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A New Chapter In Corporate Finance

The Anomaly,’ winner of the coveted Goncourt Prize in French literature in 2020,* and Don’t Look Up,’ the latest Netflix movie hit, may not share the same intellectual flair, but they have at least one thing in common: fashionably, they both tell a story describing how society reacted to an adverse reality change.

Whether confronted with a challenge to the world order resulting from the anomalous duplication of two hundred individuals, or an approaching comet set to destroy the earth, society responded poorly. Both stories came to a sorry end.

Judging by the corporate trends of 2021, likening the current times to these fictional doom stories would be unfair. A review of a large number of investor day presentations held last year shows that firms demonstrated a considerable degree of awareness of ESG issues. This view is echoed by Andrew Winston, a leading strategic consultant, in his year-end HBR article ‘Sustainable business went mainstream in 2021.’ Economic actors are looking up.

But the issues at stake need more than awareness. 2022 must witness the beginning of the next, more demanding phase – one that requires new expertise: the implementation of ESG initiatives in line with updated corporate strategies and its financial planning. As Kermit the Frog would sing, it’s not easy being green.’

At present, strategic and operational measures associated with the management of newly identified ESG risk and opportunities are not fully incorporated into business plans, publicly disclosed financial targets, and equity analyst forecasts – if at all. To illustrate the point, none of the large-cap companies monitored by Climate Action 100+ are explicitly committing to aligning their capital allocation policy with their net-zero emissions commitments. In 2021, ESG commitments were free of charge.

So, what will have to happen next?

The financial markets’ attention will switch from 2050 commitments to tangible 2025-30 milestones, with a focus on material ESG drivers. The initiatives required to meet these new interim objectives will be financially quantified and integrated into mid-term planning. As a result, operating expenses (e.g., digitization, innovation) and capital expenditures (e.g., new manufacturing technologies, new supply chain set up) will rise. On the positive side, the tangible benefits arising from these actions, including cost savings (e.g., higher energy efficiency, increased employee productivity), will be incorporated. Although less easy to assess, the ability to achieve higher prices to monetize the additional outlays will also be considered.

As financial projections adjust to the new circumstances, most companies’ growth, return on capital, and defensiveness profile will change. Optimal capital structures and the cost of capital will have to be reassessed. As updated financial and risk profiles emerge, many equity stories will need to be rewritten.

Corporate finance is set to evolve dramatically over the coming years. Next to me lies the 4th edition of the Principles of Corporate Finance(1991), a reference text describing the theory and hardcore practice of corporate finance. This week, Mr. Myers, the co-author whose class I attended, told me that the 14th edition (2022E) will include a new chapter on ‘Stakeholder Capitalism and Responsible Business.’ This symbolizes nothing else than a new chapter in corporate finance history.

Neither a new inexplicable phenomenon nor a comet represents the biggest threat to humanity. It is the ‘snooze’ button. 2022 is the year when ESG gets real. If awake, get up!

Bon Dimanche! Laurent

* Translated in English since Q4/21

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