Long-Term Sustainability Investments vs. Dividend Payouts ; In analysis of firm values in Europe

Abstract

As climate change accelerates, public debate on sustainable development, the United Nations' 17 Sustainable Development Goals, and commitment to them have spread globally. Despite this, there is no comprehensive commitment to the green transition due to, e.g., different opinions on climate change. Simultaneously, companies pay to get an ESG rating, which should define their commitment to sustainability and allegedly improve company value. Despite allegations about the prospects of ESG, the results are yet to be proven, as the trend is relatively novel, and the green actions allegedly take more time to be visible in practice. As time goes by, examination of green innovation is progressing, and the effectiveness of the green transition is being questioned, resulting in a decline in the ESG trend in designated areas. These observations raise concerns as to whether ESG-based valuation is superficial and solely based on market participants' belief in the validity of ESG ratings.

By critically examining ESG ratings and the impact of capital allocation decisions on traditional firm valuation models, the purpose of this thesis is to suggest an alternative measure to identify companies’ and their market environments’ engagement on sustainability and its impact on companies’ capital allocation decisions, resulting in changes in company valuation. As sustainability engagement requires investments and the investments positively impact ESG ratings given by rating agencies, sustainability investments should impact the company's value if sustainability engagement matters in financial markets. In theory, the interaction between sustainable investments and engagement could result in an increase in firm value in areas with a high level of commitment to sustainability. In areas of low commitment, investing in sustainability could decrease firm value, and other capital allocation options, such as dividends, could be more beneficial in terms of company value growth, depending on stakeholders’ preferences. However, in practice, changing capital allocation strategy is often based on the financial capabilities and long-term objectives rather than the stakeholders’ wishes.

The results of this study reveal a positive connection between the market sentiment of sustainability to both environmental expenditures and dividends, and their further impact on firm value, but without the need for trade-off decisions. Despite the weakness of the connection, the results support the possibility of replacing ESG ratings with another measure, suggesting that the SDG Index rating could be useful in the development of a universal measure of sustainability engagement for companies.