inaval seminar, december 16, 2005 1 the inaval project jan-olaf willums chairman, inspireinvest

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INAVAL Seminar, December 16, 2005 1

THE INAVAL PROJECT

Jan-Olaf Willums

Chairman, InSpireInvest

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Thea Intangible Asset Valuation ProjectINAVAL

A collaborative research effort to “better understand the materiality of intangible values and associated risks on corporate performance”. Launched in 2004 by

• IDEAM (part of Credit Agricole in France),

• DNV (the global risk assessment and certification group)

• InSpire Invest (a SRI / Corporate Governance research entity and former owner of CoreRatings),

• Foundation for Business and Society, an independent grant-making foundation, member of the Bellagio Forum. (originally set up by WBCSD)

For 2006, in Phase II, INAVAL is being expanded to include

• Mistra (Swedish research foundation, member of Bellagio Forum)• Innovest (leading Research house)

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Reason for launching INAVAL Project

• "The traditional accounting system is focused on transactions and historical costs. To determine the future value of a company, you don't look at past history. You need new measures to project forward.”

(Sharon Oriel, director of intellectual asset management for Dow Chemical)

• Today only 20 percent of a company’s market value is reflected in its accounting system. The largest portion of companies’ economic activities, with which they create value for stockholders and stakeholders, is no longer captured systematically. Accordingly, it is not transparent internally or externally.

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What do we want to achieve?

• develop better techniques to capture a firm’s intangible values and risks related to social, environmental and governance issues.

• help assess relationships between non-financial assets and the

future value of corporations.

– estimate the risk premium that is used in valuation of firm for different industry sectors.

• Suggest new/ better indicators and evaluate their relevance for asset management.

The project aims to encourage academic input from academia: Sofar cooperation with HEC (Paris), NSM (Oslo) MIT (USA), KTH (Sweden)

While the general findings are being published, the models and test results are proprietary to the participating members.

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Research MandateOriginal Mandate in 2004 was to• Understand the relevance and economic impact of specific social,

environmental or ethical issues for individual industry sectors. (Materiality)

• Suggest better indicators for measuring social, environmental and governance aspects of companies.

• Evaluate how to test the sensitivity of predicted financial performance to various SRI indicators when combined with mainstream financial models.

This is being expanded in Phase two (2006-) to include• Develop a transparent RISK-OPPORTUNITY methodology to

intangible value assessment, (“third generation analysis method”).• Use Delphi and scenario techniques to identify future risks and

issues of concern, and their relevance for performance drivers. • Evaluation and test the importance of “weak signals”.• Run mainstream financial models to determine materiality and

sensitivity of prioritized indicators.• Explore new ideas to help assessing future value of companies.

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Key in the Inaval Approach: Understanding Risk Management

• Risk picture gets more and more complex.

• Consequences are difficult to quantify.

• Risks are difficult to measure or calculate.

• Risk perceptions are not simply determined by individual characteristics but linked to a social and cultural context.

• A partnership between IDEAM and DNV as a global risk specialist can therefore contribute substantially to the risk understanding of the financial sector.

“I am horrified that a scientific study which took so much time and analysis to prepare should be overturned in a few hours by a group of terrorists appealing not to reason, but to ignorance and emotional blackmail” British Nobel prize winner

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What have we done so far in INAVAL:

Mapping Industry issues to find Risks and Intangible Asset Drivers

• Reviewed existing approaches to risk evaluation and economic impact of environmental, social and governance issues, and the key intangible asset drivers.

Findings:– In traditional valuation the focus is on financial value drivers, their historic

performance and regression analysis as a basis for forecasting. • There are many competing frameworks for classifying and categorizing these assets. A Gap in the methodology

– CSR issues, Governance, and other intangible assets are a general challenge for analysts: A Gap in Communication

• There are competing methodologies as to how these assets should be incorporated into mainstream valuation.

Conclusion: • Find a transparent way to assess intangible values and the risks/opportunities

associated with them.– Separate the analysis of issues /sector risks and the performance of companies in

managing/ addressing these risks:• use Delphi and Scenario Techniques to understand what is relevant,• test it out with sensitivity analysis to identify the most important drivers.

– Adapt and simplify a “traditional” way to identify the impacts on the company performance:

• use sensitivity analysis to gain better understanding of materiality.

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Steps in the Analytical Framework

1 Define Drivers and Trends– Identification of most relevant global ESG macro-trends potentially

affecting a range of business sectors• For this we have used Delphi techniques and will strengthen this with

summaries of scenario studies to highlight potential key issues.

2. Materiality– Assessment of their relevance for different sectors

• Identification of generic and sector-specific ESG issues within each macro-trend that can be expected to materially impact companies.

3. Impact on Company Level– Choice of a valuation model,

• discounted cash flow (DCF) or WACC – Beta model– Test priority (weighting) of indicators through sensitivity analysis and

comparing with information from Innovest data base.

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Separating the understanding of the drivers from the corporate performance

GLOBAL TRENDS – GLOBAL TRENDS – RESULTING EMERGING SECTOR RISKSRESULTING EMERGING SECTOR RISKS

MAPPING MAPPING DRIVERS AND THE DRIVERS AND THE

IMPACT ON IMPACT ON CORPORATE VALUECORPORATE VALUE

JUDGING JUDGING CORPORATE CORPORATE

MANAGEMENTMANAGEMENT

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WHAT IS MATERIAL?How can we capture the experience and

insight of experts and make it transparent?

CSRinitiatives

Profit /Shareholder value

Customerawareness of

companyCustomer

loyalty

Customers

SalesCSR

initiatives


Attractiveness asemployer

Employeeloyalty

Turnover

Talentedpeople

Organisationalperformance

CSRinitiatives


Clear vision andstrategy

Board andmanagement

leadership

Monitoringsystem

Risk control

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DNV experimented with modelto capture the dynamics of

Intangible Value Drivers

PotentialCustomers

LoyalCustomers

GainingCustomers

Loosing Customers

Customers fromAdvertising

Customers fromWord of Mouth

Average CustomerLifetime

Total Population

Adoption Fraction

Contact Rate

AdvertisingEffectiveness

First timesales rate

Repurchasesales rate

Average Firsttime sales

AverageRepurchase sales

ReputationIncrease inReputation

Decrease inReputation

Normaldecrease rate

Bad event

Bad Event Switch

Max reputation

Reputationfraction

Effect of reputationon customerbehaviour

Effect of reputationon customerbehaviour f

<Effect of reputationon customerbehaviour>

<Effect of reputationon customerbehaviour>

Initial reputation

Bad Event Size

Constant customerlifetime

ConstantRepurchase sales

Constant firsttime sales

Constantadoption fractionConstant

advertisingeffectiveness

Total sales rate

Price

Revenue

Reputationadjustment time

Reputationadjustment

Reputation goal

Marketing effort

Perceiveddecrease inreputation Time to adjust

perceptions

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Model applied to Value Drivers

C olla te ra lR e putation

B rand V alue

Intang ibleva lue

R e gula toryO bliga tions

Liability tole ga l actions

Long Te rnA cce s s to

S k ills

M ainte nanceof

C ompe titiveA dvantage

E X P E N S E S

MA R K E Trisk

S A L E S

T O T A LC O S T

E A R N IN G Sreta in ed

R E V E N U E SC u stom er

con tribu t ion to en v.i ssu e (e .g . c l im a te

ch an ge)

N G O s

R egu la tors

em ployees

IN N O V A T IO N

G R O W T H PO T E N T IA L

V A L U EO F

S T O C K

su pp l iers

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“The Firm” – Internal drivers

Profits

Employee costs

COGS

Marketing costs

Revenue

Costs

Accidents

Absenteeism

# Employees

Training

Average salary

Value driversBrand value

Intangible value

Collateral reputation

Regulatory obligations

Liability to legal actions

Long term access to skills

Maintenance of competitive advantage

Non-compliance

Sick leave

R&D

Recruitment

Administration

Company response

Policy development

Policy implementation

Validation and assurance

Performance monitoring

Transparency and disclosure

Envir

onm

ent Use of natural

resources

Emissions

Climate change

Soci

al

Em

plo

ym

ent

Eth

ical is

sues

Society & Community

Human rights

Product safety

Marketplace

Diversity

Working conditions

Recruitment & Retention

Strategic positioning

Business ethics

Ethical issues

1568

43

- 5%

- 1%

+ 4% + 3%

+ 1,5%

- 0,75%

inaval seminar, december 16, 2005 1 the inaval project jan-olaf willums chairman, inspireinvest

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