The 25th Annual Global CEO Survey made for sobering reading in the context of environmental, social and governance (ESG) criteria. Despite the prevailing optimism when the survey was conducted—before the war in Ukraine and the emergence of rampant inflation—just 31% of Irish CEOs had made a net zero commitment.
The Irish trend clearly is not unique. In a stark warning, the latest Intergovernmental Panel on Climate Change report states that without immediate and deep emissions reductions, limiting global warming to 1.5°C is beyond reach.
Encouragingly, the same report points to increasing evidence of climate action in the form of policies, regulations and market instruments. As this trend grows and becomes embedded at the corporate level, it will become increasingly important for companies to be able to quantify the impact of ESG-aligned activities and outputs on the value of their business.
To successfully invest for the future, companies must fully understand the impact of ESG on the value of their business. With quantitative data, decision-makers can accelerate change and prioritise investment in the knowledge that they are creating sustainable value. While traditional valuation approaches remain valid, they must be robustly applied to understand how a company is perceived by its employees, regulators, customers and investors—and the potential consequences on cash flow.
This activity will become increasingly important in the future—not only because of the intense focus on ESG criteria, but also due to companies’ deals strategies. Our recent CEO Survey found that 38% of Irish CEOs will pursue new M&A activity in 2022, for example. Meanwhile, 9% plan to sell their business and 53% said that they would enter a new market in the year ahead.
This follows a record-beating year for deal values, which exceeded $5tn for the first time in 2021. While we don’t expect 2022 to exceed last year’s levels, the indications are that it will be another strong year for M&A activity.
In that context, how can companies build ESG into the valuation process and ensure that nothing is left on the table?
From changing consumer behaviours to the transition to net zero, several factors are driving the increased focus on ESG and positioning it at the top of the CEO’s strategic agenda. While our clients know that action is important, they lack the information necessary to make informed decisions that lead to progress.
This is a common challenge, as the quality of information available to measure both a company’s ESG performance and its impact has simply not kept pace. It also varies considerably from sector to sector. For example, there are no universally accepted ESG ratings against which companies can be benchmarked, with information often volunteered as opposed to audited. And although our capacity to measure environmental factors is comparatively well-developed, the value impact of social and governance criteria is no less important.
When it comes to the value impact of ESG, our clients’ approaches to valuation typically falls into three buckets:
A targeted version of direct cash flow adjustments is the recommended option, whereby a company explores the most material ESG demands of key stakeholders and assesses the cost of meeting or exceeding them—and the subsequent financial implications. For example, consider the following:
Unless business leaders proactively identify the value impact of ESG, we risk depriving decision-makers of the very information they need to prioritise investment, accelerate change and deliver truly sustainable value.
A recent PwC report, ‘Creating value beyond the deal’, shows that just 61% of acquiring companies believe that their latest acquisition created value and only one in five said it created significant value.
Companies clearly need a strategic approach to ensure that every opportunity to create value throughout a deal is optimised. Whether you are seeking to cut costs, maximise the potential of your people, reinvent your business model or break into new value markets, you must prioritise value creation.
To do that, you must:
Amid continuing disruption, more companies are asking what they can do to improve the value of their business as a whole, and incorporate ESG criteria into the valuation process. With our expert teams and global network, we can help you on that journey. Contact us today.