Integrating ESG Factors to Equity Valuation

Abstract

ESG stands for Environmental, Social, and Governance. Investors increasingly consider these nonfinancial ESG factors to identify material risks and growth opportunities. According to the Global Sustainable Investment Alliance (GSIA), the Global ESG Investing market has increased by 55%, from USD22.8 trillion in 2016 to USD35.3 trillion in 2020. The growth is not only in absolute terms but also in relative terms – its share in the total investing market has also been constantly expanding over the years. However, traditional company valuation methods, including the Discounted Cashflow Model and the Comparable Multiple Analysis deployed by various actors in the investment industry, only consider financial variables. So, a practical framework that would allow for the integration of ESG Factors with traditional methods would be handy for the financial community.

Hence, the aim of this paper is threefold; the first is to understand the drivers of extraordinary growth in the ESG Market, such as the evolving definition of fiduciary duty, the enhanced financial performance of ESG portfolios, technological disruption and changing preferences of investors, the second is to examine some of the challenges of ESG Integration briefly and finally to explore the literature and professional practices to develop a valuation framework that can integrate the ESG information into the financial valuation of a company.