Environmental, Social, and Governance (ESG)
Considerations in Investment Analysis
Jennifer Pham, a hedge fund analyst, is evaluating Everblue, a producer of disposable diapers. Everblue reports
in Vietnamese Dong (VND).
Pham first reviews her valuation model for Everblue shares. She expects a regulatory change to take effect in
two years that will require diapers to have at least 50% recycled content. Everblue's diapers already exceed
this standard. An effect of the new regulation would be an increase of raw material costs for manufacturers
that do not meet the new standard. As a result, some competitors would likely be forced out of the market.
Pham evaluates possible adjustments to her valuation model based on the expected regulatory change.
The disposable diaper industry performed well in the year just ended. As a result, at the beginning of the
current year, Everblue and two of its largest competitors announced their intent to complete different corporate
actions:
Everblue: special dividend
Competitor 1: reverse stock split
Competitor 2: stock dividend
Before proceeding with a special dividend, Everblue considers a plan to repurchase 200 million shares at a
market price per share of VND 50,000. The company would use debt to finance the entire share repurchase.
Relevant information for the share repurchase is provided in Exhibit 1.
Exhibit 1:
Shares outstanding (most recent year end) 500 million
Book value per share (most recent year end) VND 100,000
Current EPS before repurchase VND 4,000
Current earnings yield 8%
1. To reflect the expected regulatory change, Pham's most appropriate adjustment to her valuation
model would be to increase Everblue's:
a) discount rate.
b) cost of goods sold.
c) projected revenues.
Theresa Blass manages the Toptier Balanced Fund (the Fund) and recently hired John Yorkton, a junior
analyst, to help her research investment opportunities. Blass plans to integrate environmental, social, and
governance (ESG) factors into her analysis. She is researching an equity investment in Titian International, a
global steel producer. She asks Yorkton to identify ESG factors impacting Titian and estimate the equity
valuation for the company.Yorkton uses proprietary methods to identify the ESG factors.
Yorkton points out that Titian’s steel production is energy intensive and relies on coal in producing its main
product, stainless steel. The firm’s major customers are oil and gas firms using stainless steel in their drilling
operations. Most of Titian’s steel capacity is located in developing economies, where it currently faces few
environmental regulations. Titian has a 10-member board with a chairperson and 5 independent members. The
chairperson is not the CEO, and the board is diverse, with 6 women. The company has an excellent record on
employee health and safety.
In a discussion with Blass about ESG factors in investment analysis, Yorkton makes the following statements:
Material ESG information used in investment analysis is best obtained from the individual
Statement 1 companies.
Statement 2 The level of disclosure varies among companies because these disclosures are voluntary.
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Environmental, Social, and Governance (ESG)
Considerations in Investment Analysis
Statement 3 The time horizon has little effect on the materiality of the underlying ESGfactors.
Yorkton integrates ESG factors into the equity valuation of Titian. He believes the company faces significant
long-term risk due to regulatory changes regarding greenhouse gas emissions in the developing economies.
These changes will have a negative impact on Titian’s steel capacity and its production costs. Based on long-
term forecasts from the International Energy Agency (IEA), Yorkton expects oil and natural gas demand to
decline over the next decade, reducing oil company capital expenditures on exploration and drilling. He uses
a discounted cash flow model to value Titian stock.
2. The potential problem with Yorkton’s approach to identifying ESG factors is the:
a) promotion of uniform accounting standards.
b) subjective assessment of ESG scores and rankings.
c) inconsistent reporting of ESG information and metrics among firms.
3. The most relevant industry risk factors affecting Titian are:
a) social.
b) governance.
c) environmental.
4. Which of the statements made by Yorkton on ESG factors in investment analysis is correct?
a) Statement 1
b) Statement 2
c) Statement 3
5. Titian faces long-term risk from ____ due to potential regulatory changes in the developing
economies.
6. Yorkton’s ESG integration approach is likely to impact equity valuation by:
a) increasing revenues.
b) .raising the discount rate.
c) reducing operating costs.
7. After integrating the ESG factors into the discounted cash flow model, the equity value of Titian is
likely to:
a) decrease.
b) remain unchanged.
c) .increase.
Emily Marker, CFA, is a fixed-income analyst for the Namsan Funds. Her supervisor asks her to identify ESG
factors and value the corporate bonds of BR Hotels, a publicly traded boutique hotel company. Marker notes
that BR Hotels is a “green hotel” company that prioritizes sustainability and has successfully reduced water
and energy usage at its hotels. The founding family owns 55% of the outstanding shares. Each ownership
share has equivalent voting rights.The board of directors of BR Hotels consists of 15 members, with
independent CEO and chairperson roles. The board includes one independent member and two women, and
20% of the board members have experience in the hotel industry.
BR Hotels has historically had a high labor turnover rate. Most of its workforce are paid at or near the
minimum wage, and the company offers no health benefits. Marker and her supervisor discuss how BR Hotels
will be affected by the expected passage of legislation raising the minimum wage and growing pressure to
offer benefits. Marker integrates ESG factors in the investment valuation of BR Hotels’ corporate bonds.
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Environmental, Social, and Governance (ESG)
Considerations in Investment Analysis
8. The potential conflict between or among shareholders and managers of BR Hotels can best be
described as:
a) voting caps.
b) a principal-agent problem.
c) a principal-principal problem.
9. BR Hotels’ corporate governance risk is increased by:
a) CEO duality.
b) family control.
c) the low percentage of independent board members.
10. The security analysis of BR Hotels is most likely focused on:
a) mitigating downside risk.
b) adjusting the discount rate.
c) identifying potential opportunities.
11. After integrating the ESG factors, the credit spread on BR Hotels’ bonds is most likely to:
a) decrease.
b) remain unchanged.
c) increase.
Ouse Inc., based in England, is a private company that produces and retails skin care products, primarily soaps
and lotions. Catherine Ferguson and her sister co-founded the company 10 years ago because of their shared
interest in developing plant-based products that are not tested on animals. Initially the two sisters owned all
the shares, but two years ago they implemented performance-based compensation for the top five senior
managers, and as part of this process, the managers now own a combined 10% of the equity.
The company is looking to expand its equity base to help fund a new production facility and support growth
plans. Ferguson, who is responsible for the company’s financial management, is meeting with Haji Malik, a
financial consultant, to explore Ouse’s equity financing options. Ferguson asks if they were to go public, could
they have a share structure similar to a company like Facebook, where the co-founders could retain voting
control of the company through the issuance of multi-voting ordinary (common) shares.
Malik informs her that the dual class shares she has described are not permitted in the United Kingdom. He
states that before Ouse considers going public, there are other options available. He suggests they look for
private equity investment. He mentions being familiar with a private equity fund that runs a socially
responsible investment (SRI) pool that could potentially be interested in Ouse. He says in order to qualify to
be included in the SRI pool, a company needs to demonstrate positive attributes in all areas of ESG
(environmental, social, and governance) considerations.
Ferguson is very interested in being associated with an SRI fund and asks how Ouse could qualify for the
investment. Malik explains that the private equity fund he is thinking of uses data provided by the company
and looks for other information from industry organizations, news reports, and environmental groups.
Ferguson explains to Malik that Ouse is implementing a new initiative to reduce the packaging associated
with their products. The company will stock the majority of their products in bulk containers in their retail
outlets. Customers will purchase refillable bottles, available in three different sizes, to be used for future
purchases. This change will attract customers interested in reducing their plastic footprint. The company also
expects the change to reduce shipping, packaging, and handling costs, both at the distribution centers and in
the retail stores. The numerous individual bottles that would have been packaged for shipping and then
unpacked and shelved at the stores will be replaced with larger bulk containers. Malik notes that when
announced, analysts will use this information in their valuation of Ouse.
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Environmental, Social, and Governance (ESG)
Considerations in Investment Analysis
12. The change in ownership structure that occurred two years ago most likely addressed which of the
following issues associated with family-owned businesses?
a) Poor transparency
b) Interlocking directorships
c) Ability to attract quality management
.
13. If Ouse were to go public with the share structure similar to Facebook that Ferguson asked about,
which governance issue would most likely arise?
a) Voting cap restrictions
b) Principal–agent problem
c) Principal–principal problem
14. Which of the following approaches to identifying a company’s ESG factors best describes the one
used by the private equity fund that Malik mentions?
a) ESG data providers
b) Proprietary methods
c) Not-for-profit initiatives
15. Analysts interested in incorporating ESG factors into their analysis will most likely adjust for the
announcement of the changes arising from Ouse’s new packaging initiative by:
a) increasing the risk premium.
b) increasing the company’s fair value.
c) modifying only the qualitative ESG analysis.
16. The principal–agent problem is most severe under a corporate ownership structure of:
a) dispersed ownership and dispersed voting power.
b) concentrated ownership and concentrated voting power.
c) dispersed ownership and concentrated voting power.
17. A corporation’s two-tier board of directors is most likely to consist of a(n):
a) executive board that oversees an internal board.
b) external board that oversees a nonexecutive board.
c) supervisory board that oversees a management board.
18. CEO duality refers to a situation where the chief executive officer (CEO):
a) is a shareholder in the company.
b) serves as chairperson of the board.
c) has been granted superior or even sole voting rights.
19. In fixed-income analysis, ESG integration is:
a) generally focused on identifying downside risk.
b) used to identify both potential opportunities and downside risk.
c) generally focused on identifying potential opportunities.
20. Which of the following would be least likely to help control the principal-agent relationship(PAR)
problem?
a) Fire employees who misbehave.
b) Increase the asymmetry of information between the owners of the firm and the employees.
c) Alter the behavior of executives through goal setting.
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Environmental, Social, and Governance (ESG)
Considerations in Investment Analysis
21. All of the following are examples of the principal-agent relationship (PAR) problem EXCEPT:
a) an employee calls in sick to use up their sick time since they cannot carry it over to the next year.
b) two members of a board of directors are having an illicit relationship.
c) a senior executive routinely leaves the office early claiming to work from homeyet there is no
accountability.
22. Regarding the process of evaluating ESG risk exposures and investment opportunities related to a
company, it is least likely that ESG integration will be used in:
a) fixed-income analysis to identify upside opportunities.
b) equity analysis to identify downside risk.
c) fixed-income analysis to identify downside risk.
23. Which of the following scenarios is NOT an example of a principal-agent problem?
a) A board member also serves as a consultant to the company.
b) Top management is awarded large amounts of executive stock options.
c) A senior manager also serves as a director on the board of another company.
24. In the process of identifying and evaluating ESG-related risk exposures and investment
opportunities, there is greatest consistency across companies in considerations related to:
a) environmental.
b) social.
c) corporate governance.
25. Which of the following least accurately describes one of the non-traditional "ESG" business factors
that may be critical to a company's long-term sustainability?
a) governance risk exposures
b) security risk exposures
c) environmental risk exposures
‘
26. CEO duality exists when the chief executive officer:
a) also has a controlling interest in the firm.
b) is simultaneously realistic and optimistic.
c) also serves as chairperson of the board.
27. The boards in a two-tier board of directors are most likely to be structured as a:
a) executive board and a non-executive board.
b) external board and an internal board.
c) supervisory board and a management board.
28. The principal-agent problem can best be described as:
a) the agent may act for the well-being of the principal rather than that of the stakeholders.
b) the agent may act for the well-being of management rather than that of the stakeholders.
c) the agent may act for his own well-being rather than that of the principal.
Maria Guadalupe Hernandez is a securities analyst with Grupo Financiero Evaluar, S.A.B. deC.V. (Evaluar).
Hernández is responsible for covering eleven companies in the Consumer Staples industry. Hernandez
reports to Jose Antonio Rodriguez, a senior analyst and partner with the firm.
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Environmental, Social, and Governance (ESG)
Considerations in Investment Analysis
Although Rodriguez has for a long time been aware that corporate governance can have a significant impact
on a firm's long-term performance, he has more recently become increasingly concerned with environmental
and social factors, specifically how companies manage related resources and risk exposures.
Rodriguez has noted that mismanagement of ESG factors has led to a number of widely reported corporate
events that have had significant negative impacts on securities prices. In addition to focusing on corporate
ownership structures and how these ownership structures may affect corporate governance outcomes,
Rodriguez has asked Hernandez to also take into account ESG-related risks and opportunities that are
relevant to security analysis.
Rodriguez has asked Hernandez to begin incorporating environmental, social, and governance (ESG)
considerations into her investment analyses, in order to provide a broader perspective on the risks and
investment opportunities of the various companies' securities that she analyses.
29. Hernandez is most likely to encounter principal–agent problems when analyzing a company with
an ownership structure that combines:
a) dispersed ownership and concentrated voting power.
b) dispersed ownership and dispersed voting power.
c) concentrated ownership and concentrated voting power.
30. Hernandez is analyzing the securities of a company that has mutual business interests with another
company. Two firms have cross-holding share arrangements with each other. Hernandez could
best describe this structure as:
a) horizontal ownership.
b) pyramid ownership.
c) vertical ownership.
31. Rodriguez points out to Hernandez that CEO duality is present in one of the firms that Hernandez
is analyzing. It would be most accurate for Hernandez to describe CEO duality as the scenario where
the chief executive officer also serves as the firm's:
a) chief operating officer.
b) chairperson.
c) president.
32. When integrating corporate governance and ESG factors in investment analysis, Hernandez is least
likely to face which of the following challenges?
a) ESG information and metrics are inconsistently reported by companies, and such disclosures are
voluntary.
b) Corporate governance considerations, such as the structure of the board of directors, tend to be
inconsistent across most companies.
c) It is difficult to identify and obtain ESG information that is relevant and useful.
33. A principal-agent problem may exist between:
a) managers and directors.
b) regulators and directors.
c) shareholders and directors.
34. Which of the following best describes the principal–agent problem? An example of the principal–
agent problem is when:
a) a lawyer recommends protracted legal proceedings to her client.
b) a board of directors take advantage of their position at the expense of the shareholders.
c) owners of the firm gain at the expense of the employees.
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