The list of worries that leaders of modern businesses face is getting longer and longer: Product recalls; executive misconduct; cyberattacks, including the exposure of consumers’ personal information; and supply chain disruptions can all potentially damage companies’ reputations. And that damage can hurt stock prices.
Technological innovations such as the cellphone, the internet and social media may have changed how the world communicates and provided tremendous opportunities for businesses. But, at the same time, this has come at its own cost. The rise of social media and online review sites mean that bad news travels far and fast.
Compounding the issue is the very real impact a reputational crisis can have on a company’s financial future. Studies show a direct correlation between a hit to a company’s reputation and shareholder value – the ability of a company to deliver increased dividends and capital gains for its equity-owners through rising sales, earnings and free cash flow.
It’s little wonder then that the boards of many companies are taking a growing interest in managing reputation risk. “Although risk management awareness and tools have evolved, reputation risk continues to weigh on corporate executives as one of their leading concerns,” says Randy Nornes, enterprise client leader, Aon.
Businesses around the world see reputation damage – amplified by social media – as their top risk management concern, according to Aon’s Global Risk Management Survey. It’s therefore critical that the C-suite makes the connection between the risk and shareholder value and are prepared to protect their reputations should a crisis occur.
“Communications have changed – both the opportunity for error, punished by social media, and the accelerated response times that are now assumed,” said Dr. Deborah Pretty, founding director of Pentland Analytics. A recent study published by Pentland Analytics and Aon, examined 125 reputational crises over the past decade and their impact on shareholder value over the following year.
“Technological developments have heightened reputation risk by making it easier, cheaper and faster for people to spread news,” Pretty states. Underscoring the connection between social media and reputation risk, she continues: “People now have both the environment and the means to acquire and disseminate information, globally and instantly – information which may or may not be accurate.”
The Value Of The “Reputation Premium”
The value of reputation is significant. A look at the world’s top 10 brands, as determined by Interbrand, in 2018 showed most of them enjoying, what Pretty terms “a reputation premium” – an excess in market capitalization beyond book value and brand value – that in some cases was worth hundreds of billions of dollars.
For companies facing an adverse event, such as a debilitating cyberattack or a large-scale product recall, the impact on value is significant. On average, 5 percent of shareholder value is lost over the year following the event.
The study shows, however, that following a reputational crisis, companies fall into two distinct groups: winners and losers. Winners tend to outperform investors’ pre-crisis expectation and actually gain shareholder value in the year following a reputational crisis, while losers experience a value decline that exceeds the average.
Pentland’s analysis further shows the impact of social media on reputation risk. In 2018, with the use of social media at its most prevalent, companies that emerge successfully from a reputational crisis – the winners – tend to gain 20 percent in value. This compares with a 10 percent jump in 2000, when social media barely existed. Meanwhile, in 2018, losers lost nearly 30 percent in value, nearly double the 15 percent loss of companies analyzed in 2000.
“Other factors certainly will be at play, but it is striking that, for both winners and losers, the post-crisis value impact in a social media world is double that of the pre-social media portfolio,” Pretty said.
What separates the winners from losers is how the company responds to the crisis. This gives investors an opportunity to assess the company’s managerial capabilities and its prospects for generating future cash flow.
What Winners Look Like
Companies that “win” in terms of shareholder value following a reputational crisis typically are marked by responses that embrace several key characteristics. In examining 125 reputational crises, Pretty shares the key actions of companies that not only overcame the crisis but thrived afterward:
Respond immediately – A delayed response is almost always costly. Delays can lead markets and the public to question the company’s ability to respond adequately and whether the information provided to the public could be trusted. Delays also provide more time for social media users to dictate the narrative around the crisis, rather than letting the company control its crisis response message. Deep commitment to risk preparedness helps to reduce delays when crisis strikes.
Know the facts – Move quickly to gather accurate and complete details about the crisis and its potential impact on the company and the public. Having to issue corrections as the response proceeds will undercut confidence in the company’s crisis efforts.
Be decisive – Companies are typically rewarded for responding decisively to a reputational crisis. For example, a winner might move quickly to protect consumers following a data breach or to shut down production of a flawed product and quickly announce recall plans. Strong, visible leadership from the CEO is pivotal to a value-creating response.
Be open – Winners move quickly to inform the public of the crisis and provide detailed information about the event, the steps they’re taking to contain it and what they’re doing to protect the public. They’ll also keep the public aware of the progress of their response and any changes to the response plan, should they occur.
Respond globally – The impact of the reputational crisis is best managed by addressing the crisis globally, whether it’s in terms of the information the company shares with markets and the public or the remedies it provides, instead of responding in a piecemeal fashion.
Make amends – Among the cultural shifts affecting the current reputation risk climate is an increasing expectation that companies should not only acknowledge, but also make up for their mistakes. Winners make amends with the public for the impact of the crisis, whether it’s in terms of future product features, consumer protections or restitution, customer data monitoring after a data breach, or engaging in environmental protection activities.
Valuing Reputation, Protecting Value
The impact of a reputational crisis on shareholder value – as well as what makes a winner or loser from a period of upheaval – underscore the need for reputation risk management.
“Strong visible leadership from the CEO, swift and effective action to address the crisis, accurate and thorough communications and understanding the scale of the task and the need to rebuild trust are critical to successfully navigating a reputation-threatening event,” states Pretty.
And Nornes agrees, “reputation risk management must be a top-down priority and the effort should be embraced across the organization.” Companies that take such an approach will be best positioned to preserve and even increase shareholder value when a crisis occurs.