Bridging Sustainability and Finance: The Value Driver Adjustment Approach

Abstract

Even though most large corporations view sustainability considerations and concerns as having the potential to affect their revenue and profits, and studies have shown that sustainability can affect stock returns, investors and corporate managers continue to struggle to incorporate such concerns into their financial decision‐making. As a consequence, the valuation effects of sustainability issues are not fully reflected in either the valuation of companies by investors or in capital investment decisions by corporate managers.The author argues that sustainability can be integrated into both of these kinds of financial decision‐making by linking it to business models, competitive positions, and value drivers using what the author calls a “value‐driver adjustment” (VDA) approach. The basic idea is simple: material sustainability issues affect business models and competitive positions, which in turn affect the company's value drivers—notably, sales, margins, and capital. The VDA approach explicitly considers these linkages by taking three steps: (1) identifying a company's material sustainability issues; (2) analyzing how these issues are expected to affect the company's business model and competitive position; and (3) quantifying the effects of such changes in business model and competitive position on the company's value drivers, including its cost of capital.In the first part of the article, the author provides an investor perspective that shows how sustainability can be integrated into investment decisions by asset managers. There he explains how and why ESG integration has so far failed to become mainstream, and what needs to be done to make it successful. The second part of this article takes the corporate perspective and shows how sustainability can be linked to value drivers using much the same ingredients as in asset management, but slightly different tools that can help corporate managers incorporate sustainability concerns into strategy and operations, including the finance function. And in closing, the author brings together corporate and investor perspectives while showing how sustainability programs can be used to make the relationship between companies and their shareholders both stronger and longer‐lasting.