With regard to sustainability, if a company can do things that make customers more likely to buy from it than from a competitor, because it has better credentials, those things are all going to be positive. So one thing managers need to be more thoughtful about is which things actually create value in and of themselves. Or, for another example, if they don’t invest in safety, the effect on the baseline isn’t that safety would increase their cash flow-but rather that it reduces the probability of having lower cash flows. For example, what are the consequences of not doing an acquisition? Maybe they won’t be able to achieve their base case. One trap they fall into is ignoring what really would happen, relative to the baseline, if they didn’t do something. Tim Koller: When managers make decisions, they always work off some baseline of performance. In my experience with corporate clients, there are often dynamics in the way that people think about creating value within a business that seem to be a little less than efficient.įrom your perspective, thinking about it more in terms of corporate finance, what would you say are some of the things we need to overcome in order to help managers do a better job of integrating these longer-term goals, like sustainability? Jonathan Bailey: That requires managers to be able to think about the long-term horizon, internal budget processes, and capital-allocation decisions with materiality in mind. Investors are assuming that there’s not much value beyond a certain period of time, which isn’t too far into the future. Some oil reserves won’t be produced because of the growth of alternative energy sources.” When you look closely, the market’s already discounting those concerns. If you look at the way oil and gas companies are valued, for example, people say, "There will be all these stranded assets out there. When it does become clear, the markets do react. So sometimes the markets lag behind in their valuations because some important factor is too vague or unclear for investors to see how it might affect a company’s cash flows. And what’s good about SASB’s approach is its focus on how different sustainability factors might materially affect the cash flows of companies in 79 different industries.įrom the perspective of how investors react, one thing we find is that managers have a lot more information than investors-and long before investors have it. Because eventually, these things will affect cash flows. If the forces in the world that relate to sustainability are going to be material to a business, it’s management’s job to take a longer view and figure out what to do about them. Sustainability issues aren’t any different from other things management has to worry about. Now, there have been periods of time when people said, “Oh, the rules are changing.” For example, during the dot-com bubble, all of a sudden, people said, “Traditional methods of valuation don’t make sense anymore-look at all these companies with high valuations that have nothing to do with cash flow.” Well, ultimately, it was the lack of cash flow that brought those companies’ valuations back down. That’s what you can spend as an owner, whether you’re a private owner or whether you’re a shareholder in a large company. For hundreds of years, the value of a company has ultimately come down to the cash flows it generated. Tim Koller: I think we have to separate the mechanics of valuation from what managers should be doing to maximize a company’s value and how investors react to the whole thing. Jonathan Bailey: How does your thinking about valuation reflect today’s focus by many stakeholders on sustainability and how it’s changed over time? Koller, an author of Valuation: Measuring and Managing the Value of Companies, has argued that “ creating shareholder value is not the same as maximizing short-term profits-and companies that confuse the two often put both shareholder value and stakeholder interests at risk.” In this conversation, Bailey and Koller dig into the issues related to how sustainability affects value, the asymmetry of information between companies and their investors, and how companies communicate about that information. In this December 2016 interview, excerpted from a conversation at the inaugural symposium of the Sustainability Accounting Standards Board (SASB), McKinsey’s Tim Koller joined alumnus Jonathan Bailey to discuss how accepted principles of valuation apply.
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