McKinsey & Company, the management consulting firm, published an article in March 2017 which discusses the impact of environmental, social and governance (ESG) issues on valuations.
Tim Koller, a partner at McKinsey, argues that sustainability issues are not different to other factors considered by company management. Eventually, Koller suggests, sustainability issues will affect cash flow and – consequently – valuations. However, there is often a lag in the flow of information from company management to investors. As a result, markets do not factor important information into valuations because the impact on cash flows is not yet clear. Nevertheless, when the impact does become clear, markets react. Similarly, Koller suggests that communication about ESG between managers and the wider market is often reactive following a serious incident. In contrast, the better performers are much more proactive. For example, consumer companies might proactively report about their supply-chain policies and standards.
Koller also argues that company management often falls into the trap of ignoring what would happen if they do not do something, relative to a baseline. For instance, what if a company does not invest in safety? Or if it builds a plant without considering likely future environmental regulations? Not only might the company lose ground to its competitors, but the business is unlikely to operate as usual in future.
Click on the following link to read the full article: When sustainability becomes a factor in valuation.