Stakeholder Engagement Improves Valuation

Wharton Professor of Management Witold Henisz and two co-authors researched the role that stakeholder events played in companies’ efforts to maximize profits. Their paper, Spinning Gold: The Financial Returns to External Stakeholder Engagement, found the value of stakeholder relationships worth twice as much as the value of physical assets.

The authors used data from 26 gold mines owned by 19 publicly traded Toronto Stock Exchange firms between 1993 and 2008 to calculate their net present value. They coded more than 50,000 stakeholder events, actions or expressions of sentiment from groups friendly and not-so-friendly towards mine owners.

The result: the companies traded at a 72% discount compared to their net present value. Why? Because the net present value did not take into account the probability of delays or disruptions, and the cost overruns or revenue shortfalls that result. By incorporating the stakeholder cooperation index in a market capitalization analysis, the researchers reduced the discount placed by financial markets on the net present value of the gold from 72% to between 33% and 12%.

Reducing conflict with external stakeholders in favor of winning their cooperation improves the companies’ chances that a mine plan can proceed on budget and on time, and most importantly, generate sustainable shareholder value. Notes Nenisz:

Fifteen billion dollars of gold sitting in a mountainside cannot be transformed into [profits] with financial, engineering and marketing inputs alone. It also requires the political and social support of key stakeholders, including not only members of the economic value chain, but also government officials, regulators, community leaders and members of civil society.

A quote from the COO at one of the mines in the researchers’ sample puts it another way:

It used to be the case that the value of a gold mine was based on three variables: the amount of gold in the ground, the cost of extraction and the world price of gold,” he states. “Today, I can show you two mines, identical [in term of] these three variables, that differ in their valuation by an order of magnitude. Why? Because one has local support and the other doesn’t.

The findings are applicable to a number of other industries, according to Henisz, including construction, oil and gas, agriculture, minerals, alternative energy and water – any sector that involves large building projects, substantial upfront investments and long payback periods.

Henisz recommends the following best practices for businesses that are serious about engaging stakeholders:

1. Change the mindset of the company so that employees across the board believe that stakeholders are important.

2. Get the necessary data to explain who the stakeholders are, what they want and who is connected to whom.

3. Find a way to link data to operating performance, integrating the information into risk management systems rather than treating it as a separate category.

4. Interact with stakeholders in the community in a genuine and fair manner; respond to their concerns and form connections rather than just writing a check.

5. Find a way to disseminate information about the ongoing project that is credible and transparent.

Stakeholder engagement improves valuation: study | IR Web Report, 8/4/2011.

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