ESG goals can be counted in cash-flow analyses but not necessarily elsewhere in a business valuation

BVWire–UKIssue #43-1
October 17, 2022

An example is the UK government’s procurement policy, which includes a 10% weighting for “social value.” This policy means that potentially better quality or lower-priced products from foreign sellers could be overlooked, increasing expenses. If an analyst were to adjust risk factors further based on a positive “ESG” rating or judgement, the (theoretical) value of the government would be overstated. The same problem holds true for valuations of closely held enterprises.

The clearest practice aid currently available for business valuers is the IVSC’s “ESG and Business Valuation” (available here). This offers a cautious step toward systematic use of ESG data into business valuation practice and standards.

A new academic study examines the reliability of the various ratings schemes for environmental, social, and governance (ESG) factors in both business valuation and investment contexts. Authors David F. Larcker (Stanford University), Lukasz Pomorski (AQR Capital Management), Brian Tayan (Stanford University), and Edward M. Watts (Yale School of Management) “find that while ESG ratings providers may convey important insights into the nonfinancial impact of companies, significant shortcomings exist in their objectives, methodologies, and incentives which detract from the informativeness of their assessments.” The new study, “ESG Ratings: A Compass Without Direction,” is available here.

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