ENTERPRISE �VALUE �CREATION

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Presented by Mervyn E King SC

Corporate Legal Advisers

17^TH - 19^TH CENTURIES

• 17^th and 18^th century unincorporated entities
• With unlimited liability
• Deterred wealthy families from investing
• Political leaders wanted job creation
• Consequence less risk capital was being made available
• Create an artificial person with limited liability?
• Debate 19^th century

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“OWNERSHIP” – A SOCIAL CONSEQUENCE

• Wealthy families provided the equity capital
• Members of the families directors
• Seen as “owners” of the company
• Primacy of the shareholder developed
• Public discourse of shareholders’ “ownership”
• Short term profit for shareholders even at a cost to society and the environment
• Focus on financial capital

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THE PRIMACY OF SHAREHOLDERS REINFORCED

• The Dodge Brothers vs Henry Ford 1919 – minority shareholder
• Ford wanted to use profits to pay better wages and improve plant
• Court ordered Ford to discharge its primary duty to shareholders and pay a special dividend
• So thinking was directors had to act in the best interests of the shareholders - primacy
• Corporate success was equated with increased profit, share price and dividends
• There was a focus on financial reporting

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OWNERSHIP?

Shareholders are “the owners of the business” and the responsibility of the corporate executive is to “conduct the business in accordance with their designs, which generally will be to make as much money as possible while conforming to the basic rules of society …. There is one and only one responsibility of business – to use its resources and engage in activities designed to increase its profits as long as it stays within the rules of the game ….” Friedman, 1970s

• Tacit – company not part of society
• Principal (shareholders) agent (directors and managers) – puppet directors

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OWNERSHIP MYTH DEBUNKED

• Shareholders no rights:

To possess the company’s assets

To use the company’s assets

To manage the business of the company

To the income of the company

• Shareholders have no duty or responsibility to the company
• Representative shareholder duty to their ultimate beneficiaries

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THE ERROR OF CORPORATE LEADERS

• Directors’ duties owed to the company not shareholders
• Agency theory requires directors to obey
• Independence of mind fettered
• A company’s long term health not its shareholder’s wealth
• Time has come to challenge maximising shareholder value at any cost
• Distracts boards from building the company’s long term health
• Professors Stout (Cornell) and Paine (Harvard)

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UNTIL THE END OF THE 20^TH CENTURY

• Company and its activities seen through a financial lens – reporting financial and historic
• In automotive terms a car with rear view mirrors and no windscreen
• Shareholder centric governance model
• 20^th century one of unsustainable development
• 1995 ecological overshoot
• 1997 GRI founded

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COMPONENTS OF S&P 500 MARKET VALUE

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INTANGIBLE ASSETS

• Ecological overshoot and population explosion
• Strategy – long term value creation
• Reputation – perceptions of stakeholders
• Supply chain – legitimacy of operations
• Human rights – child labour
• Stakeholder relationships – civil society
• How does the company make its money?
• Positive and negative impacts on triple context
• The quality of governance of the organisation
• Value of enterprise or sustainable development?

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Corporate Legal Advisers

BEYOND FINANCIAL REPORTING

• Reporting in monetary terms
• FR critical but not sufficient
• SR critical but not sufficient
• The two in silos divorced from reality
• Triple context – dimensions integrated – SDG’s 2015

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FROM PROFIT TO VALUE

• From Friedman’s “free” economy profits
• 21^st century enterprise value creation
• Historically book value – the difference between total assets and total liabilities
• Book value greater or less than the market value
• Value of money – the present value of discounted future cash flows
• All through a financial lens

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VALUE TODAY

• Does the company make its money in a sustainable manner?
• The positive and negative impacts on the triple aspects of the company’s business model and outputs – financial, social and environmental
• Enhancing the positives, eradicating or ameliorating the negatives - strategy
• Embedding sustainability issues into the business model
• What are the impacts of the EE and S on enterprise value?
• Impacts on financial condition, operating performance and risk profile
• Integrated thinking and reporting
• To connect the financial with the non-financial

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THE SIX CAPITALS

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• Financial

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• Manufactured

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• Human

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• Intellectual

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• Social

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• Natural

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VALUE CREATION, PRESERVATION AND EROSION

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INTEGRATED THINKING

• Every company dependent on relationships and sources of value creation
• Mindset change at board & senior management level
• Symphony of resources and relationships
• Knowledge of stakeholders’ legitimate NIE’s
• Greater stakeholder expectations – informed oversight
• Agenda items: Inputs to outcomes

Stakeholder relationships

IT governance and cybersecurity

Supply chains

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SHARE VALUE TO VALUE CREATION

• Board decides how, impacts, inputs to outcomes
• To generate the long term health of the company
• For the economy, society and the environment
• Success depends on internal and external outcomes:
• internal financial return
• external social, environmental and economic

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ACCOUNTABILITY

• The quality of the information of reports
• Directors owe their duties to the company
• Not to shareholder
• Tragedy of the primacy of the shareholder
• 20^th century – one of unsustainable development
• Using natural assets faster than regeneration

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SUSTAINABILITY REPORTING

• Was founded in 1997
• Guidance to report on the 80% of value not expressed in a balance sheet
• Not covered by financial reporting standards
• Became more and more important
• Other framework providers entered space
• Clutter and confusion

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CRY FOR AN ISSB

• The CRD of the IIRC
• Social outrage
• EC Advisory Group redesigning non-financial reporting standards
• The Group of 5 statement of intent to collaborate
• IOSCO to engage with the Group
• WEF together with the Big 4
• The FRC of the UK – three separate reports
• IFAC ISSB to lie alongside the IASB under the IFRS Foundation - its Consultation Paper

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REINVENT THE WHEEL?

• IFRS has knowledge of the Group of 5
• Harmonization as far as possible
• Merger of the SASB and the IIRC
• The Value Reporting Foundation
• Focus on sustainability related financial disclosures

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THE BOXES

• The biggest box refers to sustainability issues – sustainable development
• Then a box of sustainability issues material to enterprise value creation
• Smallest box – financial reporting standards
• Positive or negative impacts on society, the environment and the economy, biggest box, then vice versa on the company

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DRIVER OF EVC

• Driver of the harmonized sustainability standards should be EVC
• Sustainability standards generally deal with sustainable development
• Development now will not prejudice development for those who come after us
• The GRI’s focus

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THE SUSTAINABILITY COIN

• Company’s activities and product impact on E E & S
• But E E & S impacts on company
• Lehman Bros, pandemic and climate change
• Impacts on the world (GRI) and world’s impacts on company (SASB)
• Different purposes, different audiences
• Proposed SSB under IFRS Foundation – EV lens
• Consistency, reliability, rigour, improved comparability

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EVC

• Impacts of E E & S on a company
• Its financial condition – its balance sheet
• Its operating performance – income statement and cash flow
• Its risk profile - cost of capital and market cap
• The boxes of the collaborators
• EC’s NFRD’s align with EV standards in SSB?
• Assurance friendly language in SSB – IAASB
• Enterprise value creation, preservation and erosion

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VALUE TODAY

• How does the company make its money?
• The positive and negative impacts on financial, social and environmental aspects and their impacts on the company
• Enhancing the positives, eradicating or ameliorating the negatives - strategy
• Embedding SDGs into the business model
• As the conservation of water is critical to the beverage manufacturer
• Now value is seen through an enterprise value lens in a resource constrained world
• Impacts of the E E & S on the company
• Connecting the financial and the non-financial

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THE EV APPROACH

• Sustainability/related risks and opportunities most likely to affect a company’s financial condition (e.g. its balance sheet), its operating performance (e.g. its income statement and cash flows) or risk profile (e.g. its market valuation and cost of capital)

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THE SD APPROACH

• The GRI Standards focus on the economic, environmental and social impacts of a company and hence its contributions – positive or negative – towards sustainable development. Users of the GRI Standards identify issues that are of primary importance to their stakeholders. If not material to value creation at the time of reporting these impacts may become material for EVC.

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EVC VS SR

• Sustainability related financial disclosure standards would enable disclosure of how sustainability matters create or erode enterprise value. This type of reporting is different from sustainability reporting, which is designed to illuminate a company’s most significant impacts on the environment, people and the economy

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GACCRS

• A Globally Accepted Comprehensive Corporate Reporting System
• Climate change and the global pandemic
• Drivers of connection between sustainability performance and financial risk and return
• The two drivers have created a sense of urgency to establish an ISSB as a stepping stone to a global comprehensive reporting system

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ENTERPRISE VALUE CREATION

• The external environment
• The business model drawing on the capitals
• Its inputs are used in the activities to produce a product or render a service
• Outputs which are internal and external
• Product or service leaves the organisation and has impacts on the three critical dimensions for sustainable development. These impacts have outcomes which in turn have effects on the capitals
• Value manifests itself in increases, decreases or transformations of the capitals
• But the three dimensions in turn have a positive or negative impact on enterprise value

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EVC INTERRELATED

• EVC is interrelated with value created for others
• <IR> Framework 2.5 “…providers of financial capital are also interested in the value an organisation creates for others when it affects the ability of the organisation to create value for itself…”
• Example: the availability, quality and affordability of a natural capital (e.g. water) that the organisation uses is likely to affect the organisation’s future financial performance.

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CONCEPTUAL FRAMEWORK

• The IASB has a conceptual framework for its standards
• The purpose of the conceptual framework is to:
• assist a standards board to develop standards based on consistent concepts;
• assist preparers to develop consistent reporting practices where no standard applies;
• assist all parties to understand and interpret the standards
• adaptation of the IASB Conceptual Framework by the ISSB?

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CONCEPTUAL FRAMEWORK FOR ISSB

• A conceptual framework similar to the IASB. A conceptual framework is essential for a high quality standards development by the ISSB, as the conceptual framework in the IASB guides preparers to make decisions about what to report in situations where no specific guidance exists financially, so it should be on enterprise value creation matters
• Adaptation of the IASB Conceptual Framework by the ISSB?

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THE CHANGED WORLD

• Enterprise value creation preservation or erosion
• Accounting for all three aspects
• The enterprise value creation standards and pertinent sustainability standards have to be connected to the financial standards
• Integrated thinking and integrated reporting
• More essential than ever
• Board must spend more time
• Board the most informed body for accountability
• Reporting is the lifeblood of accountability

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THE REPORT

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To be accountable you have to be understandable

“If I had more time…”

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Corporate Legal Advisers

Corporate Legal Advisers