Sustainability as a Strategic Financial Decision Making Tool

By: Group 7, Section B

Rajarshi Sarkar (G16098), Ravi Shrey (G16099), Rohit Kumar Singh (G16100), Sachin Gupta (G16101),
Sameer Rajpal (G16102), Sandeep Ranjan Bhowal (G16103)

Executive Summary
"In times such as these, a company must invest in the key ingredients of profitability: its people,
communities and the environment. - Warren Buffet
In todays time of economic difficulties, when we are still recovering from recession, does having
sustainability as one of the core factors in financial decision making help a business? The general
perception is that sustainability initiatives are the cost centre for an organization and eat into the
bottom-line of the business. However, a recent Nelson global online study1 found that almost 3 out of
4 respondents interviewed considered sustainability as a shopping priority and were also willing to
pay extra for sustainable offerings. In this report we will present how sustainability can be used as a
strategic financial decision making tool.

Introduction
In recent years many companies have adopted the concept of sustainable development as a core
business value. We can define sustainability in many ways but the underline principle is of economic
well being linked to the health of the environment. Sustainability is one of the most significant trends
in financial markets for decades. Whether in the form of investors desire for sustainable responsible
investing (SRI), or corporate managements focus on corporate social responsibility (CSR), the content,
focusing on sustainability and ESG (environmental, social and governance) issues, is the same.
Here we will evaluate the importance of sustainable investing, how CEOs, CFOs, and international
investors are considering sustainability while taking investment decisions, sustainability and cost of
capital, and sustainability in mergers and acquisitions.

Sustainability Investing
Sustainability investing is neither about sacrificing performance nor about philanthropy. It means
mitigating risk, fulfilling fiduciary duty and creating value for all stakeholders. People believe that
sustainability investing is about being green and giving money away. Sustainability Investing is
traditional financial analysis that incorporates environmental, social, and governance factors into the
process. Sustainability investing is a more complete assessment of the stocks potential. Its an
established, common-sense investment approach about making money in a sustainable way.
Launched in 1999, Dow Jones Sustainability Index (DJSI) was the first global index to connect financial
performance of leading companies to sustainable driven approach. DJSI identifies sustainability driven
1

http://www.nielsen.com/in/en/insights/reports/2015/the-sustainability-imperative.html
1|Page

companies across all industries, enabling investors to track the integral sustainability performance and
including it in their Portfolio. As per their rule based methodology, companies receive a total
sustainability score between 0-100 and ranked as per that criteria which covers all the three pillars of
sustainability i.e. Economic, Social, and Environment. As per 2015 assessments, the top 10 % of
companies within each industries are included in DJSI.

How CEOs, CFOs and international investor are considering sustainability while taking
investment decision
In 2013, Accenture conducted a survey of 1,000 CEOs in 103 countries and 27 industries. They found
that 80% of CEOs view sustainability as a means to gain competitive advantages relative to their peers.
Furthermore, the study found that 81% of CEOs believe that the sustainability reputation of their
company is important in consumers purchasing decisions. On the contrary, they found that only 33%
of all surveyed CEOs think that business is making sufficient eff orts to address global sustainability
challenges.2
A research suggests that that there is a strong business case for companies to implement sustainable
management practices with regard to environmental, social, and governance (ESG) issues.
Sustainability is further important for the public image of a corporation, for serving shareholder
interests, and for the pre-emptive insurance effect for adverse ESG events. By focusing on profit
maximization over the medium to longer term, i.e., shareholder value maximization, and by taking
into account the needs and demands of major stakeholders, a company can create financial and
societal value. Firms can implement sustainable management strategies that improve performance
measures. To achieve this, companies are required first to identify the specific sustainability issues
that are material to them. As recent research by Deloitte points out, materiality of ESG data like
materiality for any input in investment decision-making should be related to valuation impacts.
Below we can see a selection of ESG issues that, depending on the individual company in question,
can have a material impact:

Selection of Material ESG Factors3

2
3

Accenture (2013) report

From the Stockholder to the Stakeholder University of Oxford, March 2015

2|Page

Sustainability and Cost of Capital

Environmental externalities impose risk on corporations reputational, financial, and litigation. These
risks can have direct effect on Company Cost of Capital special debt. BPs Credit Spread after
Deepwater Horizon catastrophe in April 2010 increased eightfold.
Cost of Capital can be divided into two major components:
a. Cost of Debt
Research investigating the effects of sound sustainability policies on a firms cost of debt has
shown that firms with superior environmental management systems have significantly lower
credit spreads, implying that these companies exhibit a lower cost of debt. Studies also show
that credit ratings are positively affected by superior sustainability performance. Better
sustainability policies lead to better credit ratings. In particular, it has been demonstrated that
employee wellbeing leads to better credit ratings
b. Cost of Equity
Studies show that good corporate governance influences the cost of equity by reducing the
firms cost of equity, as good corporate governance translates into lower risk for corporations,
reduces information asymmetries through better disclosure, and limits the likelihood of
managerial entrenchment.

Growing role of Sustainability in Mergers and Acquisitions

Sustainability has become a central theme in virtually every industry. Companies are increasingly
realizing the importance of addressing sustainability issues and requirements to achieve their strategic
and financial objectives. Mergers & Acquisitions (M&A) have been mostly driven by profitability and
return on investment targets. However, going by the recent deals in industry, sustainability plays an
important part in deciding the viability and acquisition price of such deals. As per a recent study by JP
Morgan, approximately 40% of the mergers failed in the implementation stage and the failure rate of
transactions related to M&A were even higher in service sector, at approximately 50%4.
The importance of sustainability to corporates can be best shown by the example of Dow Chemicals
acquisition of Union Carbide, one of the accused in Bhopal Gas Tragedy. The company had acquired
Union Carbide, which has $74 million worth assets attached in the criminal case5. However, Dow
Chemicals acquisition has also placed their Indian assets at risk for potential attachment in the
ongoing case. Stakeholders have long believed Dow to incorporate social and environmental issues as
an important part of their business. Their goals include creating value by including sustainability into
important business decision making. However, their lack of systematic approach towards applying
sustainability into business decision making was evident in this acquisition. This lead to a negative
impact in their valuation in Wall Street6.

Sustainable Merger and Acquisition Transactions Important Aspects as Part of a Process Model
Especially for Enterprises in the Service Market International journal of business and social science
(http://ijbssnet.com/journals/Vol_5_No_1_January_2014/8.pdf)
5
Transforming Sustainability strategy into action, Published by John Wiley & Sons, Inc., Hoboken,
New Jersey
6
http://www.nytimes.com/1999/08/05/business/dow-chemical-says-it-plans-to-buy-unioncarbide.html?pagewanted=all&_r=0
3|Page

Sustainability incorporates efficiency and cost reduction through minimization of waste. It also
improves Brand trust and reputation of a company through addressing societal concerns. These
factors play a major role in taking investment decisions by companies interested in expanding their
businesses. Companies are willing to pay premium price for a target company that already has a solid
grasp on sustainable operations.
The link between sustainability and Mergers and acquisitions continues to become stronger.
Regulatory changes at central, state, and local levels are aimed towards combating issues that impact
the environment and protecting the soil, water, and air. As environmental regulations become more
stringent, investors are increasingly demanding companies for information about their environmental
liabilities. Sustainability has become a financial disclosure issue as well. Today, the impacts are far
reaching, both in the industries affected and the types of challenges that companies face. In order to
address these issues effectively, it is important for both buyers and sellers to understand the effect of
sustainability issues on the structure, execution, and value of such deals.
The role of sustainability has evolved from being social and environmental activism to become an
important factor in valuation of deals. Mergers & acquisitions are strategically used to attain
competitive advantage in business. In a merger or acquisition, a buyer should learn how advanced the
target companys assessment of sustainability issues is and whether they are buying problems or
opportunities related to sustainability. A seller should understand its competency in sustainable
activities and should be able to accurately convey that to a buyer and ultimately strive to achieve
higher value for the sale. Changing regulations, relentlessly growing demand for energy and natural
resources, and game-changing technological advances will play an important role in shaping a
sustainable future. Irrespective of this, companies involved in mergers & acquisitions should be better
prepared by addressing sustainability issues early in the process7. As recent examples show, protecting
the environment and development of society can benefit both the planet and the profit levels of a
company.

Summary
Sustainability has an important role in financial decision making as it improves the profitability in the
long run and helps organizations attain better credit ratings reducing the overall cost of capital.
Sustainability initiatives also play an important role in evaluation of the company during Mergers and
Acquisitions. With growing awareness and stricter norms being prescribed by the government,
companies are looking at sustainability practices being followed across the supply chain. Therefore, it
makes economic sense for both big and small organizations to adopt sustainability as a strategic
financial decision making tool.

https://www2.deloitte.com/content/dam/Deloitte/il/Documents/risk/CCG/other_comittees/how_
green_is_the_deal_deloitte_102408.pdf

4|Page