Dark Matter

ESG: Visible Value – Invisibly Tracked

Look into the night sky and you see 15% of the universe. The invisible 85% is DARK MATTER physics tells us.

For us here on earth as well, there is more to the world than meets the eye.

Just because something is invisible, does not mean it does not exist. Take the air we breathe, gravity and love; to name a few.

For a company, judging its value should not stop at the visible financial statements. A deeper, more insightful, view of value is needed. Professional investors have known this for many years.

Institutional shareholders routinely value listed companies at a premium over the visible accounting net asset value.

Why is there a difference? Well, there are two main things:

  • Companies attending to assets not seen in the balance sheet
  • Delivered profit above the weighted average cost of capital.

The two are linked. It is the unseen assets which deliver the excess profit. In accounting terms this is “Goodwill” (see note).

Goodwill is the difference between what a company is sold for on arm’s length terms, less the visible net asset value in the financial statements. That is easily seen when a company is sold in full; but seen daily too for a listed company, when the quoted share price exceeds the Net Asset Value per share.

This sounds like an anomaly surely. Well, yes and no. They are doing different things.

The mismatch arises from the accounting principles which says accounts must be prudent. If in doubt, pick a low figure, often zero.

Stepping into the commercial world; companies are often sold for more than their net asset value. Unless the buyer is insane, they are paying for some invisible thing.

Accountants see that, and say the gap is “Goodwill.” It makes the books balance, literally.

But they do not like goodwill. They check each year with an eye to writing it off. And once written off, it is never reinstated. Problem solved.

For ESG Investments made by companies this is sad news.

Spend on ESG is regarded as a cost, not an investment. The ESG assets which are created are invisible, intangible items. Like 85% of the unseen universe.

Some intangibles can be separately described and sold. Accounting rules apply on recognition, carrying value and amortization.

ESG assets are not like that. While they too are invisible, their accounting value is zero.
ESG assets are to accountants, “morning mist” items – foggy and transient; and that makes them uneasy. Items like:

  • Spend on training and development,
  • Environmental protection beyond the legal minimum,
  • Care with diversity and inclusion,
  • Governance controls exceeding company law,
  • Health and safety protocols sounder than the law requires.

The list is long.

The cost is part legal compliance; but the “go beyond” part is a voluntary investment decision. And that value choice is part of company culture. Part of who we are; why we exist, what we want to do. Our corporate purpose.

In fact, at this end of the ESG spectrum these values, beliefs, and behaviors translate into strong culture and competitive advantage. Something competitors find extremely difficult to replicate. It’s not just obeying laws and expectations. It is leading the charge and changing the world for the better.

So ESG means legal observance? Yes, it does, but more than that it means doing the right thing. And in some respects, challenging convention and championing for change. A long term and deeply intended reputational investment.

All this non-recognition then is a bit unfortunate. It means that the management of companies focus most on the visible accounting value. Things that are easy to measure. Like Earnings Per Share, Profit Before Tax, Return on Equity and so on. Executive compensation incentives are littered with these metrics. That says a lot about the company’s values and intentions. Same with investor reporting.

The company’s ESG assets which form the internally generated goodwill are not visible; so, tend to be under-managed.

But good managers know full well that shareholder value means more than the accounting results. Happily, so do institutional investors.

So, what is all this “Goodwill”? Easiest to see is customer loyalty. Buyers wanting more. Plus, cross-sold goods or services. Brand trust means a buyer is willing to give it a go.

For example, Virgin records a good brand known to be solid and responsible; even progressive. They sold a load of records. Virgin then moved into airlines – Virgin Atlantic. Trains next, mobile phones, internet and condoms. Trust does not get higher than reproductive medical offerings.

Suppliers matter too. Fair contract and price mean they are there for you when times get tough.

Employees as well. Consulting firms issue reams of research on the positive link between employee engagement and:

  • productivity,
  • sales margin,
  • customer satisfaction,
  • staff turnover,
  • NPS.

Those things are valuable, yet employees are a big cost so “cut them quick!” say some. What about finance partners? In particular:

  • shareholders,
  • bondholders,
  • bankers,
  • insurers.

Telling the risk return story is a minimum. What they do not like is hidden risk jumping out to upset that understood risk return equation. Have a think about Climate Change for example? Might you trade uninsured and without capital? Good luck with that – let alone expand.

Government, regulators, lawmakers, and tax authorities have a say too. “Lawful but awful” business practices tend to become unlawful rapidly.

So does the general reputation with the public. Out of control bad governance; a formidable reputation as a horrid polluter? When there are balanced judgements, will it swing against you?

If that seems fanciful; see the PRI (Principles for Responsible Investment) summary of the IPR (Inevitable Policy Response) report of October 2021 on climate prospectively unfolding global law and regulation. Stark reading. The earlier IPR report was greeted with skepticism; and yet the upshot was even more regulatory change than IPR had predicted.

Lawsuits too can be huge money items. Tesla was fined USD 137 million for a “S” issue: work- place harassment and non-addressed racial reports. Not small change. This for a company many automatically assume to be “good” due to the green product credentials.

Obeying the law is necessary. Companies need to recognize too what others see: LAWFUL BUT AWFUL is bad. Not just that, correctly focused and truly delivered ESG has a lightening effect on employee morale and customer loyalty among other things.

Being a good corporate citizen is basic. An upstanding corporate citizen is better. But even better still is to set out to blaze the trail. In short, change the world for the better and so create sustained corporate reputational advantage.

ESG items are vital business assets. Disregard them at your peril. Your shareholders will not, nor will everyone else.

NOTE: The concept of goodwill is not new. The first goodwill book was written in 1890. The rules governing financial statements have been under development for 400 years. Double entry bookkeeping has its origins in old northern Italy. Accounting is correct; but maybe incomplete.

Robert Head

Lead Consultant

Robert works with organisations of all types as a reward consultant or interim reward professional providing reward solutions, interim management and consultancy.

Robert is experienced in working across multiple sectors (including public listed, private equity, commercial, financial, non-profit, and charity).

Robert has deep subject matter reward experience in corporate governance, executive reward, remuneration committees, reward strategy, reward policy, annual bonus, long-term incentives, transformation and change, corporate actions, mergers and acquisitions, and restructuring.

Robert is experienced in stakeholder management working closely with Chairs and executive directors including CEOs and CFOs, non-executive director members of remuneration committees, members of executive committees including business unit CEOs/Presidents, senior HR business partners and other line executives, senior management in other organisations, outside specialists and advisers, and investors.

Robert Head Corpgro

Jane Allen

Lead Consultant

Jane has over 30 years of Reward experience within listed multinational organisations and consultancy environments.

Her expertise covers Total Reward (strategy and programmes), benefits & wellness, pensions, executive compensation, Remuneration Committee support, annual and long-term incentives, VCPs (value creation plans), M&As and restructuring.

Jane has successfully established reward teams and best practices for all key reward processes, leading on complex local and international issues across UK and US listed, family owned, and PE backed ownership structures.

She has a keen interest in ESG and how this can be reflected within Executive Pay to align with the long-term sustainability of businesses. 

Jane is a Fellow of the Pensions Management Institute and a Chartered Insurer. She is an independent Trustee for The Economist Pension Plan.

Damian Carnelll

founder director

CORPGRO is a reward consultancy specialising in executive incentives particularly those connected with growth; and ESG.

Damian has extensive experience advising leading companies on all aspects of executive compensation and equity plans. He was previously with Willis Towers Watson, Aon, and Ernst and Young. 

Damian’s extensive experience in executive compensation and equity plans means he is fully familiar with Corporate Governance norms, institutional shareholder views and proxy voting both advisory and binding.

Damian Carnell Corpgro