Corporate Finance for Long-Term Value

Preface
About This Book
The Modern CFO Creates Profit and Impact
	Why Corporate Finance for Long-Term Value? Licence to Operate
	What Is Corporate Finance for Long-Term Value? Alignment Between Financial Value and Social and Environmental Value
		The Dynamic Perspective: Four Driving Forces of Internalisation
	How Can Companies Be Financed for Long-Term Value? Steering for Integrated Value
	Conclusions
	References
Preview of the Book
	Steering on Long-Term Value: Part 1
	Applying Long-Term Value in Value Flows and Cost of Capital: Parts 2-5
		Value Flows
		Cost of Capital
		Value Effect
	References
How to Use This Book
Contents
About the Authors
Abbreviations
Part I: Why Corporate Finance for Long-Term Value?
	1: The Company within Social and Planetary Boundaries
		1.1 Social and Planetary Boundaries in a Full World
			Box 1.1: The Deepwater Horizon Oil Spill
			Box 1.2: Rana Plaza Factory Collapse
			1.1.1 Planetary Boundaries
			1.1.2 Social Foundations
		1.2 Sustainable Development Goals
			Box 1.3: The Sustainable Development Goals
			1.2.1 Global Strategy
			1.2.2 System Perspective
				1.2.2.1 Examples of Cross-system Interactions and Uncertain Thresholds
					Box 1.4: Direct Drivers of Biodiversity Loss
		1.3 The Objective of the Company
			1.3.1 The Shareholder Model
				Box 1.5: The Dark Waters of DuPont
			1.3.2 The Refined Shareholder Model
				Box 1.6 Balancing the Negative Impact of Pesticides
			1.3.3 The Stakeholder Model
			1.3.4 The Integrated Model
				Box 1.7: Integrated Value Creation at KPN
		1.4 Integration of Sustainability into Corporate Finance
		1.5 Conclusions
		Suggested Reading
			References
	2: Integrated Value Creation
		2.1 Basics of Integrated Value Creation
			Box 2.1: Company Statements on Value Creation
			Box 2.2: Value Creation with a Product That Reduces Emissions
			Box 2.3: Key Players in Internalising Externalities
		2.2 Identifying Value Creation and Value Destruction
		2.3 Quantifying Integrated Value Creation
			Box 2.4: The Integrated Profit of Ambuja Cements
		2.4 Where Does Value Come from? Purpose, Strategy, and Business Models
			Box 2.5: Company Statements on Purpose
		2.5 Transition
			Box 2.6: Transition to Digital Photography: Kodak
			Box 2.7: Transition Towards Electric Driving
			Example 2.1: Investing in Healthy Food
		2.6 Steering Your Company on Integrated Value
		2.7 Conclusions
		Suggested Reading
			References
	3: Corporate Governance
		3.1 Current Corporate Governance Models
			3.1.1 The Shareholder Model
				Box 3.1: Short-Termism at Boeing
			3.1.2 The Stakeholder Model
			3.1.3 Governance and Company Value
				Box 3.2: Corporate Scandals Across the World
		3.2 The Integrated Model of Corporate Governance
			3.2.1 How Can Interests Be Balanced?
			3.2.2 Integrated Measure
		3.3 Ownership and Integrated Value Creation
			3.3.1 The Public Company
			3.3.2 Alternative Company Forms
				Box 3.3: Relative Versus Absolute Performance Measurement
				Box 3.4: IKEA Foundation
				Box 3.5: Credit Cooperatives
				Box 3.6: Danone as B Corp
				Box 3.7: State-Owned Enterprises in China
			3.3.3 Role of Institutional Investors
		3.4 Corporate Governance Mechanisms
			3.4.1 Role of Company Law
				Box 3.8: Follow This and Oil Companies
			3.4.2 Board Mechanisms at the Company Level
				Box 3.9: Future Design
		3.5 Conclusions
		Suggested Reading
			References
Part II: Discount Rates and Valuation Methods
	4: Discount Rates and Scarcity of Capital
		4.1 Discount Rates and the Time Value of Money
			Box 4.1: Arbitrage and the Law of One Price
			Box 4.2: Principal Financial Markets
		4.2 Determinants of Discount Rates on Financial Capital
			Box 4.3: Opportunity Cost of Capital
			Box 4.4: Money Market Segments
		4.3 Discounting Social and Environmental Capital
		4.4 Discounting Integrated Capital
			Box 4.5: Breaking Down Environmental and Social Risks
		4.5 Conclusions
		Suggested Reading
			References
	5: Calculating Social and Environmental Value
		5.1 Basics of Value Calculation
		5.2 Material Social and Environmental Factors
			Box 5.1: Stakeholders or Rightsholders?
			Box 5.2: Dynamic Materiality
			Example 5.1: Determining Materiality in the Garment Industry
			Example 5.2: Determining Materiality in the Airline Industry
		5.3 Quantifying Social and Environmental Impact
			Box 5.3: Carbon Budgets
			Example 5.3: Attributing Impact
		5.4 Monetising Social and Environmental Impact
			Box 5.4: Limits to Monetisation
		5.5 Conclusions
		Appendix: Shadow Prices and Natural Capital Accounting
			A.1 List of Shadow Prices
			A.2 Natural Capital Accounting
		Suggested Reading
			References
	6: Investment Decision Rules
		6.1 Calculating Financial Value by Means of NPV
			Example 6.1: Calculating the NPV of a Data Centre Project
		6.2 Other Investment Decision Rules
			6.2.1 Payback Rule
			6.2.2 IRR Rule
				Example 6.2: Calculating Payback Period and IRR of a Data Centre Project
			6.2.3 NPV Versus IRR and Payback
		6.3 Behavioural Effects on Investment Decisions
			Example 6.3: Calculating Changes in Value Due to Managerial Overconfidence and Excessive Optimism
			Box 6.1: Signs of Overconfident Managers at Enron
		6.4 Integrated Investment Decision Rules
			Box 6.2: Investment Decisions in Practice
			6.4.1 Constrained PV
			6.4.2 Expanded PV
			6.4.3 Integrated PV (IPV)
				Box 6.3: Shell Lost in Transition
		6.5 Internalisation
		6.6 Conclusions
		Appendix: Extended IPV Model with Company Case Studies
			A.1 Extended IPV Model
			A.2 Company Case Studies
		Suggested Reading
			References
	7: Capital Budgeting
		7.1 Conventional Capital Budgeting
			7.1.1 The Capital Budgeting Process
				Box 7.1: Asahi Group: Strategic Objectives for the Capital Budgeting Process
			7.1.2 Calculating Cash Flows
			7.1.3 Estimated Cash Flows
			7.1.4 Incremental Cash Flows
			7.1.5 Include the Opportunity Costs of the Desalination Plant in Incremental Cash Flows
			7.1.6 Sanity Checks in Analysing Projects
		7.2 Behavioural Challenges in Capital Budgeting
			7.2.1 Sunk Cost Fallacy
			7.2.2 Extrapolation Bias
			7.2.3 Escalation of Commitment
			7.2.4 Impact on Discount Rates
			7.2.5 Dealing with Behavioural Biases
		7.3 Integrating Sustainability in Capital Budgeting
			Box 7.2: Capital Budgeting and Sustainability in Practice
			7.3.1 Constrained NPV
			7.3.2 Expanded PV
			7.3.3 Integrated PV (IPV)
				Example 7.1: Big Oil: Choosing Between Fossil and Renewable Projects
		7.4 Internalisation
			7.4.1 Asymmetric and Non-linear Internalisation
			7.4.2 IPV Versus Internalisation
		7.5 Conclusions
		Suggested Reading
			Reference
Part III: Valuation of Companies
	8: Valuing Bonds
		8.1 Bond Types and Pricing
			Example 8.1: Calculating the Yield to Maturity of a Bond
			Example 8.2: Calculating a Bond Price from Its Yield to Maturity
		8.2 Term Structure of Interest Rates
			Example 8.3: Law of One Price: Yields on Bonds with the Same Maturity
			Example 8.4: Law of One Price: Yields on Bonds with Different Maturity
		8.3 Government Bonds and Corporate Bonds
			Example 8.5: Bond Yield and Expected Return
			Box 8.1: Bond Ratings
			Box 8.2: Market Makers and Bid-Ask Spread
		8.4 Integrating Sustainability into Bond Valuation
			Example 8.6: Credit Risk of Oil Companies
			Example 8.7: Z-Score for a Chemicals Company
		8.5 Valuation of S & E and Integrated Value
		8.6 Green and Social Bonds
			Box 8.3: Criteria for Green Bonds
		8.7 Conclusions
		Suggested Reading
			References
	9: Valuing Public Equity
		9.1 Basics of Equities
			9.1.1 Types of Equity
			9.1.2 Types of Stock Markets
			9.1.3 Equity Valuation and Its Drivers
			9.1.4 Connecting Equity and Debt Valuation
		9.2 Valuation Based on Dividends or Free Cash Flows
			9.2.1 The Dividend-Discount Model
				Example 9.1: Calculating Stock Price and Return
				Example 9.2: Valuing a Company with Constant Dividend Growth
			9.2.2 The Discounted Cash Flow Model
				Example 9.3: Valuing Adidas Using Free Cash Flow
				Example 9.4: Sensitivity Analysis for Adidas´ Stock Valuation
			9.2.3 Comparing Absolute Valuation Methods
		9.3 Valuation Based on Comparable Companies
			9.3.1 Equity Value Multiples
				Example 9.5: Valuation Using the P/E Ratio
			9.3.2 Enterprise Value Multiples
		9.4 Impact of S and E on F: Integrating Sustainability into Value Drivers
			9.4.1 Value Driver Adjustment Approach
				Box 9.1: Novozymes: Competitive Advantage from Innovation
				Box 9.2: Anglo American´s Failure to Manage Local Stakeholders
				Box 9.3: VDA Example
		9.5 Valuation of S & E and Integrated Value
		9.6 Conclusions
		Appendix: Case Study Template-How to Integrate Sustainability into Financial Valuation
			A.1 Business Model and Competitive Position
			A.2 Value Drivers: Part 1
			A.3 Sustainability
			A.4 Strategy and Reporting
			A.5 Value Drivers: Part 2
			A.6 Investment Conclusions
		Suggested Reading
			References
	10: Valuing Private Equity
		10.1 Basics of Private Equity
		10.2 Valuation of Private Equity
			Example 10.1: PE Valuation with Changing WACC in DCF
			Example 10.2: PE Valuation with Multiples
		10.3 Impact of S and E on F in Private Equity
			Box 10.1: Apollo Launches Platform in Energy Transition and Decarbonisation Investments
		10.4 Valuation of S & E and Integrated Valuation in Private Equity
		10.5 Conclusions
		Suggested Reading
			References
	11: Case Study Integrated Valuation: Inditex
		11.1 Introduction to Inditex
		11.2 Inditex´ Business Model and Transition Challenges
			11.2.1 Business Model
				Box 11.1 Sustainable Marketing
			11.2.2 Purpose
			11.2.3 Stakeholders
			11.2.4 Financially Material Sustainability Issues
			11.2.5 External Impacts (Outward Perspective)
			11.2.6 Transition
			11.2.7 Management
		11.3 Valuing Inditex in Financial Terms (Inward Perspective)
			11.3.1 Basic Model: Before Assuming a Transition
			11.3.2 Value Driver Adjustments
			11.3.3 Transition Valuation Scenarios
		11.4 Valuing S and E at Inditex (Outward Perspective)
			11.4.1 Quantification: E and S in Their Own Units
			11.4.2 Monetisation: E and S in Monetary Terms
		11.5 Integrated Valuation of Inditex
		11.6 Conclusions
		References
Part IV: Risk, Return and Impact
	12: Risk-Return Analysis
		12.1 Historical Financial Risk and Return
			Example 12.1 Calculating Historical Stock Returns
		12.2 Traditional Measures of Financial Risk and Return
			12.2.1 Variance and Standard Deviation
				Example 12.2 Calculating the Expected Return and Volatility
			12.2.2 Historical Returns and Historical Volatility
				Example 12.3 Calculating the Historical Return and Volatility
		12.3 Diversification of Financial Risk in Portfolios
			12.3.1 Portfolio Return
			12.3.2 Variance of a Two-Stock Portfolio
				Box 12.1 Correlation in Stock Markets
				Example 12.4 Calculating Return and Volatility of Two-Stock Portfolio
			12.3.3 Variance of Large Portfolios
				Example 12.5 Calculating Variance of a Portfolio
		12.4 The Capital Asset Pricing Model
			Box 12.2 Assumptions Behind the CAPM
			Box 12.3 Leading Market Indices
			Example 12.6 Calculating the Beta and Cost of Equity
			Box 12.4 The Oil Industry Now and in the Future
		12.5 Sustainability Adjusted Financial Risk-Return Analysis
			12.5.1 Social and Environmental Factor Portfolios
			12.5.2 Challenges of the Multifactor Model
			12.5.3 Working of the Multifactor Model
				Box 12.5 Impact of Differing Carbon Intensity on Discounting and Values
				Box 12.6 Investment in Safety
		12.6 Social and Environmental Risk-Return Analysis
			Box 12.7 Calculating Annual Catastrophe Risk
		12.7 Integrated Risk-Return Analysis
			Example 12.7 Calculating the Cost of Integrated Capital
		12.8 Forward-Looking Risk
			12.8.1 Scenario Analysis
			12.8.2 Inditex Case Study
			12.8.3 Strategy-Setting
			12.8.4 Transition Pathways
			12.8.5 Uncertainty
			12.8.6 Forward-Looking Indicators
		12.9 Conclusions
		Suggested Reading
			References
	13: Cost of Capital
		13.1 The Cost of Financial Capital
			13.1.1 Cost of Equity Capital
				Example 13.1 Calculating the Cost of Equity Capital
			13.1.2 Cost of Debt Capital
				Example 13.2 Calculating the Cost of Debt Capital
			13.1.3 Weighted Average Cost of Capital
				Example 13.3 Calculating the WACC
				Example 13.4 Calculating SalMar´s WACC
			13.1.4 Project Cost of Capital
				Example 13.5 Calculating the Headquarters´ Project Cost of Capital
		13.2 Integrating Sustainability into the Cost of Financial Capital
			13.2.1 Adjusted Cost of Equity Capital
				Example 13.6 Calculating the Adjusted Cost of Equity Capital
			13.2.2 Adjusted Cost of Debt Capital
				Box 13.1 Sustainability-Linked Loan for Philips
			13.2.3 Adjusted WACC
				Example 13.7 Calculating the Adjusted WACC
		13.3 The Cost of Social and Environmental Capital
		13.4 The Cost of Integrated Capital
			13.4.1 Adjusted Cost of Capital
			13.4.2 Inditex Case Study
				Example 13.8 Calculating the Cost of Financial and Integrated Capital for Inditex
			13.4.3 Assets Versus Liabilities
				Example 13.9 Calculating the Cost of Integrated Capital for Almost Identical Companies
		13.5 Conclusions
		Suggested Reading
			References
	14: Capital Market Adaptability, Investor Behaviour, and Impact
		14.1 Efficient Markets Hypothesis
			Box 14.1 Interest Rate Announcements by Central Banks
			Box 14.2 Takeovers and Market Efficiency
			Example 14.1 Calculating the Expected Stock Price Change
		14.2 Investor Behaviour
			14.2.1 Financial Investors and Capital Market Competition
			14.2.2 Behavioural Finance
			14.2.3 Bubbles
		14.3 Adaptive Markets Hypothesis and Sustainability Integration
			14.3.1 Transition Preparedness
				Box 14.3 Limitations of ESG Ratings
		14.4 Impact Perspective
			14.4.1 Impact Information Producers
				Box 14.4 Applying Science-Based Targets
				Box 14.5 Amnesty International on Oil Spills
				Box 14.6 Global Witness on Deforestation
				Box 14.7 Moody´s on Reputational Risk of Deforestation
			14.4.2 Impact Markets and Pricing
				Box 14.8 Willingness to Pay for Impact
				Box 14.9 European Green Deal More Feasible Following Elections
			14.4.3 Impact Performance
			14.4.4 Inditex Case Study
			14.4.5 Environmental Impact
				Example 14.2 Carbon Budget
				Example 14.3 Company Performance on Land Use
		14.5 Impact Investors Looking for Integrated Return
			14.5.1 Impact-Adjusted Return
			14.5.2 Inditex Case Study
				Example 14.4 Computing the Impact-Adjusted Return of Inditex
			14.5.3 Integrated Return
			14.5.4 Return on Active Ownership
				Box 14.10 Transition in the Real Economy: Exogenous or Endogenous?
			14.5.5 Impact Investors
		14.6 Conclusions
		Suggested Reading
			References
Part V: Corporate Financial Policies
	15: Capital Structure
		15.1 Financial Capital Structure in Perfect Capital Markets
			15.1.1 Theories Explaining Financial Capital Structure in Perfect Capital Markets
				Example 15.1 Calculating the WACC
				Example 15.2 Calculating the Return on Equity with Leverage
		15.2 Financial Capital Structure with Imperfections
			15.2.1 Static Trade-off Theory: Taxes and Bankruptcy Costs
				15.2.1.1 Taxes
					Example 15.3 Calculating the Return on Equity with Corporate Tax
					Example 15.4 Calculating Equity Value with Leverage and Corporate Tax
				15.2.1.2 Bankruptcy Costs and Costs of Financial Distress
				15.2.1.3 Optimal Capital Structure and Trade-off Theory
			15.2.2 Agency Costs, Information Asymmetries, and Pecking Order
				Box 15.1 Effect of an Equity Issue with and Without Information Asymmetry
		15.3 Behavioural Perspective on Financial Capital Structure
			15.3.1 Internal Errors
			15.3.2 External Errors
		15.4 E and S Affecting Financial Capital Structure
			15.4.1 E and S Affecting Financial Capital Structure Through the Business Model and Operations
			15.4.2 E and S Affecting Financial Capital Structure Through Investor Perceptions
			15.4.3 E and S Affecting Financial Capital Structure Through Management Action
			15.4.4 Academic Evidence of E and S Affecting Financial Capital Structure
		15.5 Capital Structure of E and S
		15.6 Integrated Capital Structure
			Example 15.5 Calculating Integrated Capital Structure Ratios
			15.6.1 Inditex Case Study
				Example 15.6 Calculating the Leverage Ratios of Inditex
		15.7 Conclusions
		Suggested Reading
			References
	16: Issues and Payouts: Changes in Capital Structure
		16.1 Issues of Financial Capital
			16.1.1 How Issues Work
				Box 16.1 Basic-Fit IPO Prospectus
			16.1.2 Behavioural View on Issues
		16.2 Payouts to Financial Capital
			16.2.1 Payouts in Perfect Capital Markets
			16.2.2 Payouts with Imperfections
			16.2.3 Dividends
				Box 16.2 Timeline of the Telenor 2020 Dividend
				Box 16.3 Komatsu Dividend Policy
			16.2.4 Share Repurchases
				Box 16.4 Bekaert Share Buyback Programme
			16.2.5 Behavioural View on Payouts
				Example 16.1 Repurchases with over- and Undervaluation
		16.3 Relevance of E and S for Issues and Payouts of Financial Capital
			16.3.1 Internalisation of Risks
				Box 16.5 BP Cuts Dividend After Deep Horizon Oil Spill
			16.3.2 Internalisation of Opportunities
				Box 16.6 Environmental Assets at Novozymes
			16.3.3 Impact of Governance and Organisational Capital on Payouts
		16.4 Issues of and Payouts to Social and Natural Capital
		16.5 Integrated View on Issues and Payouts
			16.5.1 Integrated Payout Test
			16.5.2 Inditex Case Study
				Example 16.2 Calculating the Payout Ratios of Inditex
			16.5.3 Novozymes Case Study
		16.6 Conclusions
		Suggested Reading
			References
	17: Reporting and Investor Relations
		17.1 Financial Reporting and Analysis
			17.1.1 Why Report?
			17.1.2 Financial Statements & Financial Statement Analysis
				Example 17.1 Market and Book Value
		17.2 Audits and Investor Relations
			17.2.1 Audits
				Box 17.1 The Big Four
			17.2.2 Investor Relations
		17.3 Sustainability-Related Financial Reporting
			17.3.1 IFRS Sustainability Standards
				Box 17.2 Disclosure of Sustainability Topics: Taking Industry Context into Account
				Box 17.3 Strategy for Stranded Assets
			17.3.2 Sustainability Reporting Company Case Study
		17.4 Impact Reporting
			17.4.1 Convergence in Reporting
				Box 17.4 European Sustainability Reporting Standards (ESRS)
			17.4.2 Impact Reporting Frameworks
			17.4.3 Impact Reporting Company Case Study
		17.5 Integrated Reporting, Analysis, and Investor Relations
			17.5.1 Integrated Statements
			17.5.2 Integrated Audits and Investor Relations
		17.6 Conclusions
		Appendix: Financial and Integrated Ratios
			Profitability Ratios
			Liquidity Ratios
			Leverage Ratios
			Efficiency Ratios
			Valuation Ratios
			Integrated Ratios
		Suggested Reading
			References
	18: Mergers and Acquisitions
		18.1 M&A Basics, Motives, and Trends
			Box 18.1 Equity Carve-Out Example: The IPO of Porsche AG
			18.1.1 Market Reactions to M&A
			18.1.2 Types of M&A by Business Activity
			18.1.3 Motives
			18.1.4 M&A Advisory
			18.1.5 M&A Waves
		18.2 M&A Valuation
			Example 18.1 Value Creation in M&A
			18.2.1 Financing M&A Deals
				Example 18.2 Cash and Stock-Financed M&A
			18.2.2 Behavioural Issues in M&A Valuation
				Box 18.2 AOL´s Takeover of Time Warner
			18.2.3 Hedge Fund Activism
		18.3 E and S Affecting M&A Valuation
			18.3.1 E and S Effects on M&A Before Valuation
			18.3.2 E and S Effects on M&A Valuation
			18.3.3 E and S Effects on Post-Deal Performance
				Box 18.3 Health Issues Destroy Value in Bayer´s Takeover of Monsanto
			18.3.4 E and S Driven M&A Activism
		18.4 E and S Valuation of M&A
		18.5 Integrated M&A valuation
			18.5.1 Kraft Heinz-Unilever Case Study
			18.5.2 IPV Criterion
				Box 18.4 DSM´s Transition
			18.5.3 Integrated Takeover Test
			18.5.4 Integrated View on M&A Activism
		18.6 Conclusions
		Appendix: Kraft Heinz-Unilever Case Study
			Available and Missing Numbers in Kraft-Heinz´ Failed Takeover Attempt of Unilever
			Long-term Shareholder Value
				Social Value
				Environmental Value
				Total Long-term Value Destruction
			Conclusions and Recommendations
		Suggested Reading
			References
	19: Options
		19.1 Financial Options
			Box 19.1 A Very Short History of Option Contracts
			19.1.1 Call Option: Long
			19.1.2 Call Option: Short
				Example 19.1 Calculating the Value of a Call Option with Premium
			19.1.3 Put Option: Long
			19.1.4 Put Option: Short
				Example 19.2 Calculating the Value of a Short Put Option
			19.1.5 Combinations of Options & Hedging
				Example 19.3 Calculating the Profit of a Steelmaker After Hedging
			19.1.6 Put-Call Parity
			19.1.7 Capital Structure Expressed in Options
				Example 19.4 Calculating the Value of Risky Debt
			19.1.8 Option Quotations
				Example 19.5 Calculating the Value of Stock Options
		19.2 Valuing Options
			19.2.1 The Binomial Option Pricing Model
				Box 19.2 Put-Call Parity in the Binomial Pricing Model
				Example 19.6 Calculating the Value of a Call Option with the Binomial Model
			19.2.2 Multiperiod Binomial Model
			19.2.3 The Black-Scholes Option Pricing Model
				Example 19.7 Calculating the Value of a Call Option with the Black-Scholes Model
			19.2.4 Drivers of Option Prices
		19.3 Real Options on F
			19.3.1 Applications of Real Options
				Box 19.3 Put option on Refinery Capacity
			19.3.2 Types of Real Options
			19.3.3 Real Options to Deal with Uncertainty
			19.3.4 Using Decision Tree Analysis for Real Options
				Example 19.8 Calculating Expected Value with a Decision Tree
			19.3.5 Corporate Use of Real Options
		19.4 Real Options on F Driven by E and S
			19.4.1 Real Call Positions Driven by E and S
			19.4.2 Real Put Positions Driven by E and S
		19.5 Integrated Value as a Set of Real Options on F, E and S
		19.6 Conclusions
		Suggested Reading
			References
Index