Introductory Remarks
Reputation risk management has become an increasingly recognised area of risk management in most jurisdictions, especially as:
- a good reputation has been evaluated as the key major asset of the business in strategic approaches to risk ; and
- the ongoing growing impact of internet technology applications can in so many ways have major impacts upon this value.
Since perception drives behaviour, calculating the effect of reputational risk - and managing such risk prudently - is vital. Therefore relationships with all stakeholders are paramount, including relevant non governmental organisations (NGOs), enhancing the importance of a clear understanding of – and linkage with - the CSR debate. Indeed in India the recent legislative amendment to Companies’ regulation and the innovative approach to CSR (mentioned further below and to be discussed in more detail in an article to follow) emphasises the value of maintaining a coherent strategy. Such a strategy should integrate the approach to reputation risk management and CSR as an aware corporate citizen in order to maintain a successful and sustainable market position nationally, regionally and globally. This is timely also given the emphasis upon transparent corporate behaviour and upright business conduct. It is also interesting bearing in mind that India initially led the world as regards corporate social responsibility many years ago evidently.*
The debate over reputation - and its value- has developed in Europe and the USA over the last two decades in particular following several widely reported cases of failure in directors’ duties, economic crime and corporate mismanagement. Moreover, according to The Aon European Risk Management and Insurance Survey 2002–2003 , loss of reputation was regarded as the second biggest threat to business (after business interruption). These findings were based on the views of risk managers, insurance managers and financial directors of over 100 of Europe’s largest companies. Aon’s research also indicated that the top 2000 private and public sector organizations regard reputation as their biggest risk. The results of a similar survey carried out in Australia revealed a very similar picture, with loss of reputation, business interruption and brand protection topping the list. It was also pointed out that the key causes of concern for brand management were ethics, corporate governance, compliance and product quality.
A decade or so earlier global investment leaders were also quoted as prioritizing reputation risk management. ‘It takes 20 years to build a reputation and five minutes to ruin it.’ Fortune Magazine reported Warren Buffett’s view in 1991, arguably the world’s most successful investor. It now takes more than just good public relations and a clever advertising campaign to successfully secure financial success – ongoing reputational due diligence and corporate governance exercises are needed. If a company commits to an idea, it does so in public and will be therefore subject to public scrutiny and examination. As is noted further below, consultation with stakeholders is the best way to ascertain stakeholder perceptions and expectations about building credibility. In relation to any organization, a good corporate reputation can influence:
- Investors’ willingness to hold its shares;
- Consumers’ willingness to buy from it;
- Suppliers’ willingness to become its partner;
- Competitors’ determination to enter its market;
- Media coverage and pressure group activity;
- Regulators’ attitude towards it;
- Its cost of capital;
- Potential recruits’ eagerness to join; and
- The motivation of the existing employees.
The Aon European Risk Management & Insurance Survey 2002–2003. Extracts available on:
http://www.aon.com/about/publications/issues/2003_uk_biennial_survey.jsp
(06 June 2004).
Stakeholders
Corporate reputation is now very much defined in stakeholder terms. One definition of corporate reputation has referred to it as the ‘aggregate perceptions of multiple stakeholders about a company’s performance.’ A good reputation is therefore achieved when stakeholders’ expectations and experiences of the company are aligned. Stakeholder expectations represent the expectations of all conceivable parties interested or in some way involved in the workings and development of a company. As noted further below, the stakeholders that really matter to the private sector are invariably customers, employees and investors. Others may include regulators, strategic partners, suppliers and the local community.
For some time in the USA and Europe and leading business jurisdictions, as a whole, it has been considered good business sense to perform market surveys on relevant consumers. The rationale behind this is that these consumers will have an effect on the corporate health of a company. If consumers like a product or brand, they will purchase it. This will result in profits. This is well understood because it can be seen to have an obvious effect on the economic bottom line. However, if consumers are examined more closely, they can be seen to be swayed by trends of fashion, values and other outside influences. The risk a company faces is having a product boycotted, found unfashionable, of poor quality or not purchased because of bad press. To minimize these risks it is sensible to address stakeholders concerns and interests and that way influence the perceptions of stakeholder, encouraging purchasing decisions and investment, whilst also ensuring a reduced exposure to liabilities. Furthermore, it will also give the business the opportunity to:
- be able to recognize market trends faster;
- change faster; and
- predict the social effect on the economic aspect of their business.
Therefore a wider range of research undertaken with regards to stakeholder groups should be enacted and an example of this is the shareowner analysis provided later in this discussion or
Fombrun, C., Gardberg, N., & Sever, J., ‘The Reputation Quotient: A multi-stakeholder measure of corporate reputation’ Journal of Brand Management, Volume 7, p.241–255. 2000.
debate. As a matter of business practice, the following are the most significant areas where a risk to reputation may arise:
- Brand damage;
- Delivering customer promise;
- Communications and crisis management;
- Corporate governance, leadership and board competency failures;
- Lack of regulatory compliance;
- Workplace talent and culture;
- Financial performance and long-term investment value irregularities, restatements, profit warnings, or missed targets; and
- Corporate Responsibility (CR).
Risk Mitigation and Corporate Governance
Businesses cannot afford to ignore risks related to their reputation and brand. However, apart from business interruption, the top risks identified by the Aon survey are uninsurable. Therefore, mitigation of such business risks is largely an issue for corporate governance. The Cadbury Report defined corporate governance as ‘the system by which companies are directed and controlled’ (paragraph 2.5). The Report’s findings marked an important advance in the process of establishing corporate governance. A broader definition of corporate governance is that it ensures that the Board of Directors develops implements and explains policies that will result in an increased shareowner value and address their concerns. It will also reduce the costs of capital and diminish business, financial and operational risks.
It should be noted in developing a risk management strategy approach that the relationship between risk and materiality is not necessarily a straightforward one. Western case law seems to have defined materiality to mean those things that would be material to shareowner interests. For example, the current US regulatory regime requires directors of listed
Committee on the Financial Aspects of Corporate Governance. Report with Code of Best Practice, [Cadbury Report], London: Gee Publishing. 1992.
companies to develop a system of detailed business controls that enables them to report accurately on any financial or business risks that are material to shareowner interests. In other words, material risks included anything that - if the information leaked out or was disclosed - could lead to a material decline in the share price or value of its bonds. This is remarkably close to what investors expect the purpose of good corporate governance to be. This implies a very much wider interpretation of risks than those usually reported on by companies in their annual accounts. This can be illustrated with respect to the well-known experience of Nike and the labor practices of its suppliers in Pakistan and Vietnam. Those local companies were found to be using unregulated child labor in the manufacture of Nike sports goods. Nike, of course, was aware of this. From a financial accounts perspective, these were not material risks or issues, other than it kept manufacturing costs low. However, once the news came out Nike’s shares dived as a result of the ensuing consumer backlash. That decline in the share price was definitely ‘material to shareowners’ interests’. Being socially responsible and engaging in stakeholder dialogue with investors and consumer groups may have helped avoid this problem. The impact on the global reputation of the company was evident.
In India another example is that of the mining group Vedanta Resources plc who has faced reputation damage from a prolonged campaign against their application to drill on Dongria Kondh tribal land in the sacred Niyamgiri Hills area of the Orissa region.. This project attracted celebrity opposition and resulted in the Indian government rejecting the potential £6.2 billion investment in August of 2010. Indeed India’s the Environment Minister, Jairam Ramesh rejected their its $1.7-billion (Rs 7,820-crore) bauxite mining project and stated that he had concerns about violations of the Environment Act and Forest Right Acts. The financial repercussions of the project’s rejection and the element of reputational damage were that shares in Vedanta Resources fell to a 10-month low in London trading having dropped as much as 7.6 percent.
Corporate Governance, Reputation, Brands and Corporate Culture
There are many lengthy publications, manuals and books that address the vital matters of corporate governance, reputation, brands and corporate culture. Clearly the comprehensive treatment of such topics cannot be attempted in this article. Instead, selected and relevant aspects will be mentioned and prioritised here. The concept of corporate governance has been attracting public attention for quite some time in many parts of the world and the practical developments and responses have been gaining momentum. The topic is no longer confined to the halls of academia and is increasingly finding acceptance for its relevance and underlying importance in the industry and capital markets. Progressive firms in many places have voluntarily put in place systems of good corporate governance. The focus on corporate governance and related issues is an inevitable outcome of a process which connects with reputation risk management in today’s world.
Accordingly there remains considerable and ongoing discussion regarding the meaning of the concept of corporate governance that can be very relevant when considering reputation risk management. Briefly, on one hand it can be regarded in a limited sense that covers financial controls and on the other hand it can be taken to extend to all of the responsibilities and policies of the business that include such matters as environmental concerns. Between these two approaches there are, of course, many variations. What is clear is that the trend is in favour of widening the scope of the term. As with previous debates over such issues as sustainability, it is recognised that the role of business in today’s global economy is profound and that accountability should be extensive. Stakeholders, including members of the public, and not only those with a direct interest in the company, are demanding more transparency and evidence of responsible behaviour. Therefore for many observers corporate governance is becoming a value and values (ethical and moral dimensions) framework under which business decisions are taken that has key consequences also for its reputation.
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