Environmental, Social Governance, and Business Valuation

Whether in business valuation or just about anywhere in media, education, webinars and training, or any other form of communication, it is difficult for even a day to go by without hearing something about environmental, social, and governance (ESG) issues in corporate decision-making. There are articles on the subject that come up frequently also.

So how does this impact business valuation? That in itself is a subject of discussion. In June 2022, Dr. Damodaran did a presentation on the effect of inflation on valuing a business. As part of that presentation, he answered questions from the attendees. One questioner asked how he handled ESG in determining the value of a business. His response was two words, which I will not use here, but he expressed his opinion that there is no impact from ESG and, therefore, it should not be considered in valuing a business. He further explained that, unless someone could show him how ESG impacts the cash flows of a business, he is unconvinced. Let me say that, on this point, I concur with Dr. Damodaran. No one has convinced me that there is any impact on cash flow or the value of assets (or asset impairment). If you accept those statements as true, then it is hard to see how you could take ESG into account. How would you? 

The BV profession, like others such as auditors, are being prodded into determining the ESG issues. Other than making some statement in your report that you considered ESG, what else can you do? Interestingly, for many years now, most of us in BV have been excluding the issue of environmental liabilities from our valuations. Consider this illustrative statement of assumptions and limiting conditions from VS100:1

[Valuation firm] is not an environmental consultant or auditor, and it takes no responsibility for any actual or potential environmental liabilities. Any person entitled to rely on this report, wishing to know whether such liabilities exist, or the scope and their effect on the value of the property, is encouraged to obtain a professional environmental assessment. [Valuation firm] does not conduct or provide environmental assessments and has not performed one for the subject property.

This seems to be in direct contradiction to the thinking SG from ESG advocates. As Dr. Damodaran noted, I have yet to see any methodology for quantifying ESG as it relates to valuation. It appears the only possible place for it on the spectrum of considerations in performing a business valuation is some sort of adjustment to the specific risk factor in the determination of the cost of capital under the income approach. This is speculative at best.

It is one thing for auditors to “report on” their review of a company’s efforts in the area of ESG. This does not require a conclusion other than the adequacy of the procedures and actions the entity took. Frankly, this in itself is speculative. But it is more difficult or impossible to quantify the effect of the entity’s actions on the value of the company. This will play out as we move forward in the profession in some manner that we cannot now predict. Stay tuned. This could be a bumpy road, given the dichotomy of opinion on this subject in general.

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1 Statements on Standards for Valuation Services; Appendix A, Illustrative List of Assumptions and Limiting Conditions for a Business Valuation, Example 9.