How ESG disclosures impact IPO valuation

IPO-ready companies will see higher valuation and growth with robust ESG disclosure practices.

In brief

• Shifting stakeholder expectations and regulations increasingly make ESG reporting more than optional for public companies seeking to operate in global markets.
• In the early stages of insight and measurement, the benefits of ESG disclosure to IPO valuation and financial performance are backed by more empirical evidence.
• Companies seeking to go public must take concrete steps on ESG through a strategic, transparent, and data-backed approach.

EY’s 2021 Global IPO Trends (pdf) report identified ESG as a key theme for IPO candidates and investors, with some of last year’s largest IPOs launched by companies in the renewable energy, automotive and electric vehicle sectors. The ESG trend will only accelerate in 2022 and beyond.

Whether companies choose to hold or move forward on going public amid a global IPO market slowdown in Q1 2022, they will still need to satisfy stakeholder and regulatory demands for resilient growth strategies backed by well-articulated and principled ESG strategies.

The ESG tide is rising

There is a growing expectation from investors, consumers and regulators that companies looking to go public integrate ESG reporting into their equity offering.

As of 2020, the US had 25%—approximately US$12 trillion—of assets under management (AUM) in ESG-rated instruments. Sustainability funds in Asia doubled in 2020 in response to regulators requiring public companies to disclose ESG data and pension funds requesting their asset managers consider ESG factors in the investment process. According to the EY CEO Outlook Survey: October 2022 (pdf), 82% of respondents identified ESG as extremely important or important, when it comes to strategic decision making.

Increasingly, regulatory authorities around the world are demanding ESG disclosures from companies looking to go public. The ESG reporting landscape is rapidly moving toward globally harmonized disclosure standards through deeper, multilateral economic cooperation:

1. In June 2021, G7 Finance Ministers and Central Bank Governors endorsed the development of ESG standards that could form a global baseline of sustainability information—commitments that were further reinforced by the wider G20 in a communique released the following month.
2. An International Organization of Securities Commissions (IOSCO) report, also released in June 2021, outlined the financial sector’s vital role in supporting the transition to a more sustainable future by providing comparable ESG data facilitated by reporting standards.
   
3. Endorsed by the G7, G20 and IOSCO, the International Financial Reporting Standards (IFRS) Foundation endorsed an International Sustainability Standards Board to develop criteria forming a global baseline of sustainability information.
   
4. In March 2022, the Securities and Exchange Commission (SEC) proposed new disclosure rules requiring US companies to disclose greenhouse gas emissions and other climate-related information across their supply chains that have “material impact” on financial statements.

The data backs ESG benefits to IPO valuation

Evolving stakeholder expectations and global regulations clearly show that ESG and climate-focused corporate mandates are increasingly critical to a company’s successful IPO and overall performance. But there is less quantitative data demonstrating exactly how ESG impacts valuations.

Nonetheless, a growing body of academic evidence is starting to reveal concrete links between robust ESG reporting and pre-IPO performance. White & Case, a New York-based international law firm, found that in more than 2,000 academic studies, 70% showed a directly positive correlation between ESG scores and financial performances of businesses.

A recent University of Lugano study — “ESG and the Pricing of IPOs: Does Sustainability Matter?” – found a significant relationship between ESG communications and IPO pricing and valuation. By conducting a textual analysis of ESG-related words and topics in 783 US companies’ S-1 prospectuses completed between 2012 and 2019, the study reveals ESG has the highest economic effect on under-pricing and price revision. 

The study initially demonstrates that more disclosure is negatively associated with observed under-pricing on first day returns and firm valuation, but it also shows a large increase in the number of ESG terms in prospectuses leads to reduced “information asymmetry” between companies and investors. Overall, more ESG communication leads to less IPO under-pricing—and a benefit to companies’ financial performance.

Increasingly, companies going public in the EU’s markets must deliver on measurable ESG reporting as part of the price of admission. With the European Commission proposing a new sustainability reporting directive that will see the number of companies required to disclose ESG issues rise from 11,000 to 50,000, many EU companies are seeking entry into sustainable indices, such as the STOXX Europe Sustainability Index.

Companies going public are aligning themselves with new global regulatory frameworks at a rapid pace, to the extent that the marketing phase of IPO roadshows now includes ESG measures as front and centre. Otherwise, they risk losing access to capital from ESG-focused investors or receiving a less than optimal valuation.

Companies going public must act on ESG now

IPO-ready companies on a high-growth, future-proof trajectory already recognize that ESG practices are intrinsic to strong employee engagement, productivity, brand equity and financial performance. But with stakeholder expectations, global standards and quantitative data still in motion, measuring and reporting ESG performance remain a significant challenge.

Here are four concrete actions that companies seeking to go public can take to ensure their business models are resiliently backed and incentivized by a robust ESG strategy:

1. Decide on key metrics and areas of focus

The term “ESG” broadly encompasses environmental, societal and corporate governance factors. IPO-ready companies should establish which industry drivers and internal issues will determine their ESG priorities and benchmarks. The World Business Council for Sustainable Development has identified more than 2,000 ESG reporting indicators requested by 600 ratings and benchmarks, including the UN Sustainable Development Goals (SDGs), the Global Reporting Initiative (GRI) Standards and OECD Due Diligence Guidance for Responsible Business Conduct. However, these frameworks must be translated into measurable criteria relevant to a company’s specific purpose, scope and sector.

2. Identify risks

It is essential that companies preparing to go public develop a robust framework that isolates and tracks risks to their business model, and this is especially true of ESG. Investors and consumers are increasingly using ESG factors, from environmental performance to employee diversity and inclusion, to mitigate risk. Companies that take a deliberate, proactive approach to analyzing and modeling related threats and potential failures will be better positioned for resiliency.

3. Implement a consistent and transparent strategy

By identifying impacts and taking measurable steps to amplify positive outcomes—and minimize negative ones—through a holistic, publicly accountable approach pre-IPO, companies can avoid “greenwashing” and demonstrate an embedded commitment to ESG principles.

4. Leverage insights to predict outcomes

In ESG reporting, it is easier to react to inputs than anticipate future outcomes and impacts. To demonstrate deep understanding rather than basic measurement practice, companies going public must use available data to optimize their processes, analyze how their operations fit within broader environmental and social systems, and foster a culture that values learning.