V O LU M E 2 9 | N U M B E R 2 | S P RIN G 2 0 1 7

Journal of
APPLIED CORPORATE FINANCE

In This Issue: Sustainability and Shareholder Value

How We Invest 10 Michael Bloomberg and Carl Pope

SASB 2016 Symposium 16 Tim Koller, McKinsey & Company, with Jonathan Bailey,
Sustainability and Rewriting the Book on Valuation: An Interview with Tim Koller FCLT Global

SASB 2016 Symposium Roundtable 22 Keith Higgins, Securities and Exchange Commission; Alan Beller,
The SEC and Improving Sustainability Reporting Cleary Gottlieb; and John White, Cravath, Swaine, & Moore.
Moderated by Mary Schapiro, Promontory Financial Group

SASB 2016 Symposium Roundtable 32 Ted Eliopoulos, CalPERS; Kristi Mitchem, Wells Fargo Asset
The Next Wave of ESG Integration: Lessons from Institutional Investors Management; Chris Ailman, CalSTERS; and Michelle Edkins,
BlackRock. Moderated by Janine Guillot, Sustainability
Accounting Standards Board

SASB 2016 Symposium Roundtable 44
Analysts’ Roundtable on Integrating ESG into Investment Decision-Making
Dan Hanson, Jarislowsky Fraser Global Investment
Management; Jennifer Bender, State Street Global Advisors;
Robert Lamy, CFA Institute; and Tom Lyons, Montgomery
Fixed Income. Moderated by Bruno Bertocci, UBS Asset
Management

Far Beyond the Quarterly Call: CECP’s First CEO-Investor Forum 56 Tim Youmans and Brian Tomlinson, CECP Strategic Investor
Initiative

Evaluating Sustainable Competitive Advantage 70 Baruch Lev, New York University

The Purpose of the Firm, Valuation, and the Management of Intangibles 76 Bartley J. Madden

Investing in the UN Sustainable Development Goals: Opportunities for 87 Willem Schramade, NN Investment Partners
Companies and Investors

Evaluating the Effectiveness of Sustainability Disclosure: 100 Arturo Rodriguez, Henrik Cotran, and Levi S. Stewart,
Findings from a Recent SASB Study Sustainability Accounting Standards Board

Lies, Damn Lies, and Statistics: Why a Widely Used Sustainability Metric 109 Jon Bartley, Al Chen, Stephen Harvey, Scott Showalter,
Fails and How to Improve It Gilroy Zuckerman, North Carolina State University, and Levi
Stewart, Sustainability Accounting Standard Board
Sustainability and Rewriting the Book on Valuation:
An Interview with Tim Koller
SASB 2016 Symposium December 1, 2016
Jonathan Bailey, left, and Tim Koller.
Jonathan Bailey: Good morning, I’m Jonathan Bailey, Direc-
tor of Research for FCLT Global, a recently formed nonprofit
whose mission is to encourage sustainability programs and
other forms of long-term investing by companies and their
shareholders. And as an alumnus of McKinsey & Company,
I’m delighted to be sharing the stage and leading a conversa-
tion with Tim Koller, a long-time McKinsey partner. Besides
serving as head of the firm’s corporate finance group for many
years, Tim is also the co-author of what many finance practi-
tioners take to be “the book” on the subject of valuation. Now
in its sixth edition, the book is called Valuation: Measuring
and Managing the Value of Companies,1 and it is widely used
in business schools as well as corporations around the world.
One of the important messages of the book is that creat-
ing shareholder value does not mean maximizing short-term
profits—and companies that confuse the two often put
both shareholder value and stakeholder interests at risk.
This message is a particularly important one when attempt-
ing to assess the value of corporate sustainability programs.
Such programs can involve significant ongoing investments
of capital that are designed to address environmental and
other social problems. And especially because such invest-
ments tend to reduce near-term earnings, investors want to
understand the expected payoffs from such investment, both
for themselves and for the social groups and causes that are
1. Marc Goedhart, Tim Koller, and David Wessels, Valuation: Measuring and Manag-
ing the Value of Companies, sixth edition, Hoboken, NJ: Wiley & Sons, 2015.
16 Journal of Applied Corporate Finance • Volume 29 Number 2 Spring 2017
targeted by such investment. But to help make that happen,
both shareholders and corporate stakeholders are demanding
more information about the environmental and social risks
facing their companies, and about management’s plan to deal
with those risks. And shareholders also want to know how
such risks and plans to manage them are expected to affect
the long-run profitability and value of the company.
During the next 30 minutes or so, I’m going to ask Tim
to tell us how the accepted principles of valuation presented
in his book can be used to support management’s efforts to
ensure the sustainability of their organizations. Our aim in
this will be to shed some light on important issues related
to how sustainability affects long-run value, including the
challenge faced by management in communicating the value
of its sustainability initiatives to investors.
As I mentioned earlier, Tim’s book has gone through a
number of editions since I joined the firm over ten years ago.
Tim, for those in the audience who haven’t had the chance to
look at the most recent ones, can you tell us a little about how
the book and your thinking about sustainability and valua-
tion have evolved over time? How does your current thinking
about valuation reflect today’s focus by many stakeholders on
sustainability?
Tim Koller: Thanks for the kind words, Jonathan. And let me
talk a little about the corporate sustainability movement, and
how I think it’s going to affect the long-run profitability and
values of public companies.
I think it’s important to start by distinguishing between
the mechanics of valuation models and two other things: how
corporate managers use such models when designing their
own performance measures and reporting to investors; and
how investors interpret and respond to those reports.
Let’s start with the valuation models. Our book’s been
out there for over 25 years now. But far from presenting new
concepts or research findings, its aim has been to codify the
ideas, and so it rests on the shoulders of people who were
thinking and writing about this stuff as far back as a couple
hundred years ago. And to summarize one of the impor-
tant messages of the book, for hundreds of years people have
viewed the value of a business or a company as deriving
ultimately from one main source: the cash flow the business
is expected to produce over the entire life of the business, and
the level of risk associated with that cash flow. Free cash flow
is what you can spend as an owner, whether you’re a private
owner or a shareholder in a large company.
Now, it’s true that we have gone through periods when
cash flow doesn’t seem to have mattered very much. For
example, during the dot-com bubble, lots of people suddenly
began saying, “Traditional methods of valuation don’t apply
anymore—look at all these companies with high valuations
that have little if any cash flow.” But eventually the bubble
burst—and it was the failure to produce cash flow that caused
the valuations of many of these companies to collapse.
What does this have to do with today’s sustainability
programs? As we argued in the last few editions of our book,
when viewed from this valuation perspective, corporate efforts
to respond to sustainability issues are no different from other
risks that management has to worry about. If the forces in
the world that relate to sustainability are expected to have
important effects on a company’s cash flows, then it’s manage-
ment’s job to take a longer view and figure out what to do
about them. Because, eventually, the risks associated with
these environmental and social problems—and the oppor-
tunities presented by managing them effectively—will show
up in the firm’s cash flows. And to the extent the market is
forward-looking, a company’s material risks—and manage-
ment’s effectiveness in dealing with them—will get reflected
in the price-earnings multiples that are being applied to its
current earnings.
We have all seen lots of cases where companies become
too short-term oriented in terms of not spending enough on
product development or marketing. And the same principle
applies to corporate sustainability programs. If climate change
or product safety or worker morale issues are expected to have
material effects on a company’s longer-run profitability, it’s
management’s job to take the long view and invest enough of
its attention—and investor capital—to limit the company’s
exposure to such risks.
And that’s why I think that the Sustainability Account-
ing Standards Board’s industry-specific approach to reporting
on sustainability risks and initiatives is likely to be especially
valuable for companies, and useful to the investors and
analysts who follow them. The SASB has proposed different
reporting standards for the “material” environmental and
social issues facing each of the 79 different industries it has
looked at in the past few years. And by thus emphasizing the
differences in material issues among industries, and limiting
the focus of corporate reporting to just the material issues,
the SASB approach will effectively force both companies and
their investors to focus their attention on the expected cash
flow and valuation effects of these sustainability risks and
programs.
Journal of Applied Corporate Finance • Volume 29 Number 2 Spring 2017
Now, in thinking about the value of such reporting to
investors—and how they are likely to interpret and respond
to such information—it’s important to keep in mind that
corporate managers often have a lot more information than
investors, and long before investors have it. And because
of this “information asymmetry,” the market valuations of
companies sometimes lag behind and take time to catch
up with what management understands to be their intrin-
sic value. Some important success factors may be too vague
or unclear for investors to incorporate into their current
estimates of a company’s cash flows. But once it becomes
clear, the markets react.
Take the valuation of oil and gas companies. Investors
today are clearly aware of the risk of “stranded assets” faced by
these companies—the possibility that significant portions of
their oil reserves won’t end up being developed because of the
growth of alternative energy sources. And if you take a close
look at the current values of such companies, you will see that
the market is already reflecting those concerns. Investors are
assuming that there’s not much value beyond a certain period
of time, which isn’t too far into the future.
Sustainability and the Capital Budgeting Process
Bailey: Okay, so management should be thinking about its
sustainability initiatives as long-term investments that, at least
in the long run, are expected to have positive net present
values. But in my experience with corporate clients, budget-
ing systems often constrain managers into showing they can
generate a pay-back period of a couple of years or less. This
may be creating dynamics which are less than efficient for
creating value within businesses. From your corporate finance
and valuation perspective, Tim, what are some of the changes
that managers could and should make to do a better job of
integrating sustainability and other longer-term goals?
Koller: When managers make decisions, they almost always
work off some baseline of performance. One trap they fall
into is to ignore what would happen, relative to the baseline,
if they didn’t do something, chose not to make an invest-
ment. For example, what are the consequences of not doing
an acquisition? Maybe they won’t be able to achieve their
base case. Or to cite another example, what would happen
if they failed to invest in safety? The decision to make this
investment typically would not affect the projections of cash
flow in their base case. But if the analysis is done correctly,
the investment should be seen as reducing the probability of
having lower cash flows at some point in the future, and so
be seen as increasing—or at least preserving—value.
So corporate managers need to be more thoughtful about
the kinds of investment that actually create value in and of
themselves—that is, without having any positive effect on
revenues or cash flows, at least in the near term. Now, some
sustainability investments are in fact expected to increase
17
revenue and cash flow in the near term. For example, if
companies engage in activities that make their custom-
ers more likely to buy their products than those of their
competitors—say, by strengthening their brands, or their
reputations as good corporate citizens—then those “invest-
ments” will end up increasing their cash flow. But for those
sustainability programs that are not expected to have such
near-term benefits, the analysts should ask themselves: what
are the consequences, relative to the baseline, of not making
the investments? If a company fails to invest in safety, or in
environmental mitigation—or if it builds a plant in such a
way that it is vulnerable to increases in regulation—expected
future cash flow could be significantly lower than what is
projected by the baseline case.
Getting these investment decisions right is, of course,
a big challenge for managers. As with all corporate invest-
ment decisions, the goal is investing the right amount of
capital—not too little, but not too much either. But having
said that, because the costs of underinvesting can be dispro-
portionately large—and even catastrophic—in many
cases involving sustainability programs, it may make sense
to err a bit on the side of overinvestment—but only a bit,
no gold-plating.
Communicating the Value of Your Sustainability
Programs to Investors
Bailey: Tim, I know some of the work you’ve been doing
recently has focused on effective communication between
managers and investors. Given the information asymmetry you
mentioned, what do the best companies do to communicate
how their sustainability programs are expected to create value?
Koller: I think we’re still very much in an infant stage in
this. Much of the reporting by companies is little more than
boilerplate. But there are some good examples of effective
communication. For example, some of the consumer-apparel
companies have become very conscientious about reporting
on the quality and reliability of their supply chains, including
their overseas sourcing. These companies have become much
more proactive in describing what they do to make sure that
their overseas suppliers are upholding certain standards. Simi-
lar developments can be seen in extraction or energy-related
industries, where reporting now includes considerable discus-
sion of environmental protection and worker safety measures.
You can also see this in the increased attention of healthcare
companies to product safety that is reflected in their report-
ing to investors and other corporate stakeholders.
And in some of these cases, though not all, these develop-
ments represent a break with the past in the sense that, until
fairly recently, such communication hasn’t typically happened
2, Rebecca Darr and Tim Koller, “How to build an alliance against corporate short-
termism,” January 2017, McKinsey.com.
18 Journal of Applied Corporate Finance • Volume 29 Number 2 Spring 2017
until after there’s been a blowup somewhere in the industry—
situations where, all of a sudden, something happens that
gets everyone’s attention, and people start to worry about it.
Bailey: Another trend we’ve seen is the growth of sources and
kinds of information now available to investors. Along with
what they learn from company disclosures, today’s investors
now get information from third-party data providers, and
from specialized research firms that track the news media
and other sources. With the help of such information, some
investors are also building their own input/output models
that construct a view of what’s happening inside a business
in terms of sustainability characteristics.
From an investor perspective, do you feel that this is
mainly just a trend toward larger quantities of data, much of
it not particularly useful, or do investors now have access to
better data as well?
Koller: I think there’s been a significant improvement in the
quality of much of the data. There are investors who look
at a Bloomberg screen to make investment decisions, and
having sustainability factors available there provides a lot
of visibility to the issues. But it’s important to recognize
that the investors who really drive the market are typi-
cally performing analysis that goes much deeper than that.
They’re spending months following companies and doing
research before they decide to invest in them. And in terms
of sustainability, as I said earlier, they’re interested mainly
in how the companies are managing the material factors
that are likely to drive their values.
At McKinsey We’ve had a lot of discussions with sophis-
ticated long-term investors, and what seems to matter most
to such investors is what corporate sustainability programs
tend to reveal about the quality and credibility of manage-
ment.2 The important thing is not the amount or even the
kinds of data. What seems to matter is the ability of corpo-
rate managers, when facing those investors one on one, to
explain how their sustainability initiatives are expected to
contribute to the company’s overall strategy, and how that
strategy is going to drive the cash flows and increase the
value of the firm.
So, the new information and disclosures are effective in
the sense that they get the conversation going. But regardless
of whether or not such disclosures are mandated or audited,
what investors really seem to want from them is the basis for
and beginning of a dialogue with management—a dialogue
that helps the investors determine for themselves whether
management really knows what they’re talking about, and
what they’re really doing to manage the exposures that
threaten the long-run value of the company.
Bailey: That’s an interesting point, because you’ll often
hear CEOs say, “Look, I never get questions from sell-side
analysts about these sorts of topics.” But my guess is that those
conversations are happening in a different forum. They’re not
happening on a quarterly earnings call; they’re happening in
those one-on-one meetings with value-based investors who
have a much more active focus.
So if you’re the CEO trying to initiate these conversations
with value-based investors, do you think that management
teams are structuring their communications and reporting
in the best possible way to attract such investors? Or do you
think that most top management teams are basically waiting
for investors to come to them, in which case the loudest voices
will be the ones that shape the discussion?
Koller: It’s a combination of the two, because there are two
worlds going on. There are the quarterly earnings calls with
the sell-side analysts, and then there are the value-based inves-
tors who tend to have private conversations with managers.
And those worlds don’t intersect for the most part.
When executives sit down with what we call intrinsic
value investors, the conversation is much deeper and it focuses
on what’s material, whether it’s sustainability or other factors
that are affecting the industry. What are the opportunities,
and what are the major risks—and how is management
positioning the company to respond to them? As I said earlier,
investors want to get a good sense of whether management
knows what they’re doing. That’s very different from what
goes on during the quarterly calls where usually only the
sell-side asks questions.
A very experienced investor-relations professional once
told me that, during her decades of working in the business,
there was only one occasion she could recall when a buy-side
investor asked a question on a quarterly call. But let me
suggest that there may be ways to change the quarterly call
that could end up attracting some longer-term investors. In
our ongoing conversations with them, such investors regularly
tell us that they would like management to be more proac-
tive in those quarterly calls; they would like management
to shape the agenda instead of leaving that to the sell-side.
These investors have said to us, “We want management to tell
us what they really think is important for the future of the
business. Stop trying to guess and respond what you think
the sell-side analysts want to know. Tell us about the results
in the context of what you’re doing longer term. And then
find a way to make sure that the most important questions
about the long term get raised. Take more charge of investor
communications and focus on what’s really important.”
Sustainability and Finance Education
Bailey: That sounds like great advice, Tim. But before we take
some questions from the audience, I have one more that I
wanted to ask you. People often talk about the importance of
Journal of Applied Corporate Finance • Volume 29 Number 2 Spring 2017
business schools and education, including the CFA programs,
in helping people think about how to integrate sustainability
and other long-term factors into the valuation models that we
use to value stocks and companies. Having written a book
that is widely used both in business schools and the corpo-
rate world, do you feel that our education system is doing a
good job of getting these ideas and concepts across to the next
generation of analysts and investors? Or do you think there’s
more that we can do on that front?
Koller: In general, I think there’s a good deal more that can
be done to integrate the mechanical aspects of finance with
the environmental and social issues that are now playing a
greater role in the strategy—and affecting the valuations—
of many of the companies that I talk to. I remember a recent
dinner with the finance faculty at INSEAD that included
an outsider, a professor of strategy. And when explaining his
decision to include the strategy professor, the chair of the
finance group told me, “We thought this was a great oppor-
tunity for all of us since we almost never have discussions
between the finance and the strategy people.”
I mention this story because I think these silos that you
find in most business schools are symptomatic of—if not in
fact an important contributor to—the divide that separates
finance from other disciplines, not only in most business
schools, but in many companies as well. I see this divide as
an opportunity to make valuable connections between these
disciplines. We now have classes on sustainability—and of
course we have long had classes on finance and account-
ing, and classes on strategy, too. And I think there’s a big
opportunity to integrate all these topics by using a valuation
framework that views corporate sustainability programs as
investments of corporate resources—including investor
capital as well as management time and energy—with long-
run expected payoffs that will show up as either higher cash
flows, or lower risk, over time. When viewed as investments,
such programs should be subjected to pretty much the same
standards and criteria that corporate practitioners use when
evaluating other corporate investments, such as R & D.
Bailey: Ok, so that was the last of the questions that I prepared
for this discussion. Do we have any questions from the audi-
ence?
How to Communicate with “Inefficient” Markets
Audience: I’m Peter Coffin of Breckenridge Investors, and I’m
of the view that markets are not always very efficient in pricing
risks and costs. And so I think that much of the value of what
the SASB is trying to do is to improve disclosure and recog-
nition so that markets better reflect the intrinsic values that
you’re talking about. But my question is this: Because of what I
think of as the shortsightedness or other limitations of financial
markets, should managements be more willing to make long-
19
term investments that reduce current earnings? And should they
be less beholden to markets, and pay much less attention to how
investors are going to respond to their investments?
Koller: I think your question is a very interesting and impor-
tant one, but I’m not sure I agree with the way you worded
it. You asked whether managements should be more will-
ing to be “less beholden to markets?” My response is that
the market is not a monolith. There are all kinds of investors
out there. There are short-term traders that care only about
the next quarter’s earnings. And there are quant funds—and
index investors—who don’t even look at fundamentals. But,
as I’ve been emphasizing, there are also significant numbers
of intrinsic investors with a longer horizon, such as Dodge
and Cox and Pzena and Wellington. And I think we should
encourage managements to identify and even try to attract
such intrinsic investors. Management should say to them-
selves, “If we’re ultimately concerned about long-term value
creation, we should be designing our communications—both
in terms of what we talk about and who we listen to—with
those long-term investors in mind.”
So, in response to your question, I do feel that managers
have to be responsive to the market—but they should pick
the investors that they are responding to. And because those
investors we think really matter tend to have a much longer
horizon, we think you should focus your efforts on them, and
spend less time worrying about the sell-side analysts, and the
next quarter’s results.
Communicating with an Efficient Market thanks for sharing your thoughts with us.
Audience: I’m John Federovitch of Kimberly-Clark; and
unlike Peter, I’m broadly of the view that markets are rela-
tively efficient. And so my question is whether you feel that
the call for increased or more systematic disclosure of sustain-
ability really has much incremental explanatory power or
value for investors. In a relatively efficient market, a lot of
what companies do in terms of safety and other sustainabil-
ity issues should already be reflected in the standard financial
information about cash flows that is being disclosed. And to
the extent this is so, you might say, “Well, if you’re outper-
forming the index, it may well be that you’re a well-managed
company in general terms—one that invests in all important
aspects of its future, including what we identify as sustain-
ability.” If this is the case, then it’s hard for me to see the value
of all these additional disclosures.
20 Journal of Applied Corporate Finance • Volume 29 Number 2 Spring 2017
Koller: Well, even if such disclosures don’t end up affecting
the decision-making of passive investors, the important ques-
tion is whether and how it affects the decisions of the more
active, intrinsic value investors. And because those inves-
tors are looking for the drivers of those cash flows—whether
it is technological change that could affect their industry
and make them less competitive, or whether it is important
changes in regulation—I think managers need to figure out
and focus on which of these sustainability issues are going to
have material effects on their future cash flows and value. As
I mentioned earlier, sophisticated investors have told me that
they think managers need to do a better job of talking about
all the changes that are going to drive their cash flows as well.
And more and better disclosure of these long-run factors, as I
suggested, can be key to attracting the right investors to the
company and getting the dialogue started with management.
Bailey: My own take on this is that many companies track
lots of things for internal or management reporting, and my
sense is that some of the reporting that SASB is proposing can
be done using the internal data and reports that are already
being collected and produced. Now such reports may not be
audited, but a lot of this data already exists. And my ques-
tion is: if management finds such data and reports useful in
operating the business, then why not consider sharing the
information with investors? That step could also be used to
start a strategic dialogue with long-term investors—one that
could lead to such investors becoming partners in the business.
But, anyway, we’ve come to the end of our time. Tim,
Koller: Thank you, Jonathan.
Jonathan Bailey (jonathan.bailey@nb.com) is head of environmen-
tal, social and governance investing at Neuberger Berman. At the time
of the interview he was director of research for FCLT Global, a not-for-
profit organization dedicated to developing practical tools and approaches
that encourage long-term behaviors in business and investment decision
making. For more information please visit www.fcltglobal.org.
Tim Koller (Tim_Koller@McKinsey.com) is a partner in McKinsey’s
New York office.
© 2017 McKinsey & Company. All rights reserved.
ADVISORY BOARD EDITORIAL
Yakov Amihud Carl Ferenbach Donald Lessard Charles Smithson Editor-in-Chief
New York University High Meadows Foundation Massachusetts Institute of Rutter Associates Donald H. Chew, Jr.
Technology
Mary Barth Kenneth French Laura Starks Associate Editor
Stanford University Dartmouth College John McConnell University of Texas at Austin John L. McCormack
Purdue University
Amar Bhidé Martin Fridson Joel M. Stern Design and Production
Tufts University Lehmann, Livian, Fridson Robert Merton Stern Value Management Mary McBride
Advisors LLC Massachusetts Institute of
Michael Bradley Technology G. Bennett Stewart Assistant Editor
Duke University Stuart L. Gillan EVA Dimensions Michael E. Chew
University of Georgia Stewart Myers
Richard Brealey Massachusetts Institute of René Stulz
London Business School Richard Greco Technology The Ohio State University
Filangieri Capital Partners
Michael Brennan Robert Parrino Sheridan Titman
University of California, Trevor Harris University of Texas at Austin University of Texas at Austin
Los Angeles Columbia University
Richard Ruback Alex Triantis
Robert Bruner Glenn Hubbard Harvard Business School University of Maryland
University of Virginia Columbia University
G. William Schwert Laura D’Andrea Tyson
Charles Calomiris Michael Jensen University of Rochester University of California,
Columbia University Harvard University Berkeley
Alan Shapiro
Christopher Culp Steven Kaplan University of Southern Ross Watts
Johns Hopkins Institute for University of Chicago California Massachusetts Institute
Applied Economics of Technology
David Larcker Betty Simkins
Howard Davies Stanford University Oklahoma State University Jerold Zimmerman
Institut d’Études Politiques University of Rochester
de Paris Martin Leibowitz Clifford Smith, Jr.
Morgan Stanley University of Rochester
Robert Eccles
Harvard Business School

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