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Distilling ESG drivers of enterprise value and the role of corporate boards

Natalie Runyon  Director / ESG content & Advisory Services / Thomson Reuters Institute

· 5 minute read

Natalie Runyon  Director / ESG content & Advisory Services / Thomson Reuters Institute

· 5 minute read

Corporate boards significantly influence the perceptions of how much enterprise value creation comes from non-financial resources, which include human, social, and natural capital

In 1975, tangible assets, such as property and equipment, constituted 83% of S&P 500 companies’ assets; while their intangible assets, like goodwill and intellectual property, were less valued, comprising of only 17%. However, by the 2020s, the scenario shifted dramatically. Intangible assets soared to represent more than 90% of total assets, driven by the tech sector’s rise in the S&P 500 and the predominance of software in the economy.

This change underscores a persistent underestimation of intangible assets in the market, including the non-software ones and have an impact on the perceived value of such assets as environmental, social & governance (ESG) risks and opportunities.

The value of intangible assets

The traditional view in the finance and accounting professions and among some corporate boards, is that only explicit drivers recorded in financial statements are crucial for shareholder value creation. However, this outdated perspective overlooks the significance of non-financial resources, such as human, social, and natural capital. These sources of capital are key inputs of sustainability impacts, but are not classified as assets in conventional accounting, despite their dramatic impact on enterprise value creation. Indeed, this understanding — and the apparent devaluing of these intangible assets — has been acknowledged by the Financial Accounting Standards Board (FASB) for many years.

Companies, investors, capital market participants, FASB, and the American Institute of Certified Public Accountants have increasingly focused on the value of non-financial drivers of enterprise value in business reporting since the 1990s. This approach includes providing information not found in financial statements and emphasizing the relevance of sustainability issues as integral to business considerations.

Corporate boards significantly influence the perceptions of how much enterprise value creation comes from human, social and natural capital, non-software intangible assets, and effective risk management, which are all non-financial resources.

In fact, according to Lisa Blais, Co-Head of U.S. CEO & Board Practice at global consulting firm Egon Zehnder, non-financial drivers of enterprise value represent some of the biggest corresponding skill gaps among board members today and are most in demand in the recruitment of corporate directors. Not surprisingly, many of these areas fall under ESG issues, and recruiting for these areas of expertise could go a long way into increasing the perception of how important these areas are to enterprise value creation.

      • Digitization and operational governance — Digital transformation experience and skills have been one of the biggest priorities in terms of company board recruitment, according to Blais. As artificial intelligence (AI) begins to strongly influence operational efficiency among companies, its usage is also a key concern in areas of trust and ethics.
      • Human capital as an important social issue — “The company boards’ appetite for functional leadership with backgrounds across many areas of human capital include executive compensation, succession planning, labor relations, the war for talent, future of work, and employee engagement,” says Blais. Indeed, employee engagement, satisfaction, and experience are key indicators of financial performance across a number of different financial metrics, including return on assets, return on sales, revenue generation, market valuation, and stock performance.
      • Enterprise risk and operational governance — Some companies are looking for risk experts to enhance their board expertise, explains Blais. As the scope of risks expands in the short- and medium-terms and operational and financial impacts of these risks becomes increasingly uncertain, boards’ ability to provide guidance on strategy around risk management is essential.

Blais describes how boards address ESG concerns, as in many cases, two traditional board committees handle key areas of governance and other ESG issues. First, the nominating and governance committee — responsible for overseeing the system of board governance and managing the structure and composition of the board — handles the recruitment process of bringing on new board members who satisfy the requirements to address a skill gap, such as human capital or risk expertise.

Then, the audit committee — which fulfills the responsibility of many boards’ oversight of the corporation’s risk management and provides oversight of the corporation’s financial reporting processes, internal controls, and independent auditors — is the place where in-depth discussions of drivers of enterprise value take place. Indeed, there are many contributors to enterprise value — tangible assets, financial, human and natural capital, customer relationships, and other factors impacting goodwill.

In addition, the audit committee may be the primary source of identifying the need for a corporate director with enterprise risk expertise, given the increasingly uncertain operating environment driven by geopolitical risks and others challenges that companies are facing today. Candidates with experience as chief risk officers, chief legal officers, or general counsels are best positioned to earn a seat on those company boards that are looking to add risk expertise, according to Blais.

Guidance to individuals with board aspirations

Operational expertise across many ESG issues is one way to be an attractive board candidate. Blais advises those professionals who are seeking board membership to acquire a broad array of experiences of issues that are important to boards, such as exposure to ESG issues that are material to the business.

In addition, learning how a board candidate can influence outcomes by asking questions about non-financial drivers of enterprise value is another critical component for success. “If I were on a board, I would look at the company’s risk register to understand the risks and opportunities facing the business, including those arising from ESG issues,” Blais says.

Other actions that can best position those with board aspirations to earn a seat as a corporate director include:

      • Ask about how the company is leveraging digitization in their products and customer relationships.
      • Understand the role of a board director and what it is like to be in the boardroom by gaining exposure to your employer’s current board.
      • Build a network with board members because many board hires are made through personal and professional networks.

Understanding how ESG factors impact both total enterprise value and aligning to in-demand skills can best position companies for forthcoming success in an uncertain and risky future.

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