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Q&A | Reputation Risk Trends: When Leadership Can’t Be Delegated

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When a reputation crisis hits — and it’s more a question of “when” rather than “if” — it can have a devastating impact on an organization. And, by all indications, the damage caused by these reputation crises is getting worse, with the impact on shareholder value growing.

The potential sources of reputation crises are numerous: product failures, poor business practices, financial irregularities and environmental issues are among them. In recent years, as every business has grown more reliant on technology, another has risen to the fore: cyber risk.

There is some good news, however. Not every company that encounters a reputation crisis has to be a loser. Organizations that are well prepared for such a crisis by communicating effectively, responding immediately and demonstrating a commitment to correcting the issues behind the crisis can actually be winners.

In a recent interview, Dr. Deborah Pretty, founder of Pentland Analytics, elaborated on her latest Aon-sponsored research on the impact of reputation crises on shareholder value — findings that are being discussed at this year’s global Aon Insights Series.

Q: Were there any immediate differences that jumped out in your most recent round of research?

Pretty: We’re now up to 270 reputation crises in our database. The sample size now enables us to be able to slice the data by industry and make observations.

When I first started doing this, about 30 years ago, the average effect was no impact. Some companies recovered very well, some companies performed very poorly, and they averaged each other out.

In the aggregate, reputation crises now are more damaging than they used to be. That is to say, the average impact on shareholder value now is negative. We’ve seen that’s also true with the number of losers versus winners. It used to be close to 50-50, then it got to 60-40. It’s probably closer to 70-30 now — we have 183 losers and 87 winners in this year’s portfolio. So losers are outnumbering winners by about 2 to 1.

In the case of the losers, poorly managed crises wiped out over $2 trillion in shareholder value over their post-crisis year.

Q: How significant is leadership’s role in how an organization fares in a reputation crisis?

Pretty: Leadership plays a very strong role in share-price recovery. The CEO has to step up to the plate and take responsibility for these crises. Leadership can’t be delegated when you’re in the eye of the storm.

Almost every day we see a different crisis hit the news wires. It’s up to the senior management team, but particularly the CEO, to take that responsibility, to communicate effectively, to make sure that all the stakeholders know the right action has been taken. And ultimately to give the stakeholders confidence in the management going forward so that they know that, OK, there was a crisis, but this is still a fundamentally good company and it’s doing everything it can to make sure such a crisis doesn’t happen again.

On the flip side: When CEOs don’t get it right, they will often lose their jobs in the wake of such a crisis. So, leadership is absolutely critical.

Q: Why are reputation crises becoming more damaging, and the number of losers growing?

Pretty: Not only are reputation crises becoming more damaging than they used to be, but it’s also harder to excel than it used to be. But we’ve always had good leaders and less-good leaders. So what’s behind this trend?

I think part of it is explained by the nature of the crises in our research portfolio. Over one-third of the crises are failures of governance or poor business practices. If I look at the shareholder value impact across all the different types of risk, the most damaging source is poor governance and business practices.

The other reason is that all stakeholders, investors included, are getting more demanding of companies and their management. Culturally and generationally, we demand more of our senior managers. And the intensifying of those demands on companies and their senior management is making the market harsher on companies when they make mistakes.

Q: What can industries learn from each other, based on the findings?

Pretty: A few lessons stand out. A number of the companies with multiple crises were in financial services, specifically banking. And many of those crises were due to governance and business practice issues. Taken together, the market starts to treat those repeat instances as a reputation problem for the whole industry. When that happens, there is a clear opportunity for a concerted industrywide effort to raise business standards.

In healthcare, the pharmaceuticals industry has been hard hit. It faces class-action lawsuits over alleged side effects from drugs, with long timelines and unknown outcomes. Investors hate uncertainty. But we also see that a company having a repeat crisis doesn’t necessarily mean it loses every time. One company had two very similar incidents four years apart: In the first, its stock fell sharply. Four years later, it applied what it learned and fared much better.

Tech was the only industry where winners outnumbered losers, suggesting that the market may forgive more easily mistakes in innovative sectors where the frontiers are being pushed hard. Also, investors are forward-looking and will have a firm eye on future cash-flow generation from these companies. Remember that the analysis is over and above the benchmark market index, so it is adjusted for the recent stellar performance of the technology sector as a whole.

Q: How do emerging risks, like cyber, factor into this trend of harsher market consequences for crises?

Pretty: Cyber attack is an example where this comes across very clearly in the data. In the early days of cyber attacks, they were chalked up to bad luck. Share prices didn’t move too much. Journalists were fond of saying “there’s no long-term impact on share price from a cyber attack.”

Looking at the last five years of cyber attacks, that’s simply not true anymore. The markets penalize you for having a cyber attack or failing to mitigate harm if you have one. It’s the same risk, but the market response to that risk is completely changed. It’s no longer considered bad luck — it’s considered bad management.

Q: How do you see the tensions within an organization between quickly admitting to an event like a cyber attack and trying to fix the situation before going public?

Pretty: You’ll be penalized more if you don’t announce it straight away. As with all the other crises, be honest from day one, be open and transparent from day one, rather than trying to hide it, as tempting as that may be.

There are natural internal tensions among the different areas of the organization and concerns by legal counsel, for example, that by speaking out you might compromise your defense. But in cases of crisis management, I would side with the marketing experts who say coming clean quickly is the right way to restore trust and confidence in the company.

Q: Are companies improving in their preparations for reputation crises?

Pretty: It’s difficult to tell. The analysis is based entirely on publicly available information, so it is not privy to the internal risk management operations of a company. All we know is that reputation crises are not going away, their impact on shareholder value is becoming more damaging and new exposures continue to emerge. Also that the demands on executive management teams around the world have intensified with the development of new technologies, social media and the growing attention on ESG [environmental, social and governance] factors.

However, it remains clear through all 30 years I’ve been studying these phenomena that there are clear opportunities for companies to emerge from a reputation crisis stronger and with increased valuations, if they prepare well, communicate and act swiftly in the immediate aftermath, and demonstrate to all stakeholders that lessons have been learned.

To hear more about Pentland Analytics’ findings on reputation risks, explore the 2020 Virtual Aon Insights Series.

Dr. Deborah Pretty
Founder of Pentland Analytics