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Extended Abstract

Enhancing Shareholder Value By Improving Sustainability Performance The Impact of Policies and Investments on Stock Price By Dennis N. Aust, CharterMast Partners LLC Forthcoming in Corporate Finance Review, May/June 2013 (Thomson Reuters)
Most public companies have come to recognize that Sustainability has increasingly become a key criterion by which investors evaluate securities. In the U.S., UN PRI signatories of the United Nations Principles for Responsible Investing manage roughly $8 trillion in assets, of which $3.5 trillion is currently invested sustainably (approximately $1 in every $8 or $9 of U.S. assets under management). That leaves $4.5 trillion in funds committed to ESG principles but still seeking appropriate investments. Serious investors recognize that sustainability is already having an impact on stock prices. The issue is not going away. From a quantitative perspective, ESG initiatives affect stocks in two ways. The obvious impact of ESG investments is on reported financial performance (primarily the income and cash flow statements). The less obvious impact is potentially much more significant. Investor perceptions and behavior, specifically ESG-related buy and sell decisions, directly affect stock price. A company whose negative ESG reputation and/or sub-par performance positions it on the restricted list for a significant number of institutional investors experiences diminished access to capital markets. The typical result is then a lower stock price. Conversely, a company that pursues attractive ESG policies and investments experiences a broader base of institutional demand, with a higher likelihood of trading at a premium. Computing company-specific discount rates (measuring the relationship between market value and a firms economic performance) provides a path to understanding the impact of ESG on stock prices. This important pricing dynamic is not captured by conventional accounting metrics, but its impact on enterprise value is dramatic. From a corporate perspective, understanding how ESG initiatives affect stock price is critical for making sound return on investment decisions. If some specific operating investment causes investors to reposition the firm as a more attractive ESG performer, incorporating the resulting stock price impact presents a different (and more accurate) picture of shareholder value creation than traditional financial analysis. Conversely, knowing when ESG performance wont affect the stock price gives management the ability to differentiate between value-creating initiatives that are shortchanged by conventional analysis vs. feel good projects that may sound appealing but are ultimately meaningless, or that may even detract from shareholder value. To address this issue, CharterMast answers several important questions: How big of an impact can ESG performance have on stock price? How does this compare with the impact of other company characteristics? How does this apply to any specific project, company, or industry, at any specific point in time? Where does sustainability have the greatest impact on stock price?

What about social issues? How can a firm achieve maximum stock price benefit from its ESG programs and investments?

So what should companies do about their ESG investment strategies? CharterMast proposes seven specific steps they can take to do well by doing good, that is, to increase enterprise value by improving sustainability performance. Understanding the relationship between ESG performance, discount rates, and stock price provides an important tool for quantifying the impact of ESG investments and increasing value for both shareholders and stakeholders. However, sustainability isnt some magic elixir that automatically improves your stock price. The devil is in the details. Potential benefits for shareholder value are substantial, but the full impact requires doing it right! Dennis N. Aust, Managing Partner, CharterMast Partners LLC, has spent over 30 years developing and implementing value creation strategies, frameworks, and tools for Fortune 500 and mid-cap firms in a variety of industries, thereby helping senior executives and boards understand/address key strategic and operational issues that are critical for delivering superior results for shareholders. Mr. Austs articles covering strategic analysis, consulting, financial management, and innovation have appeared in the Journal of Private Equity, Directors Monthly (NACD), and other publications. He has contributed chapters to The Valuation Handbook: Valuation Techniques From Todays Top Practitioners (Wiley, 2009), Managing Innovation in the New Millennium (ICFAI Press, 2002), and Stock Options An Introduction (ICFAI Press, 2005). He was featured speaker at the 2010 National Conference of the Association for Strategic Planning, and has also spoken at the National Association of Accountants (Annual Conference), the American Management Association, and the Chicago Booth Finance Roundtable. Contact Dennis directly at (312) 224-8509 or dennis.aust@chartermast.com

CharterMast Partners LLC, 120 North LaSalle Street, Suite 2150, Chicago IL 60602, (312) 224-8509