Abstract
This chapter empirically explores Oil and Gas sector, trying to investigate the effect of ESG Scores on (1) Cost of equity (COE) and (2) Firm’s profitability (FP) for a sample of operating firms. We focus on a panel of data composed of more than 100 public firms, from 2002 to 2018/2019, and the main variables of interest are (1) The Implied Cost of Equity and (2) Return on Assets (ROA). We propose a dichotomic analysis with different aims of research: in the first analysis we try to estimate the firms’ ex-ante cost of equity adopting Easton Model, which expresses the share price in terms of one-year-ahead expected dividend per share and one- and two-year-ahead expected earnings per share. For the second analysis instead, we consider Return on Assets as a proxy for a firm’s profitability.
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Notes
- 1.
For an in-depth analysis on both theoretical and empirical literature, see Chapter 6.
- 2.
Datastream considers more than 180 industry-relevant sustainability variables that successively are aggregated into ten main E, S and G components.
- 3.
See Appendix A of this chapter.
- 4.
Since the regressions are in a half-logarithmic form, the results are read as follows: Quantitative effect = β*log (1.10).
- 5.
Kramer (2020) Hybrid metrics—Connecting shared value to shareholder value. The Harvard Business Review.
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Appendices
Appendix A
Eatson Model
The model is based on the recognition of the central role of short-term forecasts of earnings in valuation. The roles of (1) forecasts of next period’s accounting earnings, (2) forecasts of accounting earning two-period ahead and (3) expected accounting earnings beyond the two-year forecast horizon. The model shows how the difference between accounting earnings and economic earnings characterizes the role of accounting earnings in valuation.
Starting with the no-arbitrage assumption:
where:
P0 = current, date t = 0, price per share;
P1 = expected, date t = 1, price per share;
DPS1 = expected dividends per share, at date t = 1;
R = expected rate of return and R > 0 is a fixed constant. Adding and subtracting capitalized accounting yields:
If expected accounting earnings EPS1 is equal to economic earnings (P0 ∗ R), then the term in the brackets must equal to zero—in other words, next period’s expected earnings are sufficient for valuation. However, if EPS1 does not equal economic earnings then valuation based on accounting earnings requires forecasts beyond the next period.
Substituting Eq. (7.3) into Eq. (7.2) yields:
where
is the expected abnormal growth in accounting earnings. This abnormal growth in earnings reflects the effects of generally accepted accounting practices that lead to a divergence of accounting earnings from economic earnings. If EPS1 and EPS2 were equal to economic earnings, then agr1 would be zero and the ratio of expected earnings to price would be equal to the expected rate of return.
The valuation role of expected accounting earnings beyond the two-year forecast horizon may be seen by substituting for P2, P3, P4, etc., in Equation (7.5) to yield:
Equation (7.6) shows that the present value of the agrt sequence explains the difference between price and capitalized expected earnings. Equation (7.6) may be modified to accommodate a finite forecast horizon by defining a perpetual rate of change in abnormal growth in earnings (Δagr) beyond the forecast horizon. If earnings forecasts are available for two periods, Equation (7.6) may be written as:
where:
Considering the special case Δagr = 0, meaning that agr1 = agr2 = …, from Eq. (7.7) we have:
Appendix B
Appendix C
See Tables 7.10, 7.11 and 7.12.
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Bellavite Pellegrini, C., Caruso, R., Seracini, M. (2022). ESG, COE and Profitability in the Oil and Gas Sector. In: Bellavite Pellegrini, C., Pellegrini, L., Catizone, M. (eds) Climate Change Adaptation, Governance and New Issues of Value. Palgrave Studies in Impact Finance. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-90115-8_7
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