Environmental, Social, and Governance (“ESG”) is a set of factors that are used to evaluate the sustainability and ethical impact of a business enterprise.
Empirical data has shown that corporations that has either engaged in the sector of clean industry or embraces ESG to be part their management policy had perceived a valuation premium compared to that otherwise.
The IFRS 2019 article “IFRS Standards and climate-related disclosures” demonstrates the linkages between ESG and value creation. the potential financial implications arising from climate-related and other emerging risks, all of which likely having direct valuation implications, may include, but are not limited to:
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asset impairment, including goodwill;
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changes in the useful life of assets;
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changes in the fair valuation of assets;
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effects on impairment calculations because of increased costs or reduced demand;
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changes in provisions for onerous contracts because of increased costs or reduced demand;
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changes in provisions and contingent liabilities arising from fines and penalties; and
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changes in expected credit losses for loans and other financial assets.
Discover how ASA explain the concepts and nuances of business valuation so that the client could pursue an accurate valuation.
How companies enhance their business enterprise value
Revenue Growth
Development and marketing of products and services that attract B2B and B2C customers with more sustainable products and services. Achieving better access to resources through stronger social networks, community and government (environmental) relations.
Financial and regulatory costs reduction
By promoting energy efficiency and low emission of waste, management costs of running business will be lower and potential legal liability in certain sectors such as the exploration of resources industry, food and beverage, and renewable energy will be diminished.
Pro-longed business tenor
As businesses are more sustainable, the business cycles are expected to be longer than corporations that do not embraces ESG in their daily operation and management policy.
Productivity uplift
Boost employee motivation by uplifting social responsibility, and attract talent through greater social credibility.
Impact on the development process of an appraisal of business enterprise value
Lower discount rate
By our research and analysis, high-ESG-rated companies have lower costs of capital. The reason might not be that hard to explain, corporations that scored high in ESG normally would be able to tolerate adverse market situations
Increased expected cash flows
High-ESG-rated companies are encouraged to attempt to forecasted their future cash flows with a higher revenue growth and / or a lower costs to revenue ratio compared to traditional market participants. Nonetheless, a higher terminal value of high-ESG-rated companies could be substantiated by a higher-than-market terminal growth rate.
Market multiples
Among the pool of selected guideline public companies, the valuation impact from the ESG status of a subject business enterprise could be analyzed and incorporated in the appraisal process by calibrating the market inputs to each respective subject entity taking into account their relative ESG performance.
Conclusion
Environmental, Social, and Governance factors play a crucial role in valuation engagements. Integrating ESG considerations into the valuation process allows for a more comprehensive assessment of a company's value and risk profile. By evaluating a company's sustainability practices, social impact, and governance structure, ESG factors provide valuable insights into its long-term performance and resilience. Incorporating ESG in valuation engagements enables investors and stakeholders to make informed decisions that align with their sustainability objectives and helps drive value creation in a responsible and sustainable manner.
As we see ESG to have increasing influence both financially and non-financially on the allocation of capital by investors, and the transparency of ESG measurement and reporting framework is being enhanced progressively, our business valuation practice is to reflect the impact of ESG on the value of a business enterprise objectively on both quantitative and qualitative aspects. Our vision of valuation practice’s role amongst the development of ESG across the globe is critical, by quantifying, realizing and explaining the benefits brought by sustainable practices