The business landscape around the world is going through a paradigm shift. Business leaders, investors and most stakeholders are finding it increasingly important to put a focus on not just wealth creation, but sustainable wealth creation. This is where the Environmental Social and Governance (ESG) reporting comes into the picture. Considering and reporting of ESG factors is a key tool for businesses to communicate their priorities to their customers, employees, business partners and the society as a whole. In India, the Securities and Exchange Board of India (SEBI) introduced the Business Responsibility Report (BRR) which was India’s version of ESG reporting. This has evolved into Business Responsibility and Sustainability Reporting (BRSR) post 2021.

Examples of ESG Factors

The ESG factors are usually reported through various ESG Key Performing Indicators (KPIs). Some of the examples for ESG KPIs are as follows:

1. Environmental: Carbon emissions, Use of renewable energy, environmental impact, Energy consumption, etc.
2. Social: Gender Pay Parity, Human Rights Policy, Child and Forced Labour, Gender Diversity (especially on upper management/board level), etc.
3. Governance: Corporate Social Responsibility, Independence of Board, Business Ethics, etc.

Importance of ESG factors

The Environmental, Social and Governance (ESG) factors of a business play a very important role in the valuation of the business for the following reasons:

• Investor Demand: The clients of a portfolio management company, unit holders of certain mutual fund investment companies or even ordinary retail investors for that matter tend to apply their personal beliefs and morals among other factors while investing. They would like to know that their investments are helping make the world a better place. Further, it is also reported that debtholders also tend to influence businesses to report on ESG considerations.

• Regulatory norms: Most developed countries and some developing countries as well are mandating the reporting of certain ESG factors in their annual reports or other public communications. Being non-compliant in this regard does tend to have an effect on the valuation of the business.

• Incorporation in valuation methodologies: Studies suggest that some valuers may include ESG considerations in the valuation of business in many ways. For example, the discounting factor used in the Discounted Cash Flow (DCF) Method is adjusted for ESG factors. In some cases, even the long-term growth factor is adjusted.

• The ‘green sentiment’: The sentiment and perception of retail investors tend to be influenced by unfavourable press reports about a particular industry focusing on adverse ESG factors such as pollution, carbon emissions, etc. The stock price of the company takes a hit as a result.

India in the ESG space

A few Indian companies have already demonstrated their resolve towards sustainability on the global platform. Tata Steel, has been recognised as the 2023 Steel Sustainability Champion by the World Steel Association and it has received this award every year for 6 consecutive years since 2018. Infosys has been recognised as one of the 2023 World’s Most Ethical Companies for the third consecutive year by Ethisphere.

Conclusion

It is becoming increasingly apparent that ESG considerations play an important role in the valuation of a company. It should not be viewed as only a compliance requirement but a tool to showcase a holistic view of the company’s commitment to sustainability and the alignment of the business goals with the same.

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