Global Climate and Sustainability Standard Setters are Changing the Definition of Enterprise Value

What is the traditional definition of enterprise value or EV? 

Simply put, it’s the market value of a company calculated as: market capitalization (stock price x the number of shares), plus the total debt, minus liquid assets or cash. 

EV = MarketCapitalization + Total Debt - C

Enterprise value has been a useful way for investors, creditors and lenders to evaluate and compare different types of companies on a purely financial basis. But not anymore. Enter climate change.

What's climate change got to do with EV?

Up until recently, about 2016, it was important when disclosing operations data for your company to show how your business impacted the environment, ie. pollution. But the way of looking at climate and capitalism has changed. Now, since 2016, you have to show not how your business affects the climate, but how Nature is impacting your business. Nature meaning the transition to a net-zero economy. So now you have to provide data and a story about how climate change policy, operating in a 1.5 degree warming scenario and new energy technologies will impact you for decades in the future. 

Enterprise value now takes into account a companies resilience and profitability in a warmer climate with next-zero policies.

So in 2022, looking at the data which is now required by global climate and sustainability standard setting boards, I might rewrite the EV equation like this:

EV = (degrees warming + net policy impact + net tech impact)(MC + Debt - Cash) 

The strange thing is that these international standard setters for business accounting--while they talk about bringing climate change into valuation as the biggest revolution in accounting since either the fourteenth century or the 1930s--they don't seem to be particularly explicit or honest that they have changed EV, fundamentally.

Why does this matter?

Just think for a minute about this like a taxpayer, a plain old hard-working individual who has to do a yearly tax return. Imagine if you had to not just account for your income and expenses, but your Green House Gases or carbon footprint. Imagine if you had a task list like this to do at tax time or every time you apply for a loan or credit:

• you have to show how you will be able to sustain your income, payments or debt in a 1.5 degree warming scenario
• you have to show the detailed emissions of all your purchases, your appliances, your heating and cooling, your transportation, your vacations, and your household waste management
• you have to show how Canadian, provincial and city net-zero bylaws affect your income and expenses now and when they become more stringent
• you have to show how you are investing in a greener future at work and at home

Do you see what I mean? When EV gets into this level of detail with climate change and the transition to net-zero, business becomes less about business and more about accounting and bureaucracy. And it's being done without an open discussion or debate or democratic election because the people changing the accounting rules--and the definition of enterprise value--are operating at the highest levels of international bureaucracy.

You're probably thinking that only an accountant or banker or investment manager should care about how we define enterprise value, but since our economy is made up of a web of corporations, independent operators, the self-employed, etc. How value is determined is rather critical to which entities in the Canadian economy will be able to survive the crush of this level of self-monitoring, data collection and disclosure, especially if we have total buy-in to the global standards from our local jurisdictions.