to material ESG matters in a transparent and consistent manner
- Prioritize investments in ESG initiatives that align with these material issues and the strategic priorities of the business and/or portfolio companies.
In summary, ESG frameworks and sustainable finance are inevitable. Companies can use their ESG risk assessment and data to drive sustainability initiatives, improve performance and attract capital. Investors expect an active and responsible ESG approach to their investments and are more interested in financing those that show good ESG performance. Like other market participants, for assessors to successfully integrate the ESG framework into assessments, they need reliable and consistent ESG metric reporting across companies, across geographies, and over time.
By Benchamaporn Piyakulvorawat, Financial Advisory – Valuation and Modeling – at Deloitte Thailand