Originally published in Enterprise Risk Magazine
Reputational risk is unique. Not only is it influenced by a corporation’s own actions, but it is also influenced by external events that can be beyond a company’s control. But importantly, an organisation’s reputation is primarily grounded in the perceptions of its stakeholders.
An accounting error could slash share prices; rogue employee misbehaviour may damage perceptions of corporate culture; a company may find itself out of step with prevailing societal attitudes on sensitive subjects. Simply put, reputation risk is the potential for any event, controllable or otherwise, to damage an organisation’s reputation. It is the risk from stakeholder perceptions to profitability, brand value, authenticity, or ability to perform your corporate function.
Reputational risk does not only impact share price but can also create long-term operational issues for a company. For example, if employees feel undervalued, this can have a detrimental impact on the way a company is viewed as an employer and affect its ability to hire talent. This is a particularly acute issue in the current environment where labour shortages are rife. Additionally, research by the Harvard Business Review found that a company with 10,000 employees and a bad reputation could be spending $7.6m in additional wages to counter it.
A lack of transparency in declaring financial results and reporting can also determine how investors perceive an organisation. If investors view an organisation as financially unstable it can determine whether they decide it will provide a return on their investment and affect the company’s market value. The difference between book value and market value is often ascribed to reputation, which can account for anywhere between 10-70% of a company’s market capitalisation.
Many business leaders are aware that reputational risk is a tangible and quantifiable business concern. It can be measured, and undeniably has a link to financial value, among other KPIs. Reputational risk can negatively impact share price. Indeed, when Elon Musk backed out of the deal to buy Twitter, the social media network’s share price dropped by 11% – that was just one example of a reputational issue that had severe financial implications.
No industry or sector is immune to the shifts in public perception, and the current political and economic environment makes companies more vulnerable to these changes. It is important for business leaders to recognise that companies often have multiple reputations, whereby their reputation differs depending on the stakeholder.
For example, investors and customers may view a particular company in a completely opposing ways. This makes it difficult for companies to anticipate reputational risk as the picture is complex. Amazon is one classic example of this divergence in stakeholder opinion – investors tend to view Amazon quite positively, which can be in marked contrast to its employees!
What are the causes of reputation risk?
The growing threat to company reputations stems from the volatile economic and political environment of the modern world. There are three specific trends that we can point to, that contribute towards the increased threat to corporate reputation: hyper-transparency, interconnectivity and media anarchy.
Hyper-transparency represents the rising demand for accountability from stakeholders, a development that has forced companies to become more transparent, even if they have traditionally shied away from transparency. This has marked a shift in the power balance between companies and their stakeholders, with the power moving towards stakeholders.
Interconnectivity represents the fact that we live in an incredibly interconnected world – one in which stakeholders with shared interests and values are able to mobilise quickly on certain issues. There are 50 billion connected devices in the world right now, which makes it easier for individuals to connect on issues they are passionate about.
Finally, media anarchy – the media plays a massive role in today’s society, and with the rise of fake news and artificial intelligence technology, it can seamlessly spread fake content in real time. Such content can be hugely damaging to business reputations.
This context has created a chaotic environment for businesses to navigate and has resulted in stakeholder entropy. Stakeholders are demanding accountability, yet they do not have the means to decipher whether companies are being truthful and as a result feel like they don’t have any control over the world they live in.
All in all, businesses are operating in an incredibly challenging environment in which stakeholder relationships needs to be managed very carefully. Companies are no longer solely judged by their economic performance; they are also judged by their contribution to society, which makes it a tough balancing act when some stakeholders are more concerned about economic activity than societal contributions, and vice versa.
Managing and measuring your company’s reputation risk
Typically, businesses conflate issues management and crisis management when it comes to reputation. But in reality, businesses should treat issues management as a day-to-day task. Ideally, issues management should prevent reputational issues from becoming a crisis.
Companies need to start by having a good understanding of their reputational risk which can help them to effectively manage issues. Methods of measuring reputation risk include creating a reputational risk assessment, which can help draw a baseline for where a company sits within the perception of its stakeholders, and in comparison to direct competitors, comparable organisations and the sector as whole. Once this baseline is established, variations from the norm can be tracked.
By gathering data from social media, print news, online and broadcast channels, companies can listen and analyse the thoughts and feelings of their different stakeholders. Using machine learning and connected intelligence tools, they will be able to mine this rich data stream to identify sentiments and topics that pose potential risk. This allows businesses to define their own specific reputation risk categories.
Once companies have an accurate measure of reputational risk, they can implement measures to protect against risk. One option is reputation risk insurance, an embryonic industry designed to cover the costs of past and future damage to organisations’ reputations.
However, companies also need to be proactive and have a fool-proof engagement plan for stakeholders. Companies need to address all of the areas of their business that can produce reputational risk, be it disgruntled employees, poor decision making by the CEO, data breaches, negative social media posts, or bad press.
Finally, companies need to be prepared to act quicky when an issue emerges, and having a rational contingency plan in place is always helpful. With the help of stakeholder intelligence, companies can anticipate emerging issues and act to mitigate the reputational damage. Companies must be prepared to communicate quickly and reach all their stakeholders.
Not communicating effectively, or allowing external parties to uncover the issue, results in more frequent and more damaging reporting of an issue, prolonging the impact of the attack. Similarly, organisations should be ready to acknowledge mistakes. Organisations should demonstrate that they have identified and recognised the root causes of the crisis. This should be followed by making the necessary changes across the organisation to address these causes and rebuild credibility.
The climate crisis and banking – a case study of reputational risk
Let us consider an example to illustrate how the management or mismanagement of issues can affect reputational risk for businesses. Sustainability is arguably the most reputationally impactful issue that companies must deal with at the present time, and their response to that issue is heavily scrutinised by stakeholders. Stakeholders are looking for companies to drive change in reducing their carbon footprint, while making positive contributions to the environment.
During COP26, several organisations in the banking sector made bold pledges to reduce their carbon footprint and made commitments to make green investments. Under the banner of the Glasgow Financial Alliance for Net Zero (GFANZ), 500 global financial service firms agreed to align £130 trillion of investments with the Paris Agreement climate goals. The alliance issued a statement that more than 40% of the world’s financial assets would be leveraged to achieve a net-zero economy and limit global warming to 1.5C above pre-industrial levels. Overall, our research shows that partnerships such as GFANZ elicits positive sentiment towards the banking sector.
In the months following COP26, stakeholders have been closely monitoring whether these organisations have stayed true to their commitments. Overall, individual companies have generated mixed stakeholder sentiment. For instance, Bank of America polled well following a keynote speech by its MD of ESG Advisory at a climate event hosted by the World Bank and Imperial College. In contrast, HSBC scored particularly badly after a senior executive was suspended for making cavalier comments about climate change, accusing central bankers of exaggerating the financial risks.
This demonstrates that stakeholders are no longer convinced by empty promises – companies need to ensure that their promises are backed by decisive and authentic action. In the context of climate change, companies need to understand and respond to the priorities of their stakeholders with regards to climate change. They cannot afford the reputational damage linked to greenwashing or the financing of global warming activities.
How can risk managers manage reputational risk?
There is no denying that businesses are operating in an unpredictable economic and political environment, where one minor misstep can derail a company’s reputation. However, there are three simple measures that risk managers can implement to better manage the reputations of their organisations.
Understand your reputational risk
Measuring and understanding your organisation’s reputational risk is an important first step. You cannot successfully manage reputational threats if you do not know where the threat is coming from. With the right tools, data, and stakeholder intelligence you will have a greater understanding of the weaknesses in your company’s reputation.
Use your data
It is equally important to use this data correctly and address the weak spots in your corporate reputation. For example, if your employees view you in a negative light, address this head on with employees directly. If investors are concerned about performance, address these issues at the next AGM. It is crucial to address any weaknesses early on to minimise reputational damage and prevent issues from hitting the mainstream media.
Implement a crisis communications strategy
In an ideal scenario companies would manage reputational issues through prevention and engagement with stakeholders, without having to deal with a full blown reputational crisis. However, companies should be prepared for the worst-case scenario, and implementing a crisis communications strategy will help them better manage crises.
Companies should learn to act quickly when a crisis emerges and reach all relevant stakeholders with a carefully constructed message. Companies should not shy away from acknowledging wrongdoing – in fact, they should openly acknowledge their mistakes. Finally, companies should use the time following any crisis to make changes across the organisation to restore credibility.
As we have already established, businesses are increasingly operating in an unpredictable corporate environment fuelled by the rise in hyper-transparency, interconnectivity and media anarchy. In this environment, businesses are often facing multiple risks and must carefully engage with stakeholders to protect their reputations. But like all other risks, reputation risk can be managed carefully and businesses may turn threats into reputational successes.