Stockholm (NordSIP) – Dirk Schoenmaker and Willem Schramade, the acclaimed academic duo from Rotterdam School of Management, Erasmus University, recently announced that they have finished working on a new book, Corporate Finance for Long-Term Value. Given the success of their previous efforts, NordSIP was eager to delve into this yet-to-be-published tome. The book they co-authored back in 2019, Principles of Sustainable Finance, has already become a classic amongst sustainability practitioners.
“We are quite excited about this new publication since it takes the concepts of our previous book and operationalises them into financial methods, decision rules, and calculations,” shares Schramade. “The book discusses all the normal corporate finance topics (DCFs, capital structure, M&A, options, etc.), first from a traditional perspective, then with E and S effects, and then valuing E and S themselves. This gives interesting results, also in fields like options and capital structure where one wouldn’t expect them,” he adds to further whet future readers’ appetite.
From theory to practice
The book unmistakably benefits from the authors’ experience from both academia and the industry, as well as from their extensive teaching practice. Relevant examples and case studies abound, making the somewhat lengthy tome highly readable even for the less theoretically minded. For students eager to test their recently acquired knowledge of the subject matter, there are a number of concrete problems to solve, complete with step-by-step solutions.
At the end of each chapter, Schramade and Schoenmaker also provide helpful suggestions for further reading and extensive lists of references. The overall impression is of a well-researched and systematically executed deep dive into sustainable corporate finance that should appeal to students and seasoned professionals alike.
The balancing act
“The key challenge for companies is to balance profit and impact. This corporate finance handbook provides the tools for this balancing act,” promise the authors in the book’s foreword. According to Schoenmaker and Schramade, the key to achieving this desired equilibrium is shifting the corporate mindset towards a dynamic model aiming at long-term value creation. Using a simple matrix, they illustrate what any forward-looking company CFO should try to achieve: a long-term alignment between profit and positive impact.
Without further ado, the authors then proceed to explain how companies can make it profitable to create long-term value. The short answer? Steer for integrated value. “A good CFO focuses on financial value (are the activities profitable?), as well as social and environmental value (are the activities future-proof?),” they explain. “Steering according to integrated value means that a CFO creates positive impact in all three value dimensions.”
Schramade and Schoenmaker discuss three essential principles that a sustainable business should use in its decision model:
- Multi-value creation: the long-term goal should be to simultaneously create positive value in both financial, social, and environmental dimensions.
- Transition: if value is destroyed in any of the dimensions, a credible recovery path needs to be established.
- Non-substitution: netting should not be allowed, i.e., adverse effects on one value dimension cannot be compensated for by positive impact on others.
The mathematics of integrated value
Corporate Finance for Long-Term Value is intended as a textbook for financial professionals. Unsurprisingly, the text is interspersed with formulas, which should be familiar to those versed in traditional valuation models. This time around, however, the suggested calculations are enhanced to allow for optimising the company’s integrated value (IV), which encompasses the triple dimensions of financial value (FV), social value (SV) and environmental value (EV).
A key point the authors discuss, for instance, is how the classical discounted cash flow (DCF) model should be expanded to take into consideration SV and EV. To achieve this, practitioners can multiply the units expressing social and environmental issues with the associated shadow prices derived from welfare theory, they suggest.
The authors account systematically for the relevance of environmental and social externalities to a company’s value flow and to its cost of capital. According to them, the expected effect of sustainability improvements on value flows is uncertain in the short term but likely to be positive in the long term. There is increasing evidence, meanwhile, that the cost of capital for companies with superior social and environmental performance is lower both in the short and long term. Thus, “higher value flows (in the numerator) and a lower cost of capital (in the denominator) are expected to produce higher company value,” conclude Schramade and Schoenmaker. “The challenge lies in trade-offs across time and between types of value, which can interact in numerous ways.”
From learning how to calculate social and environmental value and using the results when valuing companies, bonds, and public or private equity, to understanding how sustainability factors affect the cost of capital, risk-return analysis, mergers and acquisitions, etc., there are plenty of reasons to delve into this impressive compendium.
Corporate Finance for Long-Term Value might not be your typical lightweight summer read, but studying its contents would certainly be time well spent for any financial professional with sustainability ambitions.