‘ESG Ratings: A Compass Without Direction’

BVWireIssue #240-2
September 21, 2022

valuation methods & approaches
cost of capital, income approach, risk analysis, cash flow, discounted cash flow (DCF)

That’s the title of a new paper out of the Stanford Graduate School of Business that examines the concerns over the reliability of the various ratings schemes for environmental, social, and governance (ESG) factors. ESG has become a “new” hot topic (although much of it has been around for years) in the investment world, and it, of course, has implications for valuation. But the various ratings that have emerged are (still) not ready for prime time. “We 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 authors write.

The paper is available if you click here. The authors are David F. Larcker (Stanford University), Lukasz Pomorski (AQR Capital Management), Brian Tayan (Stanford University), and Edward M. Watts (Yale School of Management).

Extra: The IVSC has a perspective paper, “ESG and Business Valuation,” that represents an early step toward developing a systematic approach to the incorporation of ESG into business valuation practice and standards. To access the IVSC paper, click here.

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