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CCCCC A S EA S EA S EA S EA S E F O RF O RF O RF O RF O R C C C C C O R P O R AO R P O R AO R P O R AO R P O R AO R P O R AT ET ET ET ET E S S S S S U S TU S TU S TU S TU S T A I N A B I L I T YA I N A B I L I T YA I N A B I L I T YA I N A B I L I T YA I N A B I L I T Y

Donald J. Reed, CFA

DECEMBER 2001

SUSTAINABLE ENTERPRISE

P E R S P E C T I V E S

World Resources Ins t i tu t e

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Applying ConventionalValuation Methods toSustainability StrategiesRelative valuation (also known as fun-damental analysis) can assess the valueof strategies that reduce costs or in-crease earnings, so long as there arereliable estimates of the impact onthese income statement items.

Analysts have applied discounted cashflow (DCF) methods as a fundamentaltool to evaluate alternative corporateenvironmental strategies and projects.Paired with scenario and probabilitytechniques, analysts have estimated therelative financial exposure of companiesto potential changes in environmentalrequirements.

Applying EmergingValuation Methods toSustainability StrategiesRisk analysis can provide insights intothe value of corporate sustainabilitystrategies through refined under-standing of how the strategies mightreduce economic cycles and downsiderisks associated with incidents orchanging acceptance of corporate

business practices. Particularly in-triguing is the notion that some com-panies—mostly in resource extractionbusinesses—face a potential loss of“social license to operate.”

Intangible assets make up an in-creasing portion of the overall valueof firms. Much of the potential forcorporate sustainability strategies toadd value comes from improvedmanagement of intangible assetssuch as brand, reputation, employeegoodwill, and intellectual propertyassociated with delivering social andenvironmental benefits. Existingmethodologies for valuing brandsand reputation do not offer corpo-rate sustainabil i ty practit ionersmuch help in understanding the fi-nancial contribution their strategiescontribute to the overall value ofreputation.

An emerging methodology for valuingcompetitive advantage by estimatingthe length of time that a company isahead of competitors, and the incre-mental return the firm can earn as aresult, has interesting potential appli-

For the private sector, a criti-cal issue is how social andenvi-ronmental investments

impact a company’s bottom line. Theconventional wisdom is that such in-vestments adversely affect corporateprofits, yet many companies havefound that prudent environmentalinvestments can lower costs or im-prove efficiency sufficiently to be anet economic gain. But is theirsound financial evidence to backthese claims?

Using an analytical approach that fo-cuses on estimating the expected fi-nancial results of specific strategies ata particular company, this paper ex-amines the business case for corporatesustainability strategies and the mod-est attempts to quantify it financially.It explores some interesting new pos-sibilities for quantifying the value ofcorporate sustainability strategies thatare not yet fully developed. “Corpo-rate sustainability” strategies are de-fined here as adding social and/or en-vironmental value to external stake-holders while increasing value toshareholders.

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cations to evaluating corporatesustainability strategies.

Arguably the most potent emergingvaluation methodology for illuminat-ing the value of corporatesustainability strategies is real optionsanalysis. This technique is so effectivebecause of its ability to model thevalue of these strategies as hedgesagainst changing social and environ-mental performance expectations andas platforms for whole new businesses.Included here is a hypothetical ex-ample of how real options methodol-ogy might be applied to valuing a strat-egy designed to enhance a company’ssocial license to operate.

Applying Financial Analysisto Different CorporateSustainability SituationsThere are two important keys to suc-cessfully applying financial analysis to

corporate sustainability: 1) asking andtrying to answer the right question,and 2) using a technique that is ap-propriate to the circumstances. Ana-lysts can apply financial techniques tofour different questions:

• What is the financial justification forthe corporate sustainability strategieswe are already pursuing?

• How can we use corporatesustainability strategies to add morevalue?

• How do we know whether or not weare adding value?

• What do we tell financial stakeholders?

Different methods make sense for dif-ferent strategies. The key to goodanalysis and choosing what model touse in any particular situation is under-standing what is known and not known,what can be reasonably estimated, andwhat cannot be estimated.

Conclusion

The financial business case forsustainability is most difficult whenthe value created is not just in the fu-ture and uncertain, but also from in-tangible assets. That doesn’t make itless valuable, just more difficult toanalyze. The emerging techniques ofcompetitive advantage and real op-tions analysis are capable of sheddinglight on the value of intangibles suchas reputation, knowledge of how tooperate more sustainably, and sociallicense to operate. Companies willbecome increasingly sophisticatedabout this issue as the financial stakesinvolved in social and environmentalstrategies increase. The first key au-dience for this will be internal finan-cial staff.

I. INTRODUCTION

statistical correlation between somemeasures of social and environmentalperformance and financial perfor-mance. It has been easy for believersto make much of these observations.Taken together, they are sufficient topersuade sustainable development ad-vocates that “something is happeninghere,” but insufficient to move all buta few major companies to take onmore than a thin slice of what civilsociety argues is necessary to bringabout a sustainable future.

Theory is not practice. Generic busi-ness cases and statistical correlationsmay be indicative, but they are alsoambiguous, are not persuasive tomany, and do not distinguish the rela-tive value of distinct strategies. Moreimportantly, if companies believe de-livering more social and environmen-tal benefits to society is good forshareholders, why are there so fewspecif ic examples of corporatesustainability initiatives with well-documented, significant financial

A small but significant group ofcompanies continue to both speakand invest as if they believe thatcertain strategies deliver new valueto both society and shareholders.Yet, the business case for corporatesustainability remains an enigma.

As many have observed, there is astrong theoretical case that strategiesthat improve environmental and socialperformance can increase shareholdervalue. Another case is that there is a


benefits? Why do those that want topeg the financial case for corporatesustainability all end up with a famil-iar set of shopworn examples?

The relative absence of financialquantification is understandable forseveral reasons. First, the field isnew. Second, few of those involvedin environmental and social strategieshave financial experience. Third, per-haps the efforts are so integrated intoother decisions that it is difficult toisolate the sustainabil ity effect.Fourth, for many strategies in use todate, the efforts and value createdmay be relatively small. Nonetheless,there is unexplored potential in ap-plying modern techniques of finan-cial analysis to understanding thevalue of corporate sustainabilitystrategies, or the financial side of thebusiness case.

The goal of this paper is to think throughthe business case for corporate respon-sibility, examine the modest attempts toquantify it financially, and explore somenew possibilities for quantifying thevalue of corporate sustainability strate-gies that are interesting, but not yet fullydeveloped. The landscape is made upof a variety of corporate sustainabilitystrategies and a comparable number ofdifferent techniques for quantifying thevalue of those strategies. The challengeis how to take what is known about howcompanies are valued and blend inknowledge of how companies are build-ing environmental and social strategiesinto their business.

Though every effort has been made tomake this analysis accessible to thoseleading the corporate sustainability ef-fort in major companies, most will re-quire assistance from either internal

or external sources to implement someof the techniques described here.

The starting point is to put in placesome fundamentals of the businesscase such as defining terms, evaluat-ing where we stand, suggesting what itmight look like if we were to find theelusive business case, and describinggeneral approaches people have takento making the business case. The nextstep is to offer a framework for under-standing the basics of valuation. Thislays a foundation for the rest of the pa-per, which provides examples of howboth traditional and modern valuationtechniques can be applied to corporatesustainability strategies. The pieceends with practical advice for applyingfinancial analysis techniques to corpo-rate sustainability strategies, particu-larly answering the right questions andselecting the right techniques.

II. BUSINESS CASE FUNDAMENTALS

Defining “CorporateSustainability” and “Valuation”

Definitions of “corporate sustainabil-ity” continue to evolve both broadlyand company-by-company; in this pa-per, the term refers to business strat-egies that are intended to add socialand/or environmental value to exter-nal stakeholders while increasingvalue to shareholders.

Though certainly not exhaustive ordefinitive, the following framework is

useful in describing these strategies.Figure 1 identifies four main types ofcorporate sustainability strategies,what business values they address,their focus, and their main financialimpacts. For company-specific ex-amples of these strategies, see bothGreen Shareholder Value: Hype orHit? and The Next Bottom Line.1

Valuation is an organized way of think-ing about how assets should be priced.Here, it refers mainly to the value of

equity, or ownership interest, in all orpart of a company. Financial analysisprovides the tools buyers and sellersuse to decide whether or not to trans-act. In this sense, valuation tools un-derlie market valuations. Market valu-ations are useful for assets that are“liquid,” or are traded commonly inquantity. For example, to find thevalue of a share of IBM stock, simplyget a current quote from the New YorkStock Exchange. For illiquid assets,however, market valuations may be


unavailable or require extensive modi-fication for a particular situation. To es-timate the value of IBM’s services busi-ness, for example, it is necessary to usevaluation methodologies. Similarly, toassess an outlook for the future of busi-ness computing services, you needvaluation tools to judge the relativevalue of IBM and its competitor, EDS.

Valuation is an art, yet it often usesmathematical tools that suggest theprecision of science. There are a vari-ety of different valuation methodolo-gies. Different analysts use differenttechniques, and a given analyst mightwell use different techniques in differ-ent situations. While it is well beyondthe scope of this paper to delve deeplyinto different valuation methodolo-gies,2 the section below gives an over-view of the discipline and the follow-ing text demonstrates the applicationof a variety of valuation techniques.

What would the business caselook like if it existed?

The business case is not a generic ar-gument that corporate sustainabilitystrategies are the right choice for allcompanies in all situations, but rathersomething that must be carefullyhoned to the specific circumstances ofindividual companies operating inunique positions within distinct indus-tries. Successes in whole industriesand at other companies are useful ex-amples, but the case still has to beapplied one company at a time. Inaddition, social and environmentalagendas may not be equally importantin all industrial sectors, businesses,and companies. Nor should the busi-ness case suggest that greater socialresponsibility is a panacea that addsvalue to shareholders intrinsically,rather than as part of a carefullyplanned corporate strategy.

A useful business case would leadthose exposed to it to say, “Yes, thatseems like a good business idea andthe preponderance of evidence con-firms it.” One way of understandingwhat a suitable business case mightentail is to compare the case for cor-porate sustainability to another sig-nificant trend in corporate practice,such as total quality management(TQM) and its descendant, Six Sigma.

Both TQM and corporate sustainabilitywere untested and initially resisted oneconomic grounds. In both cases, thosewho adopted the approach at an earlystage believed in the concepts’ right-ness, rather than clear evidence thatshareholders would benefit. In fact, thecontagious quality of TQM that even-tually took hold was probably more afunction of customer preference andthe pursuit of market share than of ex-plicitly increasing returns to sharehold-

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ers. With corporate sustainability,could it be that we are only beginningto see the customer response that fanscompetitive flames to become moresustainable?

The analogy with TQM suggests thepossibilities for corporate sustainability,but there are also differences betweenthe two as business concepts. TQM wasa well-defined prescriptive program;corporate sustainability is diffuse andmore difficult to define. TQM, if prop-erly implemented, tended to enhanceshareholder value because the con-sumer benefited. Over time, producerslearned to provide greater quality at thesame or lower price, which increasedboth market share and earnings. Thesame dynamic has yet to become obvi-ous for corporate sustainability.

Approaches to the BusinessCase

WRI has identified four distinct waysthat corporate sustainability leadersmake the business case. The differentapproaches and statement of motiva-tion are:

Story Telling – “We should act be-cause others have had good results.”

Risk Avoidance – “We should act be-cause if we do not, something bad willhappen to us.”

Overall Excellence – “We shouldact because these actions demonstrateexcellence and we are excellent at allwe do.”

Analytical – “We should act becausean evaluation of our situation sug-gests action is in our best business in-terest.”

Storytelling. The stories about actualcorporate experiences are the mostcommon approach to making the busi-ness case. In WRI’s experience, mostof the stories are about implementingparticular strategies and what has hap-pened financially as a result. The sto-ries may or may not have analyticalevidence to support them, and any evi-dence may or may not be financial innature. One primary value of storiesis that they can bring abstract strate-gies to life.

The aspects of stories that appear tous to be most important are the strat-egy described in the story, the leveland scale of the example, and how dif-ferent the situation of the companytelling the story is from those exam-ining the story (e.g. “That would becompletely different in our industryor corporate culture.”)

The overwhelming majority of anec-dotes can be categorized as success-ful pollution prevention projects. Inpractice, many firms have found thatpollution prevention can be a cheaperway not only to comply with many en-vironmental regulations, but also toimprove operating margins throughgreater energy and materials effi-ciency. Most of the early anecdotes inthis category involved saving moneyby finding a less costly way to complywith regulatory mandates. Increas-ingly, companies have applied thesame techniques to going beyond theregulatory requirements because theybelieve they can gain some financialadvantage from doing so. This lattercategory is more commonly thoughtof as the heart of “eco-efficiency.”There are many well-documented ex-amples of financial benefits from

these strategies, but the best knownis probably 3M’s bold claim that it hasachieved cumulative savings of $810million since 1975 through pollutionprevention.3

Virtually all of these anecdotes areabout cost savings. That is consistentwith WRI’s experience of what mostcompanies are doing, as well as whatis most likely to be measured. Onerecurring problem with this cost sav-ings data is that it often lacks infor-mation on the expenses associatedwith obtaining the savings. Informa-tion on gross savings is not as mean-ingful financially as net savings datawould be. It is the same as the differ-ence between sales and earnings.

The “level” of the anecdote is impor-tant. The vast majority of the storieswere about a single process, plant, orproduct. A few were at the level of adivision of a company, or were com-pany-wide on a particular topic suchas waste reduction. Only a few storiesoffer company-wide information onthe financial contribution of environ-mental efforts. While examples at alllevels are instructive and indicative,larger examples tend to be the mostpersuasive. Scale is an issue that goesto the “materiality” of environmentalstrategies. Even if one agrees thatthese issues matter, the subsequentquestion is whether or not they mat-ter enough to focus on as a centralstrategy.

Many of these examples come frommature, commodity businesses such aschemicals and forest products. Theseindustries are extremely price sensi-tive. They compete for miniscule costleadership and fight vehemently overfractions of a percent in market share.


This suggests that even small cost re-ductions may be significant.

With few exceptions, which are dis-cussed later, the anecdotes offer littleinformation to compare the financialimpact with the size of the plant, divi-sion, or company. Without this context,it is difficult to make even a cursoryestimate of whether or not the impactis “material.” Nonetheless, it is easy toconclude that most of the dollar to-tals in the examples are quite modestby almost any standard.

While companies may be acting on thebelief that their corporate responsibil-ity strategies generate value, their sto-ries do not offer much convincing evi-dence of the financial results. This isnot to say that the benefits to share-holders are absent, but rather that veryfew companies are capturing the infor-mation to demonstrate the financial re-sults. This is admittedly difficult, be-cause the desired information will varywith the strategy used. What informa-tion to gather and how to organize it isdiscussed later in this paper.

Storytelling does not work well forthose who are trying to push the hori-zons. It also does not seem to be verymotivating, unless the stories comefrom within the audience’s culture. Itseems to be far more powerful if thesuccess with a certain strategy is in an-other division of the company than ifit happens at another company.

Risk Avoidance. Some have made thebusiness case by noting that adoptingcorporate sustainability strategies is theonly alternative to avoiding large per-ceived risks such as consumer boycotts,negative publicity, or environmental in-cidents. These risks are usually notquantified, but the threat of “getting

creamed” is quite real even in the ab-sence of a formal assessment or quan-tification of the external threats to thefirm related to social and environmen-tal performance.

The risk avoidance approach to the busi-ness case is arguably really just the nega-tive side of the storytelling approach. Itinvolves transposing the experience ofothers onto your own situation withoutdoing a detailed analysis of the specif-ics of your situation. I distinguish it herebecause different corporate cultures re-spond very differently to negative andpositive stimulus. In many corporatecultures, avoiding negative events orperformance is paramount, and thepower of the risk avoidance approach isnot overly sensitive to the examples ofmisfortune being in the same or similarindustries or situations. In less risk-averse corporate cultures, the relevanceof risk avoidance is heavily dependenton how close the example is to the com-pany and its situation. Shell’s experiencewith loss of market share connectedwith the controversy over the disposalof the Brent Spar oil platform may mo-tivate some strongly risk-averse compa-nies, but others find it hard to imaginea parallel for them unless they believetheir situation is quite similar.

Fear can be a powerful motivator, butthe power of this approach to the busi-ness case is limited without quantifi-cation of the scope of the threat. Thisapproach cannot address how much acompany ought to be willing to spendon an initiative in order to avoid fu-ture events. Overall, this approachsuggests only a limited set of appro-priate corporate responses.

Part of Excellence. A less-explored ap-proach to making the business case is

to argue that delivering social and en-vironmental benefits to stakeholdersis just another part of being an excel-lent company. This enterprise-wideleadership approach is built on thepremise that companies that are genu-inely good at what they do are alsogood at corporate sustainability. Thisis parallel to an approach taken in thebusiness classics on organizational ex-cellence Built to Last and In Searchof Excellence.4 This approach is alsoconsistent with the statistical case.Excellent companies deliver superiorfinancial results. Great social and en-vironmental performance is just partof that pattern.

While there are a few specific compa-nies such as Johnson and Johnson thatrelate corporate sustainability to theiroverall excellence, only modest re-search backs up the claim. There are,however, two pieces of work that dorelate to supporting this argument.One is a study by two managementprofessors at Boston College’s CarrollSchool of Management, SamuelGraves and Sandra Waddock, whoshowed that the original Built to Lastcompanies not only have continued tooutperform their peers financially, butalso have better employee relations,community relations, product (treat-ment of customer), and diversity mea-sures.5 While these characteristics donot exactly define corporatesustainability, they are reasonable par-tial measures. The water is muddied,however, by another study that ques-tions whether Built to Last companieshave continued to outperform theirpeers.6 The other study, by the Cen-tre for Tomorrow’s Company, is a com-pilation of research that shows com-panies practicing an “inclusive” or


stakeholder approach enjoy greatersuccess than do others.7

Analytical. In the storytelling and riskavoidance approaches, the emphasis ison the anecdote and its relevance: “An-other company did this and these weretheir results.” In the excellence ap-proach, the emphasis is on the exten-sion of corporate culture to deliveringsocial and environmental benefits.

In the analytical approach, compa-nies focus on a method of estimatingthe expected financial results of astrategy. Companies have done verylittle of this type of financial analy-sis. Much of the existing analysis isat the project level and comes from

the internal capital budgeting pro-cess. A fairly well-documented ex-ample of this is Georgia Pacific’sanalysis of a purchase of conservationlands for habitat for a particular birdspecies.8 These analyses typically re-late to current capital expendituresand to specific projects rather thanbroad corporate strategies.

There are few efforts to analyticallyexplore the value of corporatesustainability strategies at the enter-prise level. Such efforts are difficult,and the quality of the numbers inevi-tably goes down. The efforts oftenseem small relative to other factorsdriving value.

There is potential to use the toolsof modern financial analysis to shedgreater light on the value to share-holders delivered by well-plannedand executed corporate sustainabil-ity strategies. The point is not to ar-gue that the analytical approach tomaking the business case is betterthan the others; quite to the con-trary. Rather, the point is that dif-ferent people “get it” in differentways, and a quantified financial ar-gument is persuasive to many. I be-lieve financial audiences in particu-lar can best be reached with an ap-proach that uses a range of analyti-cal techniques to give scale to thefinancial impact.

III. A FRAMEWORK FOR UNDERSTANDING VALUATION

Figure 2, on the following page, laysout the main categories of valuationmethodologies.

The most mature valuation techniqueis relative valuation, which is alsoknown as fundamental analysis. In thisapproach, analysts compare ratios ofcertain market and accounting num-bers for a company to its peers or themarket as a whole. While certainly themost widely used valuation technique,it has substantial drawbacks. It doesnot explicitly deal with important fi-nancial concepts such as risk, the costof capital, and the time value ofmoney. It is also subject to the pecu-liarities of the accounting choices ofspecific firms.9

Everyone who has survived a modernbusiness school program knows that the

answer to nearly every interesting ques-tion involves “discounted cash flow.”The notion that the value of any assetcan be determined by projecting the netcash flows associated with the asset overits life and discounting that cash flowby an appropriate discount rate is ac-cepted dogma.

Much has been made in the businessworld of value-based quantificationmethods such as Economic ValueAdded©, Cash Flow Return on Invest-ment (CFROI), and others. Thesetechniques are all based on the samevaluation principles as net presentvalue and DCF, although they empha-size moving from accounting data toinformation about building share-holder value.10 Among the key virtuesof DCF is its ability to perform sensi-

tivity analysis, which assesses the sen-sitivity of shareholder value to certainfactors.11

However, there are weaknesses inthese approaches. For starters, theycan be difficult to implement. Specifi-cally, the level of risk is accounted forby the discount rate used to bring theestimated cash flows to a presentvalue. While there is some disagree-ment about how best to do this, it isparticularly difficult on individualprojects, where the risks are unclearor difficult to quantify. It is also diffi-cult to estimate some future cashflows under any circumstances. Willcustomers love the new product orhate it? In answering this and manyother questions, a single estimate ofcash flow seems inadequate.


One approach to dealing with thisproblem within the framework of dis-counted cash flow is to devise sce-narios around different possible out-comes, estimate the probability ofeach scenario, quantify the cash flowsassociated with each scenario, andapply discounted cash flow techniquesto get a probability-adjusted figure.WRI’s Robert Repetto and DuncanAustin in Pure Profit: The FinancialImplications of Environmental Per-formance have successfully appliedthis approach to valuing environmen-tal performance and positioning in theU.S. pulp and paper industry.

A range of emerging valuation tech-niques have evolved that addressthe various weaknesses of the tried-and-true relat ive valuat ion andDCF. For the most part, they serveas adjuncts to the established valu-ation methodologies that add in-sight in part icular s i tuations inwhich the traditional techniquesseem inadequate. This text will dealwith several of these emerging tech-niques in turn, but the key point isthat they are relatively new and lesscommonly used than relative valu-ation and DCF.

In the last decade, a number of man-agement thinkers have devised andpromoted business performance mea-suring systems that place emphasis onfactors they believe lead to the cre-ation of value rather than on the mea-sures of actual value. The best knownof these is the Balanced Scorecard.12

Others have referred to a set of “soft”factors that are precursors to financialvalue, or leading indicators. This cat-egory includes characteristics dis-cussed here such as reputation, intel-lectual property, and environmentalperformance, as well as others likeinnovation; customer satisfaction; cus-

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tomer retention; quality; new productdevelopment; research and develop-ment investment; research and devel-opment productivity; employee turn-over; employee satisfaction; and em-ployee training.

While measures of these character-istics are quite appropriate in evalu-

ating strategies including corporatesustainability, they are typically notsufficient for many finance pur-poses. They are not an establishedpart of the valuation realm. Thereare abundant examples of companiesexcelling in these characteristics andstill not delivering financial results.Here, I will make reference to these

precursor characteristics, but willemphasize how they deliver resultsin conventional financial terms.

With this foundation in the basics ofequity valuation, we now turn to howspecific types of corporate actions onsustainable development lead to spe-cific financial results.

IV. APPLYING CONVENTIONAL VALUATION METHODS

TO SUSTAINABILITY STRATEGIES

Most of the efforts to apply the tech-niques of financial analysis to under-standing corporate sustainability strat-egies have employed two establishedmethods of valuation. The first tech-nique is relative valuation, which isbased on financial statements and es-timating future revenue, earnings, and/or cash flow. The second is discountedcash flow, which is based on estimat-ing future cash flows and adjusting forthe cost of acquiring capital. The nextsection describes examples of each ofthese two methods.

We will then turn to a variety of othermethods for understanding value thatare less broadly used, but may be use-fully applied to the value created bycompanies using sustainability strate-gies. These methods include risk analy-sis; intangible assets, including brandand reputation; competitive advantage;and real options.

Relative Valuation and Earn-ings from Cost ReductionsThe most commonly used tools in rela-tive valuation are price ratios such as

price-to-earnings (PE), price-to-sales,or price-to-operating profit. At therisk of oversimplifying, there are twosteps to using this method. In the caseof using forward PE ratios, the firststep is estimating future earnings. Thesecond is deciding what “multiple,” orPE ratio, is appropriate to apply tothose estimated earnings. Whilesustainability strategies potentiallyrelate to both steps, most of the ef-fort to date has been applied to theprofit estimates.

A handful of companies have gatheredand organized data on the impact oftheir environmental programs in a waythat shows their impact on earningsthrough reducing waste, loweringcosts, and creating revenue streamsfrom waste. Cataloging these effi-ciency improvements and relatingthem to the broader operations of thecompany provides some insight intothe financial benefits of those environ-mental programs.

At least two companies have disclosedestimates of the net financial impacts

of their environmental programs as apart of their corporate environmentalreporting (CER). Baxter Internationalhas done this since 1992, and IBM be-gan the practice in 1997. This infor-mation is parallel to that provided bythe income statement in a firm’s finan-cial report. Hence, the analyst canapply the same sort of techniques or-dinarily used to analyze an incomestatement.

Table 1 takes information from BaxterInternational’s CER report and com-bines it with parallel numbers fromthe company’s financial report to pro-vide insight into the relative impor-tance of environmental activities tothe overall business. A quick look atwhat a financial analyst might do withboth sets of information show both thepotential and limitations of this ap-proach.

Baxter International’s CER identifiesand quantifies ways in which thecompany’s environmental programshave a positive impact on net incomeby either generating income or reduc-

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waste of non-hazardous materials(cost reduction). Baxter also reportsthe total cost of its environmentalprogram, including the activitiesthat produce the income describedabove. Although Baxter Interna-tional does not do this in their re-port, I calculated the net impact oftheir environmental efforts by sub-tracting the costs from the income.

At the end of 1998, Baxter Interna-tional was trading at a price-to-oper-ating profit ratio of 12 and had a mar-

ing costs. This includes the sale ofmaterials that are recovered or re-cycled and other activities that gen-erate “environmental income;” ac-tivities that result in savings as mea-sured by year-to-year reductions inactual costs (increases in actual costsare considered “negative” savings);and waste reduction and other ac-t iv i t ies that a l low cos t s to beavoided. The largest contributor tosuch savings is recycling (income),followed by energy conservation(cost reduction), and decreased

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1. Figures for “total environmental income, savings, and cost avoidance” and “total environmental costs” are taken from Baxter’s 1999 environmental health and safety performance report. 2. Remainder from income minus costs in pre-tax dollars. WRI calculation. 3. Figures for “sales,” “operating profit,” and “operating margin” are taken from Baxter’s 1998 financial report. 4. Portion of sales remaining after deduction of the cost of goods sold and expenses for selling these goods and for general administration. WRI calculation. 5. Quotient of “net environmental contribution” divided by “sales.” WRI calculation. 6. Quotient of “net environmental contribution” divided by “operating profit.” WRI calculation.

ket capitalization of $18.6 billion.This implies that the company’s en-vironmental strategies were worthapproximately $1 billion in total valueto shareholders. ($85.2 million in op-erating profit from environmentalcontribution times a price-to-operat-ing profit ratio of 12 equals $1.02 bil-lion.)

A similar analysis of the numbersfrom IBM suggests that their pro-grams make a much smaller relativecontribution to that company’s oper-

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ating profits. For IBM, the percent-age of operating margin from envi-ronmental efforts was only 1.1 per-cent, versus 5.5 percent at Baxter In-ternational.

In both cases, the companies are re-porting historical accounting figures,while analysts are most interested infuture earnings. The same is true ofall financial reporting. The implicit ar-gument to analysts in this case is thatenvironmental programs will continueto contribute profits in the future andare part of the “quality” of earnings.If analysts believe that earnings are ofa high quality and likely to be steadyinto the future, then they typically arewilling to pay a higher multiple aswell.

While this method does show how thescale of the environmental programrelates to the financial performanceof the company as a whole, it has anumber of limitations. First, the ac-counting numbers in the CER areheavily dependent on a set of as-sumptions about what the operatingconditions would be if the programhad not been in effect. The EHSleadership of Baxter makes no claimthat their numbers are of a compa-rable quality to those coming fromthe financial reports. As such, theyare uncomfortable with analysis suchas this that juxtaposes numbers fromthese two sources. Second, gatheringand organizing the data for the CER“income statement” requires a greatdeal of work, starting at the plantlevel. Third, the valuation itself isheavily dependent on the assumptionthat past efforts continue to yieldcomparable benefits in the future. Inthe final analysis, one must ask: Is the

level of confidence in the resultsworth the effort?

B. Discounted Cash Flow/Economic Value MeasuresDiscounted cash flow (DCF) is basedon the idea that the value of any assetcan be determined by projecting thenet cash flows associated with the as-set over its life and discounting thatcash flow by an appropriate discountrate that is adjusted for the risk. Themethod is built on the understandingthat the asset holder has particularrights to future cash flows. The tech-nique deals with both the time valueof money and the notion that eco-nomic value is only added when an as-set produces a return greater than itscost of capital.

Company financial reports categorizecash flows by their source. The threetypes of cash flow are driven by thefollowing common financial metrics:

Cash flow from operations—sales, margins, and tax rate

Cash flow from finance—cost of capital

Cash flow from investing—amount of fixed and workingcapital

Together, these yield the componentsused in calculating discounted cashflow: cash flow from operations, thediscount rate, and the level of debt.

Several different researchers have ap-plied DCF to valuing corporate envi-ronmental efforts. Frank Figge andStefan Schaltegger laid out the over-view case that most corporate environ-mental strategies have results that arepositive for shareholder value (as cal-

Box. Implementing an IncomeStatement Approach

There are several points to rememberwhen pursuing this approach. First, onehas to develop a system—to gather bothcosts and benefits from the processchanges and program elements—that isparallel to the existing systems for gath-ering plant and product financial data.

Get help from your finance office. Explainthat you are trying to produce somethinglike an income statement. You will usu-ally want to compare at operating profitlevel (revenue minus expenses, includingadministration, but before taxes and in-terest).

Those who have pursued this approachsay that it is important to be willing tobalance credibility and “doability.” It willnot be possible or worthwhile to gatherevery relevant piece of information with-out getting bogged down in complexity.This means one should:

• Build a pipeline of information be-tween those with the operating data(typically at the plant level) and thoseresponsible for aggregating the data;

• Build momentum by starting with datathat is relatively easy to gather andbuild to more difficult data collectiontasks;

• Design and implement systems for col-lecting data that is already being gath-ered by someone;

• Become relevant to plant managers;and

• Build slowly, with initial results show-ing the value of discrete, identifiableefforts to give everyone the opportu-nity to say, “This is a good idea.”

The approach requires you to make rea-sonable assumptions. It makes sense tobe transparent about those assumptionsso that analysts can vary them and gaugethe results.

The types of adjustments to consider in-clude a) corporate actions, buying, orselling businesses; b) opening and clos-ing plants; c) growth or decline in pro-duction levels; d) prices for commodi-ties disposal; and e) persistence of sav-ings.


culated by DCF) by reducing capitalintensity, reducing materials used,boosting sales, increasing margins,and reducing risks.13

Kaspar Mueller and his firm, Ellipson,have applied DCF, and particularlythe approach laid out by AlfredRappaport, to strategy and valuationdecisions in several company-specificcorporate sustainability situations.The most detailed of these in the pub-lic domain involves Ciba’s ChemicalsDivision (before the merger that pro-duced Novartis). This research exam-ines the impact of process changes attwo different units of the chemicalcompany. It begins with an analysis ofthe free cash flows of each operatingunit and the relative degree to whichthey are sensitive to changes inweighted average cost of capital,working capital, fixed capital, operat-ing margins, and sales growth rates.The research then demonstrates theimpact of the process changes on eachof these factors in both business units.The study concludes that the value of

an environmental strategy can bequantified, that environmental strat-egies must be adapted to a businessunit based on the value driver sensi-tivities, and that only the “right” strat-egies add value to the company.14

Ellipson has also applied this tech-nique to estimating the impact ofAssiDoman’s decision to have its for-estry operations certified by the For-est Stewardship Council.15

In 1995, Ralph Earle and ToddRhodes set out the foundation for ap-plying DCF to environmental strategydecision-making based on a processinvolving issue identification, scenarioanalysis, and DCF.16 The process de-scribed is designed to generate andevaluate alternative strategies to dealwith the risks and opportunities asso-ciated with the uncertain develop-ment of specific environmental issuesas those issues progress through alifecycle.

A different application of DCF tech-niques to the valuation of corporate en-vironmental strategies comes from

WRI’s Repetto and Austin in PureProfit. This path-breaking study com-bines DCF with the development ofscenarios around key environmental is-sues facing a particular industry—theU.S. pulp and paper industry in thiscase—to estimate the financial valueassociated with different environmen-tal performance and positioning withinan industry. The results show that a setof environmental issues identified bythe industry as being significant is fi-nancially material, and that its finan-cial effect varies substantially from onecompany to the next.

These techniques work particularlywell in situations where the analysthas a reasonable ability to project thecash flow impacts. It all comes downto what one can best estimate. Theapplication of scenarios and probabili-ties to the analysis increases the rangeof this technique, but the fundamen-tal limitation remains the difficulty ofestimating certain types of cash flows,especially those that involve the exist-ence of future decision points.

V. APPLYING EMERGING VALUATION METHODS TO

SUSTAINABILITY STRATEGIES

The traditional means of valuationdiscussed so far have served ana-lysts well over several decades.They do, however, have profoundlimitations that are not confined tounderstanding the value of corpo-rate sustainability strategies. Ana-lysts and academics have developeda number of new methods for quan-

tifying, or at least estimating, thevalue of a variety of corporate quali-t i e s tha t u sed to be t aken fo rgranted or understood only in quali-tative terms. In several instances,these techniques build upon or in-corporate DCF. This section willb r i e f l y e xp l a in some o f thesesources of value, techniques for

measuring them, and—where pos-sible—how they can be applied tocorporate sustainability. While lessuniversally used, they are estab-lished tools with the ability to re-veal certain aspects of corporatesustainability strategies better thanrelative value and DCF.


Risk AnalysisThe most common methodologies fordetermining the value of a change inthe level of risk are incorporated inthe relative value and DCF methods.Using relative value techniques, ananalyst might say that a particular de-crease in risk for a company shouldwarrant an increase in its price-to-earnings ratio to that of another com-pany in a comparably risky situation.Alternatively, an analyst using DCFmight say the decreased risk wouldlead to a lower discount rate, andthus an increase in value. Neither ofthese techniques is particularly use-ful in understanding or measuring thevalue of corporate sustainabilitystrategies in reducing risk. The lackof comparable companies with simi-lar strategies limits the use of therelative value technique and there isno accepted means for determiningthe size of a discount rate change inthe DCF methodology.

I have included risk analysis in the cat-egory of emerging valuation method-ologies because this section focuses onother methods of analyzing the valueof risk reductions. Risk, like beauty,is in the eye of the beholder. Manydifferent concepts masquerade underthe single heading of “risk.” Justwithin the financial world, risk is aconcept with several different mean-ings.

Most advocates of corporate sustain-ability tend to focus on individualcompany risks, such as the risk of:

• an accident or major incident (aris-ing from normal operations) with so-cial or environmental consequencesfor which the company will be heldresponsible;

• unexpected costs or benefits fromchanges in regulation; and

• damage to reputation and brand eq-uity.

In modern financial theory, however,the risk of owning an asset is definedby how much it contributes to theoverall risk of an investment portfo-lio. Thus, financial risk analysis putsthe emphasis on the degree to whichthe stock of a company is correlatedto the rest of the market.

We know of one example where acompany, DuPont, specifically arguesthat its corporate sustainability strat-egies make their company less corre-lated to the market, reducing thecompany’s financial risk to sharehold-ers. DuPont argues that the decisionto replace a portion of their petro-leum-based feedstocks with renew-able resource feedstocks makes thecompany less cyclical, and hence lesscorrelated with the market. The argu-ment is sound, but lacks the quantifi-cation and rigor ordinary in commu-nications with investors.17

Two works have related corporate en-vironmental performance to this con-cept of systematic financial risk. ICFKaiser has done a statistical regressionof beta to a large range of factors, in-cluding several measures of environ-mental performance and environmen-tal management systems.18 The con-clusion is that the relationship be-tween these measures of environmen-tal performance and the standardmeasure of systematic financial riskare statistically significant. The secondwork is a piece by Bank Sarasin thatmakes the theoretical case for how tothink about the effect of environmen-tal performance on a company’s cor-

relation to the rest of the market andhow some environmental risks cannotbe eliminated through diversifica-tion.19

While these two studies contribute toour understanding of these issues,they do not offer much help to com-panies trying to quantify the financialimpact of their corporatesustainability efforts. They do not helpanswer the questions, how much doesthis reduce our risk? And how muchis that reduction in risk worth?

In reality, investors do not think aboutrisk solely in terms of correlation withthe market. Investors also care about“downside” risk. What is the risk thata company will have some unexpectedbad experience that will cause thestock to go down? Harvard BusinessSchool Professor Forest Reinhardtpoints out that environmental risks areasymmetric. They are more like “se-curity risks such as war and kidnap-ping, in that it has no short-term up-side,” than financial risks such as cur-rency risk.20 It is these risks that bestcorrespond to how many companiesare thinking about the risk-reducingvalue of their corporate sustainabilitystrategies.

The insurance industry routinelyprices some of these risks for under-writing purposes using historical prob-ability and cost information. Actuarialdata may be useful inputs for a vari-ety of approaches to risk analysis, al-though it is not widely used outsideof the insurance industry. Companiescan also estimate the value of certainrisk reductions by understanding howtheir corporate insurance premiumswould be affected if they adopted cor-porate sustainability strategies. This


may be difficult information to obtain,especially for the substantial numberof companies that are self-insured.

Various services offer the financial ser-vices industry ratings of company-spe-cific environmental risks. While theyare intended to show how companiesare in different risk positions, they arenot structured as pricing tools, butrather as screening tools.21

There is another category of risk thatseveral companies believe their cor-porate sustainability strategies re-duce. These companies face the riskthat society will not let them continueto operate despite their compliancewith all applicable laws. This is mostfrequently referred to as a potentialloss of “social license to operate.”The most noted example is Shell’s ex-perience with Brent Spar, the oil plat-form in the North Sea. They faced aspontaneous consumer boycott overtheir handling of the disposal of therig, even though they were in com-pliance with the law. Timber compa-nies in environmentally sensitive ar-eas are another example. Because thepublic outcry against clear-cuttingparticular holdings was so powerful,the BC Coasta l Group ofWeyerhaeuser Canada (formerlyMacMillan Bloedel) faced the riskthat they would not be able to har-vest timber they had legal rights to,even though there were in compli-ance with the law.

How does one capture and describe thefinancial dimension of these risks? Onealternative would be to use DCF withscenarios like those used by Repettoand Austin. You could describe sce-narios of different possible outcomesfor the social license to operate of a

company. For example, the scenariosmight be 1) no change, 2) limitationsapplying only to certain assets, and 3)broad loss of right to operate. Then,you would consult a range of expertsabout the probability of each scenario.The next step is to estimate the finan-cial impact of each scenario on the rel-evant set of companies. Another alter-native is discussed in the section on realoptions.

Valuing Intangible AssetsIntangible assets generally. Many ofthe assets developed by companiestrying to improve their sustainabilityare intangible. They are knowledge,brand, and reputation. Intangible as-sets are a broad category that includesbasically everything of value at a com-pany that is not property, plant, equip-ment, cash, or securities. Establishedaccounting techniques focus primarilyon tangible assets, with only a few con-cessions to the notion that intangibleassets produce value. The key intan-gible assets of brand and reputationare discussed separately below.

Despite the general agreement thatintangible assets are an increasing por-tion of the market values of compa-nies and are increasingly important tocompanies’ futures, the literature onthe subject is somewhat confused.There is no consistent language usedin categorizing different intangibleassets, which are sometimes also re-ferred to as intellectual capital.

The clearest framework for catego-rizing intangible assets was devel-oped by Sveiby and is used bySkandia, a Swedish financial servicescompany, in its annual reporting. Itlays out four types of intangible as-

sets: 1) human; 2) intellectual prop-erty; 3) internal systems, methods,and tools; and 4) (external) customerloyalty and brand.

Sveiby argues against putting financialvalues on these intangible assets in fa-vor of focusing on a scorecard ap-proach that measures attributes of theindividual components rather than fi-nancial values.22 It is therefore nothelpful in actually valuing intangibleassets.

Professor Baruch Lev of New YorkUniversity’s Leonard Stern School ofBusiness and Marc Bothwell, a port-folio manager with BEA-Credit SuisseAsset Management, have developed anew method for valuing knowledge as-sets that is based on segregating outearnings from tangible and financialassets from overall earnings.23 Whilethis technique gives dimension to in-tangible assets, it is difficult to relateit to any corporate sustainability ef-forts in a meaningful way. Nonethe-less, the intangible nature of many ofthe sustainable development assetsstands. It is unique knowledge thatenables a company to operate its fa-cilities more efficiently, to design newproducts and business models that useless material, and to connect with itsstakeholders in a strategic way.

Brand and reputation. Reputation andbrand value are important business is-sues across a large range of industries.They have become such standard ideasin the sustainable shareholder valuelexicon that they merit a separate dis-cussion here. While “reputation” and“brand” are not synonymous, they areclose enough to be discussed as a singletopic. The emphasis placed on thistopic in discussions of corporate


sustainability is clearly appropriate, butlacks analytical rigor. Analysts havebeen valuing brands rigorously at leastsince the late 1980s, when there was awave of brand acquisitions.

Analysts think of two different typesof brands: company brands and prod-uct brands. Sometimes the two arenearly indistinguishable. Coca-Cola isa good example. Procter and Gamble,on the other hand, is built aroundmany different product brands, in ad-dition to a corporate brand. One canimagine social and environmental per-formance issues affecting both prod-uct and corporate brands, but most ofthe emphasis has been on corporatebrands. Likewise, it is unclear whetheror not consumers sufficiently connectcorporations with the product brandsfor this to be an important consider-ation. For example, if the Tide brandis tarnished, how much does this mat-ter to other Procter & Gamble prod-uct brands?

In thinking through the importance ofthis issue, there are two separablequestions. How important is corporatesustainability (in both positive andnegative ways) to a given brand? And,how dependent is a given company onbranding? An appropriate analyticaltechnique needs to deal with bothquestions.

There are a number of techniques forvaluing brands, but only one is sophis-ticated enough and addresses both ofthese questions.24 Interbrand, a unitof the advertising group Omnicom, isarguably the guru of brand valuation.Interbrand annually values the top 60global brands and compares that valu-ation to the market capitalization ofthe companies. Coca-Cola is the most

valuable brand at $84 billion, or 59percent of the company’s market cap.Other highly valued brands representhigh proportions of the total value ofthe firms, with Apple, Nike, and BMWeach coming in at 77 percent of mar-ket cap from brand value. On theother end of the spectrum, GeneralElectric has the fourth most valuablebrand in the world, but that value isonly 10 percent of GE’s market capi-talization.

If the threat to highly valued brandsis such a powerful motivator for com-panies to pursue sustainable develop-ment priorities, then why are none ofthe owners of the top ten brands typi-cally identified with the corporatesustainability agenda? In fact, some ofthe sustainable development leaders,whose brands made the list of mostvaluable brands, have minimal por-tions of the market cap in the form ofbrand value. British Petroleum andShell were 45th and 49th respectively,but their brands represented only 3percent and 2 percent of their totalmarket capitalization.

The method used by Interbrand to es-timate the value of brands is to 1) es-timate the earnings from intangibles;2) estimate the proportion of earningsfrom intangibles attributable tobrands; 3) evaluate the strength ofthose brands going forward, andhence, the security of future brandearnings;25 and 4) discount the rev-enue stream by a factor that accountsfor the differences in risks to thebrands (as determined in step 3).

It is these last two steps where the im-pact of corporate sustainability strate-gies comes into play. How do you gofrom the evaluation of the strengths of

the brand to the discount rate? Pre-sumably, corporate sustainability strat-egies reduce the risks to the brand, butby how much? This is the same issueraised earlier with adjusting the dis-count rate in DCF calculations to ac-count for lower physical environmen-tal risks.

This study found no corporate effortsor studies that quantify the value ofcorporate sustainability strategies tobrands. The existing methodologies forvaluing brands don’t lend themselvesto obvious adaptations to focus on thevalue of these strategies. One possibil-ity would be to apply the Interbrandapproach to several different scenariosfor both positive and negative possibili-ties for a particular brand.

Valuing competitive advantage. An al-ternative way of thinking about theproblem of valuing these intangibleassets is that reputation, brands, tech-nology, and “know-how” all boil downto competitive advantage. Some ana-lysts object to the general nature ofthe concept of competitive advantage,arguing that any advantage will ulti-mately take the form of increasedsales, margins, or other more standardfinancial measure. While this is true,there are instances in which competi-tive advantage is broad, and perhapsmore easily measured as broad advan-tages rather than in future sales.Microsoft is an example. Do analystsreally know what volume of whatproducts the company will sell yearsinto the future, or are they more likelyto be on solid analytical ground esti-mating the broad advantage the com-pany has over its competitors?

One recently developed valuationtechnique focuses on the dimensions


of competitive advantage and trans-lates that into valuation terms. Thistechnique is the sales-driven franchisevalue model.26 Focusing on the com-petitive advantage of firms, the modelinvolves specific analysis of both thesize of margins earned above what awell-financed competitor could earn(excess returns) and the length of thecompetitive advantage period (CAP).Figure 3 plots excess returns and CAPon the two axes. In the first graph, theshaded area below the line representsthe financial value of the competitiveadvantage. In the following twographs, the shaded area shows howgreater excess returns and longer CAPincrease the financial value.

The underlying argument is that ana-lysts are better able to estimate themargins and length of the competitiveadvantage period than they are ableto estimate the specific impact on fu-ture earnings. This technique repre-sents an opportunity for equity ana-lysts to capture the new level of thevalue that sustainable business strat-egies generate.

The use of this analysis is still in itsearly stages, but several prominent in-vestment banks have incorporated itinto their company-specific analy-ses.27 If the model shows promise ex-plaining the value of competitive ad-vantage, then the connection to cor-porate sustainability is one of relatingthe sustainability strategies to thelength and magnitude of those advan-tages. Could one reasonably argue “acompany has an 18 monthsustainability advantage over its com-petitors and that it is worth a quarterof a percent in marginal return”? Ifso, this model shows promise in ex-

plaining how sustainable developmentstrategies can lead to direct value toshareholders. The underlying pointgoes back to using a model that uti-lizes the inputs you are best able toestimate. In any given situation, thequestion for the analyst is, “Am I moreconfident in my ability to estimate thelength of the competitive advantageperiod and the premium in margins,or am I better off estimating futureearnings or cash flows?”

An example focuses the question.Toyota and Honda are the first auto-mobile manufacturers to introducegenerally available hybrid gas-electricvehicles. Given major uncertaintiessuch as the size of the market for sucha vehicle, one might be more confi-dent in a valuation built on estimatesof the length and margin impact ofToyota and Honda’s competitive ad-vantage, than one based on estimatesof future net cash flows.

Real OptionsSome investments produce discrete,reasonably estimable cash flows witha beginning, middle, and end, whileother investments create business op-tions and will involve additionalchoices in the future. Discountedcash flow techniques work well foranalyzing the former investments,but do not produce reliable resultsfor investments that create optionsthat require future choices. This hasled some to explore other techniquesthat explicitly incorporate the valueof options created by these invest-ments. These options have a greatdeal in common with financial op-tions, and thus, the real options ap-proach is defined as “the extensionof financial option theory to options

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Figure 3.Competitive Advantage


on real (non-financial) assets.”28 Thissection discusses when it is useful toapply real option analysis and how itcan be applied to valuing corporatesustainability strategies, then con-cludes with a hypothetical example ofsuch a valuation.

When to use real options. Amran andKulatilaka, leading authors on real op-tions valuation, advise analysts to usereal options analysis when there is:

• a contingent investment decision;

• sufficient uncertainty to wait for moreinformation;

• value from possible future growth forwhich estimates of DCF are difficultor impossible;

• uncertainty large enough to makeflexibility a key criteria; or

• a likelihood of project updates andmid-course strategy corrections.

Others have observed that real op-tions are best at valuing the “next bigthing,” such as most Internet, or dot-com companies. Many have arguedthat the valuations achieved by thesecompanies even after these stocks fellfrom their heights of early 2000 ismerely a speculative bubble, but theunderlying premise of almost all valu-ations of early-stage companies is thatthey are establishing platforms thatgive them the option to participatein future markets. That option to ac-cess these future markets is the pri-mary source of value for which it isvirtually impossible to estimate fu-ture cash flows. Likewise, analystsvaluing these companies have littlehope of estimating future cash flows.Any estimate of future cash flowswould be a product of mildly in-formed guesswork.

Discounted cash flow accommodatessituations with “detail complexity,” inthat the analysis involves many de-tailed assumptions about the future.29

The technique of combining scenarioanalysis with discounted cash flowmentioned above adds to the qualityof the valuation, but also adds consid-erable detail complexity. Real options,however, work best in situations char-acterized by “dynamic complexity.”That is, this technique models thecomplex alternatives that a companyfaces in the future as it develops orabandons a project.

Perhaps the most helpful advice aboutwhen to use which technique comesfrom someone in the securities valua-tion profession. Michael Mauboussin,chief strategist with the research de-partment of Credit Suisse First Bos-ton, advises analysts to use discountedcash flow to value a company’s currentbusinesses, then add the value of thereal options they have created.30

The underlying concept is that defer-ring decisions about when and howmuch to invest or even whether or notto continue operating has value. Thisvalue flows from two sources.31 First,it is generally preferable to pay laterthan sooner. The same preference ap-plies to making decisions. The secondsource of real option value is that theworld can change, and it is thereforebetter to make some decisions laterrather than sooner. That is true bothbroadly and in the specifics of acquir-ing assets, developing systems, andhiring people.

While it may be a bit early to judge, itseems fair to say that much of the fieldof valuation is heading in the direc-tion of using real options. In fact, valu-

ation expert Tom Copeland antici-pates that in 10 years real options willbe the primary means of valuation,with DCF used as a special instanceof real options valuation.32

Application to corporatesustainability. Applying the conceptof real options to corporatesustainability is not exactly new, butvery little work has been done in thefield. The possibility was mentioned asearly as 1992,33 and developed in moredepth recently.34 Nonetheless, the hy-pothetical example developed here isthe only attempt I know of to apply realoption analysis to a specific valuationof a corporate sustainability strategy.

There are several types of real optionvalue that can be created by corporatesustainability strategies. One is devel-oping new products or changing exist-ing products through environmentallybeneficial technology. For example, acompany that develops a significantlylighter fuel cell may be concentratingon the applications in the transporta-tion market, but is also creating a realoption to enter the market for power-ing remote or off-grid electronic de-vises. Using real options analysis tovalue new technologies is not uniqueto sustainability strategies; the sameanalysis should be useful to under-standing a range of new technologies.

A second instance in which real op-tion analysis appears to be relevant ishedging risks, a primary function offinancial options. The relevant corpo-rate sustainability risk might be thatthe world will become decidedly lessfriendly toward business practices thatdo not add value to society. Develop-ing corporate sustainability strategiescan be a hedge against the risk of such


a change in the operating environmentof a business.

Certain strategies might create a thirdtype of real option value that is argu-ably unique to corporatesustainability. The section above onrisk analysis refers to preserving orenhancing “social license to operate”(SLTO). Increasingly in many indus-tries, maintaining legal compliance isinsufficient to preserve the corporateSLTO. WRI has worked with forestproduct companies that believe theirSLTO may be severely limited in thefuture despite operating entirelywithin the laws. Likewise, WRI hasworked with a metal mining companythat believes that it gains SLTO inemerging markets because of its sus-tainable development efforts. In bothcases, the value created is best under-stood through the use of real optionsanalysis.

So how much is it worth to these com-panies to develop a program that pre-serves or enhances their SLTO? Noestimation will be precise, but an or-der of magnitude would be helpful. Isit worth only $1 million, or is it worth$100 million? Real options analysiscan provide an answer.

Methods of using real options analy-sis. There are two different techniquesused to value real or financial options.The first is the Black-Scholes model,which uses information on publiclytraded instruments such as commodi-ties or stocks as inputs to value op-tions. It is difficult to apply this modelto real options unless there are mar-ket instruments such as other stocks,commodities, or derivatives that rep-resent the corporate sustainabilitystrategy being valued.

In the second technique, the analystconstructs a binomial model of ex-pected values of the strategy at spe-cific future times in order to calculatethe value of an option today. That isthe technique used below and de-picted in Figure 4. A binomial modelis built on the assumption that thevalue of the asset at a particular timein the future will be either A or B, andthat a similar process can be used todescribe the value for each successiveperiod.

A hypothetical example of real op-tions. In our hypothetical case, a min-ing company is deciding whether ornot it is worthwhile to invest $5 mil-lion today in making its operationsmore sustainable in order to enhancetheir SLTO. They believe there is a50 percent chance in each of the nexttwo years that there will be a changein the marketplace that will give theirSLTO strategy greater value. Thiscould be either an opportunity to de-velop a new property or avoid losingthe right to operate in an area. Sev-eral resource extraction companieswith which WRI works take this viewof the value created by their corpo-rate sustainability strategies. In themining arena, several companies be-lieve that their access to future con-cessions will depend heavily on theirability to demonstrate better socialand environmental performance thantheir competitors.

Figure 4 depicts a binomial modelof the estimated value of this strategyin one year and two years, separatefrom its costs, which will be incorpo-rated later. At the start, or T=0, thestrategy has a value of $5 million,equal to its cost. At the end of one year

(T=1), it has an estimated value of $25million if the SLTO strategy bearsfruit, and only $5 million if no situa-tions arise that give the strategy un-common value. Likewise, by the endof year two, the value of the strategycould either go up or down from eachof the two states that existed at theend of year 1. At the end of two years(T=2), the strategy will have experi-enced either: 1) two years in which thestrategy produced new value ($50 mil-lion), 2) one year in which it did pro-duce new value and another year inwhich it did not ($25 million), or 3)two years in which it did not producevalue ($5 million).

Where did the values come from?Here, they were made up. Ordinarily,one could estimate them using dis-counted cash flow based on appropri-ate assumptions for the conditions.The column on the right shows thevalue of the option at the end of yeartwo. This is the value of the strategy.In option terms, the $5 million costto put the strategy in place is the “ex-ercise” or “strike” price.

Given this information, one can cal-culate the value of the real option.The process is essentially workingbackwards from the option value atthe end of year two to its value at theend of year one, and finally to itsvalue at the time of the initial invest-ment decision. Appendix 1 goesthrough the calculation, but it is notnecessary to understand the compu-tation to understand the value of thismethodology. 35 The conclusion isthat the real option created by themining company’s SLTO operatestrategy has a posit ive value of$470,000 net of the $5 million costat the time of the initial investment


decision. This option value would notbe obvious through other analyticaltechniques.

Spending money on making the opera-tions of the company more sustainableand enhancing the license to operatecreates future opportunities for thecompany to grow. Many companiesbelieve they can enhance their SLTO,but expect that the main payoff will

be at an unknowntime several yearshence. The value ofsuch intangible“sustainability as-sets” is both uncer-tain and volati le.The uncertainty per-tains to both theamount of benefitand the timing, thetwo things an analystwould most want ifusing DCF. Thevolatility is not the

same as the day-to-day volatility ofprices that are often associated withoptions. The volatility of the value of“sustainability” assets stems from thepossibility that these assets may be ofrelatively little value, or they may beenormously valuable.

All else being equal, an option becomesmore valuable when volatility increases.Options are useful for hedging specific

risks. Developing sustainable compe-tencies and assets is a hedge against afuture in which those assets could sud-denly become substantially more valu-able. Thus, the analytical frameworkdeveloped for valuing options seemsappropriate for certain corporatesustainability strategies.

One key downside of real optionanalysis is that it is relatively compli-cated and unfamiliar to most. Assuch, it has not taken corporate plan-ning offices by storm. In the mostrecent annual survey of corporatemanagers on analytic tools by BainConsulting, 46 percent of companiesin North America said they had ex-perimented with real options analy-sis, but had given up on it.36 Like-wise, the application of real optionsto investment analysis has also drawncriticism, largely on the basis of dif-ficulties applying the technique.37

Perhaps those trying to better under-stand the value of the corporatesustainability strategies will find itworth the extra effort.

$5$5

$25$25

$5$5

T=0T=0 T=1T=1 T=2T=2

$25$25

$5$5

$50$50

VVAA

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FFOO

PPTT

II OONN

$20$20

$0$0

$45$45

Figure 4. Valueing an SLTO Strategy Using Real Option(in $MM)

VI. APPLYING FINANCIAL ANALYSIS TO DIFFERENT

CORPORATE SUSTAINABILITY SITUATIONS

How to best apply these financialtechniques to corporate sustainabilitydepends critically on two questions:

1) What question are you trying toanswer?

2) What analytical technique is thebest match with the strategy beingevaluated?

Applying the right technique to agiven strategy to answer the pertinentquestion of the moment seems obvi-ous, but all too often people fail to getthese two right.

Answering the right questionThere are many different questionsabout corporate sustainability that

could be answered with financialanalysis. Those questions fall into cat-egories that typically depend on wherethe company is in the process of inte-grating corporate sustainability intotheir business: deciding whether ornot to pursue corporate sustainabilitystrategies generally, justifying whatthey are already doing, planning new


efforts, evaluating efforts, and com-municating results to stakeholders.

Should we pursue a corporatesustainability strategy? The initialbusiness case is often the most diffi-cult. Companies typically lack relevantinternal financial data and are uncom-fortable with the modest or nonexist-ent financial information on compa-rable companies. Naturally, a companywill not have internal evidence of fi-nancial gain until they are further downthe road. As was the case with the earlyadopters of TQM, the goal is a solidlogical case, but the only truly convinc-ing evidence will be proof a companygenerates itself. The key to success isto avoid getting bogged down in theo-retical and philosophical issues in fa-vor of planning and evaluating specificinitiatives using the techniques of fi-nancial analysis.

What is the financial justification forthe corporate sustainability strategieswe are already pursuing? Frequently,a company has developed a collectionof activities that constitutes its corpo-rate sustainability strategy. Often,these are actually several unrelatedinitiatives that have evolved separatelyand are really a coherent, proactivestrategy. Likewise, these strategiesoften evolved without a consistentview towards how they would createvalue. They typically lack a mechanismfor gathering and organizing data toevaluate whether or not they are cre-ating value.

It is difficult to retrospectively deter-mine whether an existing set of initia-tives is creating value if data collec-tion was not designed into the effortsfrom the outset. Many retrospectivelooks at sustainability value creation

are left trying to determine the broadimpact on reputation. As noted above,the existing tools for valuing reputa-tion do not lend themselves to attrib-uting portions of that value to corpo-rate sustainability. In short, it is muchharder to demonstrate value creationwithout an established plan for how itis to occur and means of confirmingthat it is or is not taking place.

How can we use corporatesustainability strategies to add morevalue? Once a company has commit-ted to developing a sustainability strat-egy, the question becomes, “What ex-actly should we be doing that wouldadd the most shareholder value?”Here a company needs a conceptualframework that helps generate ideascombined with an evaluation of theshareholder value impacts with whichto compare alternatives, refine initia-tives, and establish performance tar-gets. This instills the discipline of con-necting planned actions to traditionalfinancial return measures or measuresof value precursors such as customersatisfaction that are accepted in theindustry.

Companies can use a four-step processdeciding what financial techniques touse to evaluate strategies, ideas, andinitiatives against other alternatives:

1) If you can estimate the basic num-bers necessary for a DCF analysis, doit.

2) If evaluating different scenarios ap-plies to the situation, add them to theDCF approach using estimated prob-abilities.

3) Think next about how the strategymay create real options. For example,does it create a platform or capability

that could be used to form other newbusinesses? Use real option analysisto value these option qualities.

4) If you still believe you are not cap-turing all the value, think of what pre-cursors to financial value this effortcreates and how the plan will ensurethat the precursors actually lead to thefinancial value.

How do we know whether or not weare adding value? Surprisingly fewcorporate sustainability efforts havebeen designed with data collection toanswer this question. It is critical toset targets in the planning stage andto track results. This provides both thebasis for a system of measuring theimpact on shareholders and criticalinformation necessary to improve theplanning process in the future.

What do we tell financial stakehold-ers? The reporting process shouldproduce evidence if strategies are re-ally creating value, but to effectivelyconvey the financial value of its envi-ronmental and social strategies—orother strategies for that matter—acompany must understand how it isbeing valued in the capital marketsand provide financial stakeholderswith information that relates to howinvestors are valuing the company. Ifinvestors care primarily about the abil-ity of the company to introduce newproducts, then talking about the costsavings of their sustainability strate-gies is less valuable than explaininghow social issues provide a source ofinsight for new product development.

Most publicly traded companies haveat least one person dedicated to com-municating with investors. Usuallythis Director of Investor Relations


Selecting an Approach

Figure 5 re-visits the framework Iused at the outset to describe corpo-rate sustainability strategies. The ad-dition is a row with the most likelytechniques for quantifying the valueof each strategy.

Different methods of analyzing the fi-nancial impact of sustainability strat-egies make sense for different strate-gies. The key to good analysis andchoosing what model to use in anyparticular situation is understandingwhat you do and do not know, whatyou are reasonably capable of estimat-ing, and what you cannot estimate.

If you actually feel you can estimatecash flows and the cost of capital for agiven initiative, use discounted cash

(IR) is the best starting place for un-derstanding how a company is pres-ently being valued. Do not assumethat you already know the answer. Askthe IR person what measures share-holders use in the industry and howthe company stacks up against othersin the industry by these measures.Also ask for help in thinking throughhow the sustainability strategies at thecompany might affect those measures.It may help to see a few reports frominvestment analysts on the company.

The goal is to have several “story lines”to test, such as, “Our reputation as themost sustainable operator in our seg-ment of the mining industry gives uspreferential access to certain newproperties in the developing world,”or “By involving nearly everyone in

the process of thinking about processchanges that reduce emissions, wehave an advantage over others in ourindustry at reducing our costs in acommodity industry where the goal isto be the least-cost producer.”

If one has followed the steps in plan-ning and documenting the financialeffects of the corporate sustainabilitystrategies, the company should havedocumentation on the real value cre-ated and how that compares withplanning expectations. While this isuseful information to convey to inves-tors, its greatest import is not in thenumbers themselves, but rather inproviding evidence of a focus onshareholder value and the ability todemonstrate whether or not a strat-egy is working.

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flow. This would typically be true ofinvestments that increased energy ormaterial efficiency. The example ofCiba Chemical’s shareholder value ap-proach by Mueller discussed above il-lustrates this well.

If an analysis indicates there are dif-ferent outcomes that would each leadto well-defined costs and benefits,but where the eventual outcome isuncerta in, then combining dis-counted cash flow with scenario andprobability analysis is most appropri-ate. The example is the work ofRepetto and Austin on the U.S. pulpand paper industry.

If, however, cash flows are very dif-ficult to predict or if the value of aparticular possible outcome willchange significantly over time as anevent approaches, then other meansare necessary.

In some cases, it is possible to pre-dict how a strategy will affect com-petitive advantage. For example, if a

strategy will provide an advantagethat should earn a return 1 percentgreater than that of a competitor andthat advantage should last six months,then the sales-driven franchise valuemodel could be used. This techniquefits best with strategies designed todevelop broad competitive advan-tages with significant expected dura-tion. More tactical moves are diffi-cult to value.

With new product development andpreserving or enhancing “social li-cense to operate,” the most appropri-ate method is real options valuation.The common element is the changingnature of the competitive environ-ment and the opportunity to makenew decisions at later points in time.

There are certainly other cases wherelittle is known about either the likeli-hood of particular outcomes or theirscale. This is ignorance and should berecognized as such. There are somesituations in which no analytical toolswill help.

As for using measures of characteris-tics that are logical precursors of fi-nancial value such as innovation andcustomer satisfaction, keep two pointsin mind. First, if you believe that aprecursor is key to understanding thevalue of a corporate sustainability ef-fort, then assure that it is strongly as-sociated with value in your industry.For example, it is true that customersatisfaction is always a good thing, butit is not necessarily an importantdriver of value in commodity indus-tries in which customers have lowswitching costs and are extremelyprice sensitive.

Second and more important, buildingprecursor measures alone is notenough. As noted above, there are nu-merous examples of companies gettingthese “soft” measures right, but stillfailing to deliver financial value. Inusing these measures, you should alsobe able to explain how those precur-sors will in fact deliver results in con-ventional financial terms.

VII. CONCLUSION

An increasing number of major corpo-rations are moving seriously on busi-ness strategies that create shareholdervalue by delivering social and environ-mental value to society. All else beingequal, it is good to produce more valueto society, but “all else” is almost neverequal. That is why superior tools toevaluate the shareholder value createdare critical to the success of corporatesustainability strategies.

Those who care about the value to so-ciety also should care about the abil-ity of companies to deliver share-holder value. The financial dimensionof the case for corporate sustainabilitystrategies has long eluded those whohave sought it. Many of the pat an-swers can safely be rejected. The fi-nancial case is neither obvious, nor im-possible. It is not a matter of aggre-gate statistics. It is understood most

meaningfully at the company level inthe context of that company’s strategywithin their industry.

There is a transition in thinking aboutfinancial value in business. Relativevaluation is still the standard in muchof the investing world. DCF and re-lated techniques show advantages, aredominant in corporate capital expen-ditures, and are ascendant among in-


vestors. Emerging techniques—par-ticularly real options—are beginningto take root on the corporate planningside, but are still drawing puzzledlooks among investors.

Investors will not be the ones to breakthe code to understanding the valueof corporate sustainability strategies.Investors do not lead the creation ofvalue; they follow it. It is up to thosecompanies that believe they are creat-ing value through sustainability strate-gies to clearly articulate that value to in-vestors and financial analysts.

Those who are struggling to more fullyunderstand the elusive financial valueof corporate sustainability strategiesdo, however, have much to learn fromthe evolving discipline of financialanalysis. There are a variety of possi-bilities for how one might take whatthose on the investment side of theshareholder equation have developedand apply it to the company side.

The f inancial business case forsustainability is most difficult whenthe value created is not just in the fu-ture and uncertain, but also from in-

tangible assets. That doesn’t make itless valuable, just more difficult toanalyze. The emerging techniques ofcompetitive advantage and real op-tions analysis are capable of sheddinglight on the value of intangibles suchas reputation, knowledge of how tooperate more sustainably, and sociallicense to operate.

Companies will become increasinglysophisticated about this issue as thefinancial stakes involved in social andenvironmental strategies increase.The first key audience for this will beinternal financial staff. Once chief fi-nancial officers become comfortablewith these applications of financialanalysis, they will then be willing tomake the case to shareholders. Thisstep is essential if companies are toclaim credit for the value of their cor-porate sustainability strategies. Like-wise, CFOs need to be more familiarwith how leading companies are man-aging risks and realizing opportuni-ties through corporate sustainabilitystrategies, and measuring the finan-cial results. While the techniquesrange from accounting to options

valuation, they all have a key commoncharacteristic. They will not make adifference unless enough companiesstart using them to differentiatethemselves from their competition inthe investment marketplace.

Acknowledgments

Special thanks to The Wallace GlobalFund, The Joyce Foundation, TheSurdna Foundation, and The SpencerT. and Ann W. Olin Foundation whosegenerous support made this publica-tion and other work of the SustainableEnterprise Program at the World Re-sources Institute possible. Thanksalso to the reviewers who helpedshape the thinking and presentationof these ideas: Kaspar Müller, RalphEarle, Allan Willis, David Tepper,Oliver Dudok van Heel, Matt Kiernan,Matt Arnold, Janet Ranganathan,Duncan Austin, and Don Doering.

Don Reed works for the Ecos Corpo-ration and can be reached [email protected].


APPENDIX 1. USING BINOMIAL MODELS

Solving a specific binomialmodel of an option value isdone in two steps. The firstis to value the end of thenodes.

$50$50

$25$25

$25$25

$25$25

$5$5

$5$5

$25$25

$5$5

$5$5

$50$50

$25$25

$25$25

$5$5

$25$25

$5$5

CCALLALL VVALALUEUE

$50*A – (1.05*B) = $45$50*A – (1.05*B) = $45

$25*A – (1.05*B) = $25$25*A – (1.05*B) = $25

A = 1 B = $4.76A = 1 B = $4.76

$25*A – (1.05*B) = $20$25*A – (1.05*B) = $20

$5*A – (1.05*B) = $$5*A – (1.05*B) = $

A = 1 B = $4.76A = 1 B = $4.76

$25*A – (1.05*B) = $20.24$25*A – (1.05*B) = $20.24

$5*A – (1.05*B) = $.24$5*A – (1.05*B) = $.24

A = 1 B = $4.53A = 1 B = $4.53Call option = $5*1 – $4.53 = $.47Call option = $5*1 – $4.53 = $.47

Call option = $5*1 – $4.76 = $.24Call option = $5*1 – $4.76 = $.24

Call option = $25*1 – $4.76 = $20.24Call option = $25*1 – $4.76 = $20.24

55

2525

55

T=0T=0 T=1T=1 T=2T=2

2525

55

5050

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$20$20

$0$0

$45$45The binomial model is based on the idea that thecash flow of any option can be replicated with theright portfolio of risk-free borrowing or lending andthe underlying asset.

The value of a call option is the current value of theasset times the number of units of the asset in thereplicating portfolio (A) minus the borrowingneeded to replicate the call option value (B).

C = V*A – B


ENDNOTES

1. Reed, Donald. 1998. Green ShareholderValue: Hype or Hit? Washington, DC:World Resources Institute. And Arnold,Matthew, and Robert Day. 1998. The NextBottom Line: Making SustainableDevelopment Tangible. Washington, DC:World Resources Institute.

2. The most widely cited texts on securitiesvaluation are Aswath Damodaran,Investment Valuation: Tools andTechniques for Determining the Value ofAny Asset (Wiley Frontiers in Finance),1995 and Tom Copeland, Tim Koller(Contributor), Jack Murrin (Contributor),Valuation: Measuring and Managing theValue of Companies, 3rd Edition, NewYork: John Wiley & Sons, 2000.

3. 3M. 1998. 3M Pollution Prevention Pays:Moving Toward EnvironmentalSustainability. St. Paul, Minnesota: 3M

4. James C. Collins, Jerry I. Porras. Built toLast : Successful Habits of VisionaryCompanies. New York: HarperCollins,1994 and Thomas Peters, Robert H.Waterman. In Search of Excellence:Lessons from America’s Best-RunCompanies. New York: Warner Books.1988.

5. Samuel B. Graves and Sandra A.Waddock, “Beyond Built to Last…Stakeholder Relations in ‘Built-to-Last’Companies,” unpublished, presented atThe Colloquium on Socially ResponsibleInvesting, New York Society for SecuritiesAnalysis, October 1999.

6. Greg Filbeck and Raymond Gorman, “IfBuilt to Last, Are They Built for Value?”,Journal of Investing, Volume 9, Number3, Fall 2000.

7. The Centre for Tomorrow’s Company,The Inclusive Approach and BusinessSuccess, the Research Evidence, GowerHouse: Aldershot, UK, 1997.

8. Global Environmental ManagementInitiative, Environment: Value to Business,Washington: GEMI, 1998.

9. For a more thorough discussion of thelimitations of fundamental analysis, seeMauboussin, Michael, Thoughts onValuation, Credit Suisse First BostonEquity Research-Americas, October 21,1997.

10. For more on the inter-relatedness ofeconomic value added measures and netpresent value analysis, see PamelaPeterson and David Peterson, CompanyPerformance and Measures of ValueAdded, Charlottesville, Virginia: TheResearch Foundation of The institute ofChartered Financial Analysts, 1996.

11. For more on sensitivity analysis, seeAlfred Rappaport, Creating ShareholderValue, New York: Free Press, 1997.

12. See by Robert S. Kaplan and David P.Norton, The Balanced Scorecard:Translating Strategy into Action,Cambridge: Harvard Business SchoolPress, September 1996.

13. Figge, Frank and Stefan Schaltegger,Environmental Shareholder Value, WWZ/Sarasin Basic Report, March 1998.

14. See World Business Council forSustainable Development: (WBCSD)Environmental Performance andShareholder Value. 1997. Also on theEllipson website: http://www.ellipson.com/.

15. Sustainable Forestry Pays, A WWFResearch Report, December 1999.

16. Ralph Earle and Todd A. Rhodes, “UsingScenario Planning for CompetitiveAdvantage,” Corporate EnvironmentalStrategy, Volume 3, No. 1, Summer 1995.

17. Conversations with Paul Tebo, DuPont.

18. Stanley Feldman, Peter. Soyka, and PaulAmeer, “Does Improving a Firm’sEnvironmental Management System andEnvironmental Performance Result in aHigher Stock Price?” a paper by ICFKaiser Consulting, November 1996 andStanley Feldman & Peter Soyka,“Capturing the Business Value of EH&SExcellence,” Corporate EnvironmentalStrategy, Winter 1997.

19. Frank Figge, Systematisation of EconomicRisks through Global EnvironmentalProblems: A Threat to Financial Markets?.WWZ/Sarasin Basic Report No. 56,August 1998.

20. Forest Reinhardt, “Tensions in theEnvironment,” Mastering Risk insert toThe Financial Times, Part Eight, June 13,2000.

21. For more on several environmental riskratings, see Marta Suranyi, Blind toSustainability?: Stock Markets and theEnvironment, London: Forum for theFuture,1999.

22. Karl-Erik Sveiby, Measuring Intangiblesand Intellectual Capital – An EmergingFirst Standard, August 1998, website.

23. S.L. Mintz, “A Knowing Glance: TheSecond Annual Knowledge CapitalScoreboard,” CFO, February 2000.

24. See Charles J. Fombrun, Reputation:Realizing Value from the CorporateImage, Cambridge, Massachusetts:Harvard Business School Press, 1996. and

Aswath Damodaran, InvestmentValuation: Tools and Techniques forDetermining the Value of Any Asset(Wiley Frontiers in Finance), 1995

25. Yates, Jane. 1999. Brand Valuation and itsApplications. Interbrand.

26. See Martin L. Leibowitz, Sales-DrivenFranchise Value, The Research Founda-tion of the Institute of CharteredFinancial Analysts, 1997.

27. The most notable is Credit Suisse FirstBoston.

28. Martha Amran and Nalin Kulatilaka, RealOptions: Managing Strategic Investmentin an Uncertain World, Harvard BusinessSchool Press, 1999.

29. Jim Smith, “Much Ado About Options?”Fuqua School of Business, DukeUniversity, July 1999, at http://www.real-options.com/smith.htm.

30. Michael Mauboussin, Thoughts onValuation, Equity Research-Americas,October 1997, Credit Suisse First BostonCorporation.

31. Timothy Luehrman, “InvestmentOpportunities as Real Options: GettingStarted on the Numbers”, HarvardBusiness Review, July-August 1998

32. Dirk Swagerman, et al, “New Develop-ments in Valuation,” Strategic Finance inthe 21st Century: Fifteen ExpertOpinions, New York: John Wiley & Sons,2000. Interview excerpts available athttp://www.monitor.com/cgi-bin/templates/ideas/index.html?article=75.

33. D. Keochlin and Kaspar Mueller,“Environmental Management andinvestment Decisions,” in Green BusinessOpportunities: The Profit Potential,London: Pitman, 1992.

34. Mark Milstein and Todd Alessandri, “NewTools for New Times: Using Real Optionsto Identify Value in Strategies forSustainable Development,” unpublishedworking paper, University of NorthCarolina at Chapel Hill.

35. For examples of the algebra, seeDamodaran.

36. “Fading Fads, The Economist, April 22,2000.

37. “CSFB Strategist’s ‘Dumb Agent’ StockApproach Attracts Followers,” The WallStreet Journal, September 1, 2000.


SUSTAINABLE ENTERPRISE PROGRAM (SEP)

A b o u t W R I . . .A b o u t W R I . . .A b o u t W R I . . .A b o u t W R I . . .A b o u t W R I . . .The World Resources Institute is an environmental think tank that goes beyond researchto create practical ways to protect the Earth and improve people’s lives. Our mission is tomove human society to live in ways that protect Earth’s environment for current and fu-ture generations.

Our program meets global challenges by using knowledge to catalyze public and privateaction:

• To reverse damage to ecosystems. We protect the capacity of ecosystems to sustain life andprosperity.

• To expand participation in environmental decisions. We collaborate with partners worldwideto increase people’s access to information and influence over decisions about natural re-sources.

• To avert dangerous climate change. We promote public and private action to ensure a safeclimate and sound world economy.

• To increase prosperity while improving the environment. We challenge the private sector togrow by improving environmental and community well-being.

In all of its policy research and work with institutions, WRI tries to build bridges betweenideas and action, meshing the insights of scientific research, economic and institutionalanalyses, and practical experience with the need for open and participatory decision-mak-ing.

Empowering business professionals to promote environmental progressFor more than a decade, WRI’s Sustainable Enterprise Program has harnessed the powerof business to create profitable solutions to environment and development challenges. WRIis the only organization that brings together corporations, entrepreneurs, investors, andbusiness schools to accelerate change in business practice. The program improves people’slives and the environment by helping business leaders and new markets thrive.

World Resources Institute10 G Street, NE, Suite 800

Washington, DC 20002http://www.wri.org/wri

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