Hudson (2005)

Hudson, Julie. "Why Try to Quantify the Unquantifiable?" UBS Investment Research, April 11, 2005.

This report presents a new CSR framework, and in the process conducts a thoughtful and careful discussion of the importance of social factors in corporate financial results. The author argues that "when a firm makes changes in any of product strategy, financing decisions, governance, or social issues, it is likely that the cost (or risk) to the company of not taking action is perceived by the firm to be higher than the cost (or risk) of doing something. For companies, this suggests that there is a connection between at least some social issues and finance; in short, that social risk is business risk. [Therefore]...[p]otential corporate social liabilities should be viewed as a potential claim on the business, and therefore can be incorporated into standard valuation models, such as the enterprise value-added model."

The CSR framework has a three-part structure:

First, key issues are identified - the author views the 'triple bottom line' framework as a good place to start.

Second, the potential significance is assessed - "how much will people (the public, investors, company management and employees, regulatory bodies, lawyers) care about it?" At this stage a calculation may be made of "the financial value of damage done, or costs externalized."

Finally, the estimated financial impact is incorporated into standard valuation frameworks. The author recommends use of scenario analysis to capture the potential impact of liabilities.

The report concludes with examples of the implementation of this framework in specific industries. This is the most comprehensive attempt we have seen to date to incorporate social factors into a sell-side valuation framework.


LK 2018 comment:  Hudson was one of the first sell side analysts to write on the topic of climate risk, and in this paper was among the first to explore the twin concepts of materiality and ESG integration.