The Emergence of Reputational Risk Management
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The Emergence of Reputational Risk Management
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The Emergence of Reputational Risk Management
Transcript of The Emergence of Reputational Risk Management
The Emergence of Reputational Risk Management
Executive Summary
The purpose of this research is to assess the level of recognition and evolution of reputational risk management by tackling two main issues. First, whether reputational risk is acknowledged and implemented as a common risk management procedure and second, does reputation (and a so called reputational impact) have a tangible value and can it be quantified? To answer these questions, secondary research is used as the main methodological approach due to the sufficient depth of some of the studies already performed. The findings of this study are that reputational risk management is indeed recognised as a useful (almost vital) practice to implement but lacks properly established structures and frameworks for the majority of companies to adopt. The current quantification methods of reputational management are vague and do not have any significant added value in senior level decision making. This study therefore provides a synthesis of reputational risk management’s current state of affairs and aims to supplement the debate by providing assistance and guidance on future research in the subject but most of all, to stir up awareness concerning the rising importance of reputational risk management.
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Table of ContentsExecutive Summary............................................................................................................ii
Acknowledgments.............................................................................................................iv
List of figures and tables.....................................................................................................v
1 - Introduction...................................................................................................................1
2 – Literature Review..........................................................................................................3
2.1 - The State of Corporate Reputation at the present time.....................................................32.1.1 - The concept of Expectations..............................................................................................................52.1.2 - Crisis Management............................................................................................................................72.1.3 - The difference between a reputation and a brand...............................................................................7
2.2 - Reputational Risk, its benefits and its state today.............................................................82.2.1 - Reputational Risk defined..................................................................................................................82.2.2 - The Reputation-Reality gap as a measure of stakeholder expectation discrepancies........................112.2.3 - Benefits of good proactive reputational management practices:......................................................15
2.3 - Attempts at quantifying reputation, reputational risk and reputational loss......................172.3.1 - Quantifying Reputational value.......................................................................................................182.3.2 - Quantifying Reputational Risk of Loss............................................................................................22
3 – Research Methodology...............................................................................................27
3.1 - Reputation : Risk of Risks..................................................................................................27
3.2 - Other information sources................................................................................................28
3.3 - Limitations of the method used.........................................................................................28
4 – Analysis of findings and recommendations.................................................................30
4.1 - Pinpointing the concept is crucial....................................................................................30
4.2 - Concerning reputational valuation..................................................................................34
4.3 - Concerning further research...........................................................................................40
4.4 - Research Limitations.......................................................................................................41
5 - Conclusion...................................................................................................................42
Appendices.......................................................................................................................43
Bibliography.....................................................................................................................46
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Acknowledgments
I wish to address my thanks first to my supervisor Dr. Assad Jalali-Naini whose support, guidance and supervision allowed me to constantly have steady progress throughout my business report. I also would like to show my gratitude to Dr. Thanos Verousis for his advice.
This management report is dedicated to my family.
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List of figures and tables
Figure 1 : Examples of the different stakeholder expectations..............................................................5
Figure 2 : BP’s share price plunge during the Deepwater Horizon explosion and oil spill...................13
Figure 3 : The Relationship between the cost of equity and the disclosure level................................16
Figure 4 : Banca Italease's share price during the trouble period........................................................24
Figure 5 : Who is responsible for managing Reputational Risk ?.........................................................31
Figure 6 : Who is responsible for specific reputational activities ?......................................................31
Figure 7 : The rate of perception and expectation assessments..........................................................32
Figure 8 : Reputation Management equals Corporate Social Responsibility ?.....................................33
Figure 9 : Reputation, a category of risk of its own ?...........................................................................33
Figure 10 : Threat importance categorisation.....................................................................................34
Figure 11 : Impact of different factors on reputational risk management...........................................36
Figure 12 : Attributions of the Reputational dichotomic variable in BP's share price data..................38
Figure 13 : Reputational Risk Management’s common barriers..........................................................40
Table 1 : Attributes of the Reputational Quotient...............................................................................18
Table 2 : Ranges of the Reputation Quotient index.............................................................................20
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1 - IntroductionCompanies nowadays can no longer afford to be careless as to the consequences of their
actions, the awareness that the corporate entity has duties to fulfil is increasing among the
public and this is strongly affecting the way corporate reputation should be managed. As a
result, the “socially responsible” trend in enterprise development has emerged and became an
ethical categorisation. Corporate responsibility, social responsibility, corporate governance
and corporate citizenship, all these terms are basically used to express practices that make a
company act in the benefit of the environment it operates in, instead of only its own profit.
This increase in the public’s expectations has a direct influence on the reputation of
companies. As a matter of fact, reputation is rapidly becoming a major (if not the most
important) asset for competitive advantage a firm can hold.
Many factors are affecting the fragility of corporate reputation nowadays, making it an even
more difficult asset to protect in case of harmful events happening. Eccles et al. (2007)
declared that 70% to 80% of companies’ market value comes from intangible assets (like
reputation, brand equity, intellectual capital and goodwill among others) that are difficult to
assess and quantify, therefore organisations have become much more sensitive to any
reputational damage than in the past, since reputation has become more crucial in the
determination of business success or failure. Just as risk is an entire part of business,
reputation ends up encapsulating all corporate operations. It is now agreed upon that
reputation, or what Resnick (2006) defines as “your organization’s primary intangible asset”
is an extremely precious asset that should be protected, managed and developed, rather than
just a momentum effect to benefit from or to be subjected to.
This being said, it is clear that companies should try their best to anticipate their
environment’s reactions to future potential decisions, and choose knowingly what course of
action to take and how to communicate it correctly. The fact of reputation being an intangible
asset subjects it to the famous management motto of “you can’t manage what you don’t
measure”, which renders reputation management rather intricate as it is by no means an exact
science.
This study therefore discusses whether reputation management (i.e. Reputational Risk
Management) is acknowledged as an important practice nowadays and to what extent
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reputation assessment techniques are currently integrated and understood by managers and
academics alike. It also examines the potentials and future developments of this practice.
The author has chosen this topic as a management report as an attempt to blend his
background in marketing with his current Masters of Science studies in management and
finance together through a management issue that broadly touches all the aforementioned
fields.
This management report is made up of five chapters. Its structure is as follows:
Chapter 1 constitutes this introduction that prepares the reader for the topic discussed
afterwards and shows the motives behind the management issue examined.
Chapter 2 consists of a literature review concerning reputation, reputational risk and
quantification methods.
Chapter 3 provides an explanation and a justification of the research methods used in
conducting this study.
Chapter 4 offers the findings, the analysis and the recommendations that have resulted from
the research.
Chapter 5 concludes this management report.
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2 – Literature Review
2.1 - The State of Corporate Reputation at the present time
This section discusses the current perception and understanding of corporate reputation
through a literature review of the most relevant definitions and closely related concepts, such
as the diversity of its perception among different stakeholders, and expands on what changed
corporate reputation in the last decades. Crisis and brand management are briefly discussed
and separated from reputation management in an attempt to distinguish reputational risk
practices later on.
The internet efficiently managed to disturb the balance of power between firms and their
stakeholders. It reduced the weight and effect of official corporate communication, almost
plaguing it with a large number of uncontrollable opinions linked through the web and
gathered under the banner of self proclaimed or newly created authorities like specialised
websites. This is an important change to the way reputation should be seen by managers, as
their claims are more likely to be challenged and argued openly by any individual, however it
also represents an additional platform for improving information sharing between a company
and its stakeholders. According to research done by internet specialists Infonic (cited in
Larkin, 2003:14), relatively small groups can boost their visibility through the internet
because of its low requirements in term of the resources needed, creating what was qualified
as a disproportionate visibility. It is therefore easier than in the past for activism to confront
corporate practices and to mobilise civil actions such as boycotts through the wide spread of
the internet.
Another factor that makes reputation different today is the accentuation of what is referred to
as a “victim culture” (ibid:15), although its initial motives of consumer protection are indeed
highly justified and noble, the media can quickly turn casual complaints into emotionalised
personal tragedies. Ultimately, companies should stay alert of new demands and expectations.
As whether managers want it or not, these factors directly influence the firm’s reputation.
Reputation is arguably the shared perception of all the company’s internal and external
constituents concerning the way it operates. This perception can be either positive or
negative, and is deeply entwined with the future dealings of the said company. Reputation
can therefore affect many aspects such as stakeholder trust or have a behavioural impact on
employee loyalty and workplace satisfaction. It is now easily perceivable how important this
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intangible asset is to any business in the world. The complex characteristic of reputation is
that whether a certain event affecting the company is real or just perceived (as in, thought to
be real by one or many stakeholders), reputation is very likely to suffer in both cases
(ibid:vii). It is a fragile intangible asset that, if well managed, could protect companies from
future bad events by giving them the benefit of the doubt thus greatly mitigating any harmful
effects, or could worsen relatively small issues if not dealt with properly. Therefore, to some
extent, corporate reputation can be described as a multiplication factor that is linked to the
perception of internal and external issues.
According to Gardberg and Fombrun (2002), reputation is a collective representation of a
company’s past actions and results, that describes its ability to deliver the adequate outcome
to the adequate stakeholder. The authors also identified four trends that makes the
management of corporate reputation even more important. First, the global interpenetration of
markets that are constantly pushing toward a globalised view of companies, thus
exponentially increasing reputational impact all throughout the world. The second trend is the
excessive crowding of the media and press environment that offers divided opinions of
certain issues to the public, that can result in an overall trust decrease. Third, the appearance
of more vocal constituenties, that is to say stakeholders that are less passive and whose
opinion has gained substantial weight in the last decades through various groups rallied under
specific banners such as consumer protection or ecological associations. The fourth trend that
the authors thinks increases the importance of reputation is the commoditisation of products
offered. A large number of products made by a particular brand are sold more than its
competitors because of its reputation, even if the quality is more likely the same. Hence,
while the various practices to differentiate products and services are stagnating, reputation
represents a long standing asset that is definitely important.
The 2001 MORI annual survey of Britain’s Captains of Industry (cited in Larkin, 2003:4)
indicated that, to the question “What are the most important factors you take into account
when making your judgement about companies?”, senior management’s answers indicated
that financial performance is less significant than in 1997 in their eyes (from 75% in 1997 to
59% in 2001) but regard the general image and reputation of the company as more important
than before (from 46% in 1997 to 60% in 2001). It is clear that with the press as major news
and scandal vehicles, a tiny black spot in the reputation is nowadays costing more than in the
past. It is also important to add that with a trend toward a general decrease of trust,
stakeholders are less keen on trusting an official source and taking the information provided
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as valid and truthful, even if it is. This is mainly due to the large amount of mediatised
management frauds and the growing view that companies are amoral and heartless profit
generators.
2.1.1 - The concept of Expectations
“Reputation declines when experience of an organisation falls short of expectation”
(Ross, 2005:4)
Behind this short statement lie different aspects that need to be defined and understood. The
most important one to understand is that reputation is a relatively subjective concept, i.e.
different stakeholders have different expectations and view the company from different
perspectives. Reputation is not entirely based on revenue, profit or strong marketing
campaigns alone, it is made of much more different aspects as shown in figure 1 below.
Figure 1 : Examples of the different stakeholder expectations
Source : Christiaens, 2008:2As show above, different actors in the environment have different expectations from a
company, while these expectations might not be mutually exclusive and might overlap
occasionally, the general observation is that each different constituent has a specified and
different need. Customers, investors and regulating authorities probably constitute the biggest
influence to the overall reputation of a company. It is also important to note that stakeholders
communicate with each other, if not directly, through knowing what happens in the media
and the press.
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It is also safe to assume that some expectations might contradict others, for example
corporate social responsibility issues (represented in “Community/Society” in Figure 1) and
investor satisfaction (under “Investors”). As a matter of fact, industrial companies are
constantly facing critics regarding pollution. In general, ecologically friendly practices
increase a company’s costs and sometimes the whole operation process needs to be thought
through and changed again in order to comply with new ecological standards. On the other
hand, some of its old practices that may not be “green” may result in substantial profit (in a
relatively short term though) and thus increase the satisfaction of shareholders through
increased revenue. Obviously, this example is very theoretical as in this particular case, long
term planning will definitely force a reconciliation of both expectations in a common ground.
These two expectations are indeed difficult to satisfy fully and reputation will definitely
suffer if a stakeholder expects more than the company can deliver. Therefore, as a general
line of conduct, an equilibrium between different expectations needs to be found and, most
importantly, maintained.
Soprano et al. (2009) suggests that companies should assess their image exposure by
identifying beforehand what are the main reputation-damaging events, such as :
Internal and external fraud, bribery, insider trading;
Breaching of law and regulations;
Main service interruption, such as cash machines and internet banking for banks;
Involvement in industries shunned by the media or general public;
Environmental policies.
“Reputation is at risk as soon as the expectations exceed reality. [...] it [The company] needs
to either lower expectations (through communication) or increase performance (through
operations)” states Christiaens (2008:4). Indeed, the expectation factor can act as a multiplier
of reputational effects. In the example of a member of senior management committing fraud,
a large well known company will eventually suffer more reputational loss than a small one,
which isn’t followed as closely by the public and the media (Walter, 2006). This fact alone
represents an alarm bell to allocate more time to the management of reputation and to
integrate it with the overall risk management process, as nowadays it is probably the most
important risk a company can face when including all the indirect costs that can result from a
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scandalous event. In addition, taking for example that one wrong or inadequately expressed
statement to the media can literally ruin a business, it makes the matter even deeper.
2.1.2 - Crisis Management
So far, the most recognised way of dealing with issues affecting the company’s image is
crisis management, which refers to damage mitigation and controlling what is communicated
to the public in the case of unpredictable events happening, in order to regain the lost image
and reputation and try to restore stakeholders’ faith in the company and their positive
perceptions. In fact, it can be said that reputational risk management has roots in crisis
management practices, as in identifying potential crises and developing strategies aiming to
stop their effect, however, reputation management extends to other horizons. Some of the
main differentiation points between these two are the fact that current and future expectations
of stakeholders are expected to be constantly monitored in reputation management, and
attempting to include reputation in common risk management routines, to be quantified and
to have specific future values. Reputation is mostly seen from a “soft” perspective, an asset
that can be delegated and outsourced to public relations firms or advertising agencies for
them to manage and enhance, and not as a part of the company’s risk assessment programme,
which gauges, prevents and mitigates prevailing risks a business can face.
In short, the idiom “An ounce of prevention is worth a pound of cure” says it all. It is only
common sense that prevention, in this case referred to as reputational risk management, will
be probably more beneficial to any firm than reactive crisis management.
2.1.3 - The difference between a reputation and a brand
It is important to specify the difference between these two concepts in order to be able to
build proper reputational risk management practices that will not be confused with
marketing’s efforts on brand management.
A reputation and a brand are two different notions. According to Ettenson and Knowles
(2008) a brand is a “customer-centric” concept, i.e. the brand image of a company focuses
mainly on customers’ perceptions and its commitment to them. A brand can also be
considered to be the sum of functional and emotional aspects of a certain product or service
(Bergstrom, n.d.). On the other hand, reputation is “company-centric”, in the sense that
reputation results from respect and trustworthiness that arise from the perceptions of a
broader set of constituents, such as employees, regulators and journalists. The differentiation
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also comes from the fact that ethics and corporate social responsibility have gained
increasingly important support from the society. Indeed, customers are no longer satisfied if
the product they buy is of high standards and is able to fulfill their needs (brand-related
concept), they now request that what they buy has been produced under fair conditions with
respect to a variety of expectations, such as ecological and labour welfare concerns.
It is therefore possible to have a high brand value but a relatively tarnished reputation. While
Nike always had a strong brand equity with its fitness attitude, its sport support imagery and
fancy marketing campaigns, sweatshop labour allegations (made notorious via Michael
Moore and his interview with Nike CEO Phil Knight) have tarnished its reputation.
A reputation and a brand call for confusion at first, as both terms overlap each other to some
extent. Ettenson and Knowles (2008) argue that the main reasons that push people to confuse
the two are first, that both are intangible. Second, that both require communication strategies
in order to affect their external environment. Third, the emergence of the internet makes it
difficult for companies to separate their stakeholders and address them individually. This was
the case long ago when it was possible to keep customers away from financial analysts for
example.
2.2 - Reputational Risk, its benefits and its state today
It is necessary to define the rationale behind managing reputation and the acknowledgment of
a new type of risk. Therefore, in order to understand the call of academics and researchers
concerning the incorporation of reputation in risk management, this type of risk needs to be
defined and explained.
2.2.1 - Reputational Risk defined
Official sources such as the Basel II Accord1 texts or the Enterprise Risk Management2
framework only briefly discuss reputational risk, stating that it is part of what is called
“strategic risk”, with no further details on strategic risk either. If one was to deduce that
strategic risk is the risk of a decrease in company value due to poor decision making,
reputational risk is therefore only partially covered if included under strategic risk. One
1 The Basel II Accord texts is the second edition of a set of rules and regulations published in 2004 by the Basel Committee for Banking Supervision aimed at improving banking practices of internationally-active banks. The Committee consists of senior representatives of banking authorities of 27 countries.
2 The Enterprise Risk Management (ERM) is a framework of risk management best-practices created by the Casualty Actuarial Society in 2003.
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explanation of the absence of more details concerning reputational risk could be the fact that
there still is no official structure to manage it fully. Even though the Basel texts quickly
mentions reputational risk (only twice in its texts with no definition or explanation at all in
fact), it acknowledges reputation as separate from operational risk (Basel Committee, 2003).
This raises the issue of whether reputational risk should be considered a first or a second
order impact. Considering it a first order impact would be to treat reputational issues the same
as market or credit risk i.e. a risk category of its own with proper management practices to
deal with it. On the other hand, a second order impact would be to categorise reputational risk
as a consequence of other first impact risks and of various events related to the company’s
operations.
Despite the fact that the Basel texts separate reputational from operational risk, it seems like
it is not the case of practitioners and researchers in the subject, who constantly link the two.
The justification behind it is that reputational loss arises from various operational
misconducts (including human-related internal failures such as fraud, rogue trading, etc),
hence their declarations merely point out the natural relation between reputation and other
risk types as they invariably affect firm value.
“Reputational risk often results from operational, credit, or market-related events [...]. Damage can result from perception, not just reality, and once the perception has been impaired it is difficult to fix.” (Mayer and Settar, 2003:7)
This definition considers reputational risk as a second order impact. It also stresses a very
important fact that makes reputation management more awkward which is that damage can
result from perception alone. That is to say, the behaviour of constituents will be altered
(even if by a small amount) by events such as rumours, notwithstanding whether they are true
or not. It also includes third party (i.e. business partners) reputational risk, in the sense where
reputation is considered to be transferable, thus mental associations can be made depending
on whom the company deals with. It is safe to consider that the reputation of a company is
indeed submitted to the contagion effect – “If their [business partners’] reputation is good,
mine is probably good too” (Ross, 2005). Taking financial institutions as an example,
reputational loss can also result from financing controversial industries like nuclear plants
projects, or engaging in what is considered to be risky behaviour. The negative perception
can also spread from clients and employees to financial markets, investors and shareholders
(Soprano et al. , 2009), thus extending the view that reputation is probably the worst type of
risk a financial institution can be exposed to.
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Operational risk is defined by the Basel Committee as the risk of loss resulting from
inadequate or defective internal processes or external events (Basel Committee, 2003).
Different hypotheses subsist in this matter since, to some extent, reputation can be considered
a consequence of both ineffective internal processes or people and abnormal external events.
While the Committee does not deny the relationship between companies’ reputation and their
operations3, categorising it separately (as “other” risks) does indicate that a separation is
needed in order to better manage reputational risk, and that using the same methods as in
operational risk might not prove successful. On the other hand, Soprano et al. (2009) do
propose a reputational risk management approach closely linked to operational risk, which
will be discussed later on.
Different opinions exist in this matter, a number of pieces of literature on the subject (Walter,
2006; Reiss, 2009; Soprano et al. 2009; Perry and Fontnouvelle, 2005) tend to disagree
somehow with the Basel explanation, stating that reputational risk should be considered as a
consequence of all the other risks a company faces (operational, liquidity, credit and market
risk mainly) not as a separated class of risks. Their argument is indeed logical as any internal
process failure or misconduct (as in operational risks for example) does have a direct impact
on the reputation of the company.
Standing the middle ground is the argumentation of Christiaens (2008) that reputational risk
can be both of a primary and a secondary order impact, through independent risks that can be
associated with ethics and other “soft” unquantifiable concepts where the majority of other
risks faced by a company can be considered tangible to a certain extent.
Soprano et al. (2009) simply define reputational risk as “the risk of damaging the institution’s
trustworthiness in the marketplace”. Trust is indeed a valuable asset, and specific events can
damage it intensely. A company’s trustworthiness in the marketplace influences all its
dealings with stakeholders, from the number of clients it attracts to better deals with
suppliers, shareholders’ approval and financial institutions.
2.2.2 - The Reputation-Reality gap as a measure of stakeholder expectation
discrepancies
Based on the fact that reputation is affected by external constituents and that it is of an
entirely perceptual matter, Eccles et al. (2007) proposes a three step determination of
3 Financial institutions only in the case of Basel II regulations, although it is possible to generalise the definition to any industry.
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reputational risk, that bases itself on determining the gravity of the gap created between what
a company can deliver in reality and what it promises or thinks it can deliver, this process can
help in understanding some of the mechanics behind corporate reputation :
1 – First step : The Reputation-reality gap
Reputation being based on various expectations, it is therefore of primary importance to first
assess whether expectation gaps exist and where does the company stand. Just as it is possible
for reputation to show an underrated image of a company when it is doing well, there are
also cases where reputation is much more positive that the actual performance in reality. This
second case can be beneficial in the short term but eventually, as discussed earlier, high
expectations will crash against a less bright reality image and it will be foolish to not deal
with this gap.
Both situations can be interpreted as possible future risks that can seriously affect corporate
reputation and therefore need to be bridged. The authors argued that in order to deal with
these gaps, a company has either to meet superior expectations or reduce them through
adequate communication efforts, as in, by not promising more that what it could offer.
2 – Second Step : Changing Beliefs and expectations
One of the peculiar things about perceptions is that they are not static in time. Many issues
that were not considered important in the past receive extended media coverage lately.
Therefore when a company bases its operations and views of the stakeholders’ expectations
on specific beliefs and does not re-assess them periodically, it might widen the expectation
gap and ends up working by specific standards that were probably good 5 years ago, but does
not represent what some stakeholders expect anymore. The most obvious case in the last
decades is being ecological and friendly to the environment, which has become a major asset
for any company’s reputation nowadays. This example, although very noticeable, shows how
expectations can change, whether as a consequence of new scientific findings or just
increased awareness. In fact, the media talks now about greenwashing, or the fact of
exploiting the positive image of being “green” solely in order to improve the image, this itself
represents a reputation-reality gap risk. There are obviously some more subtle perceptional
and behavioural changes that are difficult to quickly identify by managers, these also
contribute to determining the aforementioned gap. As a rule of thumb, customers and clients
are the most likely to change their needs quickly, while other constituents are slower in the
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process. Therefore managers should continuously monitor the way stakeholder expectations
change since they can easily vary in a matter of years or even months due to coverage.
The recent 2008 financial crisis changed more than one stakeholder’s view on the financial
sector, especially concerning financial institutions dealing in specific types of complex
financial derivatives and their consequential abuse. As a matter of fact, this crisis resulted in a
great decrease in public trust concerning the validity of internal banking practices, which are
perceived as complex, mystifying and not transparent at all. As a result of these short-sighted
investment and possibly greedy management behaviour, regulations are changing concerning
the whole financial sector, and ways of operating and disclosing information are being
restructured. Academics and regulators speak now of improving macro-prudential regulations
i.e. rules that are aiming to regulate the financial sector as a whole and consists of new
practices to be adopted by banks and other financial institutions in general.The general public
is therefore advised to learn more about the use of their funds by the banks and increase their
awareness concerning these issues. This represents how suddenly beliefs and expectations of
stakeholders can change.
3 – Third Step : Internal Coordination
Internal coordination refers to how information is coordinated and disseminated within a
company. While different functions within a firm have specific knowledge about different
constituents, the author claims that it is rarely efficiently shared with the rest of the company,
rendering this third determinant mainly an information asymmetry problem. Therefore if one
group creates an expectation which can hardly be met by other groups within the company, it
generates a significant part of reputational risk (again, through amplifying the gap).
4 –The reputation-reality gap illustrated : The case of BP
British Petroleum (BP) illustrates the reputation-reality gap issue to a great extent. Their
massive advertising and re-branding campaign “Beyond Petroleum”, aiming to show BP as a
socially responsible corporation that sees “beyond” fossil fuels and invests more in clean and
renewable energy, resulted more in a wider expectation gap than in a greener image. In
addition, there is a complete disillusion of the public as to the sincerity of the company.
According to Eccles et al. (2007), BP has been running a marathon of reputation crushing
catastrophes, including4 :
4 Please refer to appendix 1 for an illustrated timeline of BP media coverage events
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Allegations of tax evasion in Russia in the last quarter of 2004. The Texas city refinery explosion in the first quarter of 2005. Job Cuts in Europe in the last 2006 quarter. The Prudoe bay leak in the first quarter of 2006. Allegations of propane manipulations in the second quarter of 2006. A $87 million OSHA5 fine for failure to fix potential hazards in 2009, becoming the
largest fine issued by them so far. (OSHA, 2009) Texas city refinery chemical leak (538,000 pound of chemicals leaked.) in 2010. The Deepwater Horizon explosion and oil spill in 2010.
The allegations against BP stating that it was aware of potential operational risks and
compliance failures increased the overall media coverage which threw even more “oil” on the
fire. In fact, while BP was trying to raise expectations of its performances in the beginning of
2001, mediatised issues continued to produce reputational damage. Nowadays, it is probably
safe to say that the expectation gap issue was dealt with, albeit to BP’s substantial loss, as not
only there is a huge fall of expectations from the community, but also that BP is viewed as an
irresponsible and incompetent company in 2010. Stakeholders are now aware of the fact that
even if disastrous happenings are unpredictable, it is mandatory to be prepared for their
eventuality beforehand.
Figure 2 : BP’s share price plunge during the Deepwater Horizon explosion and oil spill
Source : Google Finance (2010) (dates are my emphasis)The graph above shows how influential disastrous events can be on a company’s share price.
Continuing with the example of BP and The Deepwater Horizon catastrophe, it proved to be
extremely harmful to its image. The graph above shows a 54 percent share price decrease
between April 15 (5 days before the explosion) and 75 days later (70 days after the event).
According to the New York Times (2010), BP did not even have a worst-case scenario plan
in case a catastrophe such as the Deep Water oil spill happened, taking in consideration that
safety research is usually done by oil companies to ensure safe drilling, this sort of
5 The Occupational Safety and Health Administration
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information says a lot about BP managers’ mindset to its stakeholders. Underdeveloped
crisis planning shows a clear lack of reputational risk awareness, BP probably underestimated
risks associated with operational failures in the Gulf of Mexico area.
BP failed to correctly assess some of its stakeholders’ expectations, which is a major source
of dissatisfaction. While BP focused on public relations by communicating about the oil spill
and promising to deal with all the consequences, the public’s expectations was simply for BP
to mitigate the damage done. This shows an important lack of expectation assessment. The
company has managed to anger three vital constituents. First, the society at large because of
its blatant lack of respect to the environment and its lack of transparency concerning its
accountability. Second, it proved to regulators that it does not fully comply to the rules
(failure to fix potential hazards, pipeline safety, honesty and transparency issues for
example). Third, shareholders, with decreased share prices, and still according to the New
York Times, BP’s cleaning efforts only began as an answer to angry shareholders.
While oil companies like BP were exploring new technological ways of gathering oil like
underwater digging, fewer efforts were done in technologies that avoided, contained,
mitigated possible spills and disasters according to the Harvard business review (2010). A
disregard for contingency strategies can greatly affect a company’s value, and consequently
its reputation. Contingency strategies can be considered a part of the broad view of
reputational management that emphasises the potential harmful risks that can arise from
operational failures and catastrophes, as is the case with BP. In fact, it is possible to consider
reputational risk management in this case as a long term strategy that encapsulates all the
other practices, in the sense that reputation is ultimately linked to its operations.
Therefore, even if BP manages to restructure and improve its operations and manages to
mitigate the ecological effects, it will still get weak response for it because it decreased its
stakeholders’ expectations to an unbelievably low level, as even nowadays its electronic
communication efforts involve live streaming webcam images that show the current repairs
done by BP, but are ultimately perceived more as a selfish image redemption attempt rather
than a real sense of responsibility and guilt.
2.2.3 - Benefits of good proactive reputational management practices:
Considering corporate reputation beyond a solely crisis management point of view offers
many advantages to firms according to various literature, the most noteworthy being :
14
Positive effects on the brand and image: Reputation and brand equity are obviously
highly entwined. A positive reputational risk system can not only help in assessing
future reputational risks but also helps the company gain the benefit of the doubt in
the case of a harmful event happening. Being thought of as a well reputed company
also increases the likelihood that prospective business partners will be more willing to
associate themselves with the company and trust it. In the case of a company that is
listed in the stock exchange, it is acknowledged (Larkin, 2003; Soprano et al., 2009)
that reputational events have a concrete impact on share price. Good reputation
management practices are believed to be among the factors that reduce share price
volatility.
Minimises threats of increased market scrutiny by regulators and press due to any
unusual information reported about the company, this can result in increased
information disclosure, staff and system costs due to the fact of dedicating more time
to the extended disclosure needed, this scrutiny also generates rumours among the
interested parties (as in, why would they investigate Company X if it did not do
anything wrong?). Even if a low level of scrutiny reduces reputational risks, providing
some key constituents with higher quality information that is more detailed in itself
improves the overall image of a company and can, according to Armitage and
Marston (2008), even reduce the cost of capital as discussed in the next point.
Cost of Capital reduction: A seemingly indirect consequence of proactive reputation
management, some quantitative researches found a negative relationship between
disclosure level and the cost of the capital (Armitage and Marston, 2008:19; Meyer
and Zamostny, 2006). It can be said that a higher level of disclosure allows a
company to appear more open, thus increasing its reputation for transparency that
will, to some extent, influence its cost of capital and cause it to decrease. According to
Armitage and Marston (2008), financial directors think that the most important type
of informational tool that helps reduce the cost of capital is face-to-face contacts with
analysts, lenders and fund managers. It is also important to note that there is a
threshold to which disclosure affects the cost of the capital, beyond a certain level
(seen as “adequate” disclosure), the cost of capital will no more be influenced by
more sophisticated disclosure methods, as illustrated by the graph below.
15
Figure 3 : The Relationship between the cost of equity and the disclosure level
Source : Armitage & Marston, 2008:11 Employee loyalty: Loyalty and trustworthiness play an important role in the quality
of their performance. In addition, employees are, whether they know it or not,
ambassadors of the company. Soprano et al. (2009) shows the link between
reputational risk events and high staff turn-over6, therefore it could be inferred that a
good management of corporate reputation reduces this ratio.
Financial Performance: Although one of the assumed benefits of a good reputation
is increased financial performance due to the fact that stakeholders will prefer to be
associated with well reputed companies, there is apparently no empirical evidence for
such a claim according to Rose and Thomsen (2004). Surprisingly however, corporate
financial performance is found to affect and improve reputation in the same study.
Adversely, a survey done by Hills and Knowlton (2006) shows how financial
performance can be influenced indirectly through the positive influence that corporate
reputation represents as an intangible asset on the ratings of financial analysts. In that
survey, the majority of analysts7 agreed that the quality of the leadership team and the
fact of staying true to promises highly affects their rating judgement and their advices
to invest in specific companies. Proactive Reputational management could also help
companies cushion some of the fall in share due to event anticipation.
6 Rate at which a company gains and loses employees, generally a high staff turn-over is harmful for the long term survival of a company.
7 Respectively 86% and 85% of analysts highly viewed leadership quality and “making good on promises” as important criteria in their ratings (Hills and Knowlton, 2006).
16
2.3 - Attempts at quantifying reputation, reputational risk and reputational loss
This section describes the implementation and the advancements of reputational measurement
techniques, including reputational capital valuation and the quantification of reputational loss,
illustrated by literature examples.
“Although the Committee recognises that ‘other’ risks, such as reputational and strategic risk, are not easily measurable, it expects industry to further develop techniques for managing all aspects of these risks.” (Basel Committee, 2003:151)
Academic research and literature on reputation as a risk to be quantified only began recently
in the 1980s and 1990s (Walter, 2006). Even today, there is still no agreement upon what
method to use, as very different valuing methods (some purely qualitative and others
quantitative) were put forward throughout these decades.
It is indeed very complex to exactly quantify thoughts and perceptions, which reputation
ultimately represents in the end. Therefore, the principal way of quantifying it that is
currently researched by academics is through discerning the impact of events that seemingly
alter corporate reputation on key financial numbers and ratios of a company. While flagrant
scandals can be easily perceived even by the non-financially informed public in a share price
index, isolating proper reputational effects from other factors influencing the share price is
much more difficult. There is still no widely accepted method of quantifying and managing
reputational risk, the few companies that indeed are interested in this risk type do so
internally but results often do not get acknowledged as fully valid decision making practices
because, at the present time, they only give estimations at best. Christiaens (2008) asks, in the
case of financial institutions, whether they should set some capital aside in order to cushion
unexpected losses due to reputation. Nevertheless, it is mandatory to have a solid quantitative
risk assessment of a “reputational capital” first, in order to proceed with such a decision
Qualitative reputational assessment effort that arises from crisis management point of view
can be seen as the most plausible starting point in order to proactively manage reputation.
2.3.1 - Quantifying Reputational value
The two most notable attempts at reputational valuation are through an index called the
Reputation Quotient, and through accounting estimations.
2.3.1.1 - Annual Reputation Quotient (RQ)
17
Quantifying companies’ reputation based on a qualitative approach is the logical way to
tackle intangible perceptions. Nevertheless, with trends and opinions ever changing, results
will only be valid for a specified amount of time. Therefore, a timely repetition of the
research can definitely overcome this disadvantage, and that is what the Reputation Quotient
does.
Initiated by Harris Interactive in 1998, the Annual Reputation Quotient is the most
acknowledged reputation measurement tool (used by Fortune 500 for its annual Most
Admired Companies) and also the closest to a standardised international measurement
instrument there is nowadays. The first ranking officially began in 2001. In fact, the RQ
ranking has already begun to be a benchmarking standard to which the general public looks
out for and debates. It is probably deemed credible because of its different reputation
categorisations and its relatively large sample size used which captured the opinion of almost
30,000 persons for its 2009 edition (Harris Interactive, 2009).
The RQ analyses various people’s perceptions from different constituent groups and
industries of over 200 of America’s most known companies (Fombrun and Foss, 2001). The
RQ incorporates 20 different attributes collected in 6 categories, the whole shown in the table
below :
Table 1 : Attributes of the Reputational Quotient
Emotional Appeal
Product and Services
Workplace Environment
Financial Performance
Vision & Leadership
Social Responsibility
“Feeling good about “
Admiration and respect
Trust
Quality
Innovation
Value for money
Reliability
Quality of employee rewards
How it is to work in
Quality of the employees
Position compared to competitors
Risk Investment perception
Profitability
Future prospects
Leadership quality
Clear and established vision
Market opportunities it aims to
Supporting good causes
Concern about the environment
Concern about the community
Data collected from Harris Interactive, 2009.
The RQ index represents the average of people’s perceptions on these 20 attributes. The
constant change in perceptions allows the RQ to map trends in popularity throughout the
years.
The RQ Methodology
18
The Reputational Quotient process begins with a nomination section (where the interviewees
are asked to name companies) and a rating section containing various 1 to 7 rating scale
questions, with 1 meaning that the statement asked in the question does not describe the
company the RQ is currently rating, and 7 being that the statement describes it very well.
The interviewing process is done solely online. In the rating section, respondents are assigned
two familiar companies to rate. The process of assigning companies the respondent is familiar
with comes from the nomination stage. The interviews last 30 minutes each. The named
companies are taken as the most famous or “visible” in the RQ survey, allowing a mapping of
the 60 most known companies within the sample. After the naming, two open ended
questions are used asking the respondents to name two companies having the best reputation
and two having the worst. The named companies are then consolidated with subsidiaries,
annexes and categorised under a general brand name if possible (Ibid).
Taking the example of the 2009 Reputational Quotient (ibid.), 120 companies where
measured through a sample size of 29,963 interviewees, with an average number of rating per
company of 407.
The final RQ index of the companies rated is then calculated as follows:
RQ Score=[ (∑ of ratingson the 20 attributes )Total number of attributesanswered ×7 ]×100
Source: Harris Interactive, 2009
The RQ score is calculated by summing the ratings on the 20 attributes gathered from the
interviewees and dividing it by the result of the total number of answered attributes
multiplied by seven, which represents the scale score from 1 to 7 mentioned before. The final
scorecard of the RQ is shown in the table below.
Table 2 : Ranges of the Reputation Quotient index
RQ Index Range Significance
80 and above Excellent RQ quotient, the company is very well viewed by the general public
From 75 to 80 Very good rating.
From 70 to 75 Companies rated in this range are considered having a good reputation.
From 65 to 70 Fair reputation.
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Less than 65 The RQ quotient does not specify proper scaled ranges for indices that are less than 65.8
Data gathered from Harris Interactive, 2009
Current Limitations of generalising the Reputational Quotient
While the Reputational Quotient has been a strong reputation evaluation method that is
officially used in the United States, its long term aim is to be generalised all throughout the
world as a leading reputation ranking method. It is now agreed on that businesses are not
viewed in the same way in different countries, and that what might gauge a particular side of
reputation for the American sample might not be very accurate for other nationalities.
Therefore research validity issues arise here, conceptual equivalence being the most
important if the RQ quotient is to be used worldwide (Gardberg and Fombrun, 2002). This
concept is used in research methods as a validity test that refers to the issue of whether a
certain indicator (within a research, an interview for example) is assimilated the same way
across different samples, nationalities in this case.
Falkenreck (2010) states that, apart from conceptual equivalence, there are also two other
issues that currently limit the international spread of the Reputation Quotient. First,
instrument equivalence i.e. whether the scale system used and the response categories are
interpreted and understood the same way across nations. Second, translation equivalence, or
whether the translated items measure identical concepts. This concept is also supported by
Walsh and Wiedmann (2004) showing that using the RQ in Germany necessitates the
addition of four new “German” categories9 to the existing six in order for it to reflect a
complete image of the way German stakeholders best rate their companies. This therefore
shows the current limitations of using the RQ internationally. While this problem is only
momentary and the RQ scales will be customised for each country, customisation will indeed
be a hindrance to the original motive of the RQ which is standardising the reputational
perception.
2.3.1.2 – Reputation estimations through accounting
8 However, by following the logical index progression, it is safe to assume that the public is indifferent to companies whose indices range between 60 and 65, and has a bad perception of any company ranking below 60.
9 The new German categories are as follows : Fairness, Trust, Transparency and Customer Orientation. (Walsh and Wiedmann, 2004)
20
Although not in their primary function, the variety of accounting indicators have the potential
to constitute a solid purely quantitative valuation of intangibles such as corporate reputation.
Three estimations are discussed, royalties, market-to-book value and goodwill.
1. Royalties
According to Fombrun and Van Riel (2004), accounting values and discounted cash flows
can represent a valuation method for corporate reputation. They argued that the net present
value of royalty payments over an extended amount of time (20 years for example) can be
considered as an estimation of corporate reputation. This claim is also corroborated by Larkin
(2003:8) claiming that “...one estimate of the value of a company’s reputation is the present
value of all expected royalty payments over a given period”. There is, however, little
empirical evidence in the literature as to the effectiveness of this method, as probably it is not
perceived as a durable valuation method, first due to royalties and licensing agreements
limitations (only large companies license their brand name) and second, because it remains
rather approximate. In addition, it is very important to consider how royalty income is linked
to the company brand, and not its reputation in general.
2. Market-to-book value
The impact of intangible assets on a company’s overall value is increasing year by year.
According to Baruch Lev (cited in Baukney, 2001), the market value of S&P 50010
companies is more than six times their book value. That is to say, the actual perceived value
of each $1 recorded in the balance sheet is over $6 in the market.
A positive correlation between market to book values and a high brand value has been
empirically tested by Little et al. (2010).
3. Goodwill
In order to form an attempt at valuating reputation, it is logical to begin with an intangible
asset having the closest characteristics. Within goodwill lie different elements such as
trademarks, patents, brand name value, intellectual capital or any other intangible privileges
that ultimately helps increase the firm’s value. Brand name value does mean that reputation is
10 The S&P 500 index shows the traded stock prices of 500 of the biggest American non-government owned companies. Therefore companies listed in S&P 500 have a strong visibility and a relatively high reputation.
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involved somehow within goodwill. Atrill and McLaney (2004a) define goodwill as a term
used to encapsulate attributes like quality of the products, employees’ skill and customer
relationship. It is obvious to the reader that these attributes also play an important part in
corporate reputation. However, valuing goodwill is also not reliable as the quantification
occurs only when the need arises in the case of acquisitions for example. The following
example given by the same authors (2004b) illustrates this notion: CRH, a Dublin-based
construction material business, bought the Dutch Cementbouw’s production operations for
€646 million. This price was made up of €354 million in net assets (assets less liabilities),
leaving a €292 million payment for what is considered as goodwill.
Theoretically, a company’s goodwill could be extrapolated into a reputational measure as
well. Unofficially it is possible to claim that Cementbouw’s reputation at the time of purchase
is valuated at the numerical value of €292 million. This is however only an assumption that is
debated and not agreed-upon among academics as so far goodwill represents a purchase price
that is other than is added to the asset value. Then again, it is the closest simple quantification
possible that is available so far.
2.3.2 - Quantifying Reputational Risk of Loss
A regression model is a statistical analysis tool that is used to explain, partially or totally, the
changes and fluctuations of one variable depending on other variables using datasets and time
series, resulting in an equation that links them and allows the understanding of each
variable’s impact and offers the possibility of future predictions. The rationale behind using
regression analysis to seize and quantify reputational loss events is first due to the fact that, as
mentioned before, effects of reputational loss are visible on a company’s numerical indices
(such as share price) over time. Second, because operational risks such as internal and
external fraud are fully covered by operational risk management and that these events can
also be a source of reputational loss. Therefore this methodology implies that reputational
risk is of a purely second order nature.
The motive behind describing two reputational loss measurement models in this study is to
show that results greatly differ from case to case, and that there still are no unified standards
whatsoever. These two examples can represent empirical tests of Fombrun and Van Riel’s
claim (2004) that reputational values can be valued through losses from crises.
1 - Soprano et al.’s reputational risk assessment
22
Soprano et al. (2009) made an attempt at measuring reputational capital risk as a function of
share price volatility by using the share price history of the listed Italian bank Banca Italease
during a reputation threatening event.
The authors estimated the influence of a reputational event by applying a multi-factorial
model similar to the Arbitrage Pricing Theory11, based on the assumption that a company’s
share price will reflect new information announced (including reputation harming ones).
They came up with the following model that related the return on the stock to three factors :
R¿=α i+ βi 1 R(Mkt , t)+β i 2 R(Bank ,t )+β i3 R(Rep ,t )+ϵ ¿
Where
R¿ is the return of the stock i at time t.α i is the part of the return that is not explained by the factors (theoretically it predicts
the value of the return if all the other factors where equal to 0, which is impossible in this context).
β i is the sensitivity coefficient relating the share price R¿to each factor respectively.R(Mkt ,t ) is the return at time t of a market portfolio, the Eurostoxx 50 index in this case.R(Bank , t) is the return of the industry sector concerning, in this case, the banking sector with
the Eurostoxx Banks index.R(Rep, t) is a dichotomic (which can only have two possible values) dummy variable12, that is
equal to 1 when a reputational event occurs and 0 otherwise.ϵ ¿ is the residual term of the stock i at time t.
2007 was a difficult year for Banca Italease. In May 3 rd, CEO Massimo Faenza was suspected
of being a collaborator in a fraud carried out by a real estate investor (who was arrested two
months before). On June 1st, the bank announced a €400 million loss on derivative contracts it
signed with its clients. A week later, it announced that the losses amounted to €600 million.
On June 12th an important Italian newspaper reported that Banca Italease was under
investigation by Italian market regulators because of its derivative deals.
In order to integrate these events into the regression analysis, “1” was assigned to the dummy
variable R(Rep, t) on these three dates ( June 1st, June 8th and June 12th ) in order to represent
reputational events.
11 The Arbitrage Pricing Theory is a valuation model that prices an asset based on the fact that its price is a function of its expected value and the influence of external factors (generally market indices). These external factors are multiplied by sensitivity coefficients that link each factor exclusively to the asset in question.
12 Dummy Variables are used in regression models to introduce factors that are qualitative in nature, which is the case of reputational events.
23
The graph below represents Banca Italease’s share price before, during and after the trouble
period.
Figure 4 : Banca Italease's share price during the trouble period
Source : Soprano et al. (2009) (the June dates highlights are my emphasis)
As seen from above, the effect of the June 1st and 8th loss announcements are clearly visible in
the share price. All other things being equal, one can suppose quantifying the weight of the
share price drop according to the loss announcements possible.
Unfortunately, the regression analysis did not prove to be very useful. The R Square13
coefficient was 0.014, meaning that only 1% of the share price fluctuation can be explained
by the multi-factorial model constructed before. The authors concluded from this
unsuccessful quantitative attempt that a qualitative assessment would fit reputation better. In
fact, in addition to this conclusion, one could also show how the depth of any reputational
event (if identified) is ignored by the sole use of the dichotomic variable.
2 – Ingo Walter’s JPMorgan and Banesto Case
Through a similar multi-factorial regression analysis, Walter (2006) was able to approximate
proper reputational loss in term of shareholder’s value using the JPMorgan and the Banco
Espanol de Crédito (Banesto) takeover by the Bank of Spain in December 1993.
13 The closer the R square coefficient is to 1 the more the regression line fits and explains the observations exactly. The closer it is to 0, the less it explains it. (Dougherty 1992:71)
24
JPMorgan was involved in Banesto in various direct and indirect ways according to the
author, mainly advising the bank on its operations and on how to raise capital. As a
consequence, Banesto’s lending book increased four times as much as the other Spanish
financial institutions at that time, this reckless increase invariably led bank into being stuck
with large losses due to an important amount of bad loans. As a result, the Bank of Spain took
control over Banesto claiming irresponsible lending behaviour.
This announcement is bound not only to have repercussions on Banesto but also on
JPMorgan’s reputation, as it was its main operation consultant. The hypothesis made by
Walter was that, in the case of JPMorgan, the market response to the takeover announcement
would exceed the book value exposure related to Banesto. Basically, it means that
JPMorgan’s value will decrease by a bigger amount that just an accounting write-off of
Banesto from its books.
The regression model used was the following :
RJPMt=−0.0014+0.5766 R(Mt )+0.2714 R(¿)+u t
where :R JPMt is the return on JP Morgan stock;R(Mt ) is the return on the NYSE (New York Stock Exchange) index;R(¿) is the return on a group of 20 banking and securities companies within the
same industry that show the same characteristics as JPMorgan;ut is the excess return attributable to the event, from 50 days prior to the
announcement to 50 days after.
The author noticed a 10% cumulative shareholder loss 50 days after the announcement. This
10% was translated to $1.5 billion, while the direct accounting loss on Banesto was $10
million only. While there is no direct conclusion that the $1.5 billion loss is all reputational,
the author suggests it as the most probable explanation, with the market reaction being
assigned to a decrease in trust in JPMorgan’s ability to advise its clients, it can be considered
reputational loss. Therefore, to some extent, this model worked.
These are only two models from many attempts, many practitioners have been trying to
encapsulate and give quantification models for either reputational capital, reputational loss or
empirical evidence for reputation’s impact on performance (McGuire and Branch, 1990;
Christiaens,2008; Perry and Fontnouvelle, 2005; Helm, 2005; Rose and Thomsen, 2004;
Little et al., n.d.).
25
The problem with such an intangible is that its effect can be felt and acknowledged, but it is
very difficult to gauge exactly.
26
3 – Research MethodologyThis chapter presents the research methodology used in this study.
This study is entirely based on secondary analysis14 of already available data and therefore
constitutes a desk based research, with the main sources whose results are used being three.
First, the “Reputation: Risk of Risks” survey conducted by The Economist Intelligence Unit
(EIU). Second, through the use of scholarly journals and periodical articles. Third, historical
share price datasets that were used to generate a regression analysis.
3.1 - Reputation : Risk of Risks
This survey constitutes roughly the basis from which the findings of this business report are
drawn from. It was conducted by the EIU that was founded in 1946 as an internal research
unit for the newspaper The Economist (EIU.com, 2010) aiming at providing trustworthy
business intelligence to decision makers. It specialises in disseminating business intelligence
through qualitative and quantitative research elaborated by over 120 analysts and
professionals worldwide.
This particular survey was made in December 2005 by Alasdair Ross15 for The Economist
constituting the fourth report in the Global Risk Briefing research programme that is targeted
at senior executives in order to spread actual findings concerning corporate risk (Ross, 2005).
Advantages of using this survey :
1. A high-quality sample : The sample used that consists of senior risk managers
represents the exact population from which such a study aims to collect information.
Having a better sample would have been almost impossible as a student since the
issue of reputational risk management is mostly discussed within senior management.
2. Quality of the research : It is safe to assume that the internal research unit of a well
reputed entity such as The Economist has high methodological standards and that
issues related to validity and internal reliability are kept to a minimum.
14 Secondary analysis refers to the “analysis of data by researchers who will probably not have been involved in the collection of those data” (Bryman & Bell 2007:p732)
15 Alasdair Ross is the current Risk Briefing editor and Global Product Director at The Economist Intelligence Unit and also a international speaker on operational risk and risk management.
27
Methodology of the survey :
“Reputation: Risk of Risks” is the result of both quantitative and qualitative assessments.
The quantitative part is in the form of a survey carried out online by the EIU in October 2005.
The survey collects the answers of 269 senior risk managers on issues concerning
reputational risk, and their views on reputation management.
The survey contains 12 questions. Eleven of which come in the form of structured closed
format questions that ask respondents a direct question in the form of a statement in each time
and offer multiple choice answers. The remaining question is a dichotomic one offering only
two answer choices.
The qualitative analysis consisted of “in-depth interviews with executives” (Ross, 2005:1) that
were conducted face to face with no traces of further details as to the exact methodology in
the final report. Contacting the EIU asking for more information concerning the qualitative
procedures of this survey yielded limited responses.
3.2 - Other information sources
The other secondary information sources that were used in this study constitute periodicals
and journal articles on the subject which were collected from various business and
management journals that are available through well reputed electronic databases like
EBSCO Business Source Premier and JSTOR. The free access to these multi-disciplinary
academic databases is provided by Swansea University.
Concerning historical share price data for the oil and energy companies used to establish a
statistical regression analysis, they were gathered electronically through the Yahoo! Finance
internet portal and Google Finance.
3.3 - Limitations of the method used
The main limitation of the research method used in this study is the fact that the “Reputation:
Risk of Risks” was published in 2005. However, with the important number of worldwide
corporate reputational events that happened in the meantime, one can assume that if the
research was repeated in 2010, the results collected would still follow the same trend, as no
major breakthrough or key management practice in the field of reputation management was
found (this issue will be further discussed in the findings section). In fact, the gravity of some
28
of the latest corporate reputational events and their effect on the companies might even
accentuate the answers given and make them converge more in the favour of this study.
29
4 – Analysis of findings and recommendationsThis chapter constitutes the analysis of the data collected which is supplemented by the
synthesis of the current academic opinions on the matter and the outcome of a reputational
loss quantification attempt through multivariate linear regression. It also proposes
recommendations, either as potential managerial implications or as more specific future
research topics.
The key findings of this study are two : First, managers do recognise the imminence and the
importance of establishing reputation management standards. Second, there is a general
confusion when it comes to understanding the exact nature and boundaries of Reputational
Risk Management, especially concerning how to implement any strategy or method due to
the lack of well-established frameworks that succeed at properly valuing reputation in terms
of capital. The practices that are available now are mostly company-specific rules of conduct
that are developed and applied internally and whose generalisation will hardly be viable.
These findings will be explained in more details in the following sections.
4.1 - Pinpointing the concept is crucial
Reputational Risk Management is indeed acknowledged as an emerging practice that is likely
to overshadow crisis management in the future. It is only logical that a tool that helps
managers to avoid dire reputational events will prove to be more interesting to investigate
than investing in damage mitigating techniques and expensive communication professionals.
Reputational management practices have yet to fully form themselves and to acquire a solid
grip of the multiple nature of corporate reputation, as shown by the narrow scope of
application of current attempts and procedures. The current situation is that most methods
available are only estimates, predictions, or one case models that would probably give
fallacious results at best if generalised. Therefore Reputational Risk Management is only
rarely integrated and applied by managers to its full potential due to the absence of official
methods.
30
Figure 5 : Who is responsible for managing Reputational Risk ?
Source : Ross, 2005Regarding Figure 5 above, senior management and especially the CEO is seen to be the
person responsible for managing a company’s reputation. Taking in consideration that the
respondents were all senior risk managers, it seems that reputational risk is still not fully
implemented within their own area of expertise (as Risk managers ranked 3 rd in Figure 5),
even if they thought that the chief risk officer is ought to be the one in charge for practical
quantitative issues related to reputation (which represents an important part of reputational
risk management) according to the findings in figure 6 below.
Figure 6 : Who is responsible for specific reputational activities ?
Source : Ibid. These two findings further prove that reputational risk management is still vague as to its
implementation and that it needs rigorous specifications in the future, because theoretically
the first steps of correctly managing a phenomenon are by giving it specified boundaries as to
what it is, i.e. in this case, who is responsible for it and to what extent.
Corroborating what was stated in the literature review earlier concerning the lack of
distinguished description of reputational risk management, the survey finding that out of the
269 risk managers surveyed, 118 (44%) ranked the fact that reputational risk lacks the
fundamental tools and established techniques as the main obstacle for it to be managed,
coupled with the second important issue shown by Figure 6 being that no one is really in
31
charge for this function, one can draw one main conclusions, that confusion still reigns in
senior management as to who should really be responsible for reputational risk within their
departmental structure.
Figure 7 : The rate of perception and expectation assessments
Source : Ibid.According to the survey result above extracted from the EIU survey, 46%16 of the managers
surveyed stated that their companies are focusing their assessment of expectations and
perceptions of customers on a constant basis. The percentages are visibly decreasing with
other constituents. This shows the continuous perception of reputation as a brand
management issue more than anything else, which is not adequate under a reputational
management logic. As a matter of fact, the findings show an undervaluation of the
importance of many constituents. Important stakeholders such as industry regulators and
media groups are not given proper regular assessments. In fact, with 59%17 of risk managers
not constantly evaluating media groups, this can represent a first step towards a widening of
the theoretical reputation-reality gap by not giving enough importance to some constituents
and therefore lagging behind if expectation changes do occur in the future.
In addition, reputational damage mitigation is seen to also be mainly a CEO task (55%),
rather than a pure communicative role through public relations and brand management (12%
of respondents). This shows the current improvement of perception that these communicative
departments are mainly customer oriented and that they cannot deal (alone, at least) with
complex reputational threats and that reputation is more than a corporate communication
matter.1646% represents the sum of the two answer choices “Continuously” and “At least once a month” concerning the “Customer” category (40 + 6). Both can be seen as adequate assessment intervals.
17 59% represents the sum of “Never”(24%), “Occasionally in the Past“ (19%) and “Once in a year” (16%).
32
Figure 8 : Reputation Management equals Corporate Social Responsibility?
Source: IbidNevertheless, according to figure 8, hesitation shows itself when it comes to really specifying
what is reputational risk with the majority (40%) of the managers surveyed. In fact, corporate
social responsibility can be only considered as a portion of reputational risk management
undertakings. This again shows the importance of coining official definitions and the need for
professional frameworks in order to improve the awareness and encourage the creation of
standardised practices in the future.
Figure 9 : Reputation, a category of risk of its own?
Source: Ibid.Results through figure 9 also show that, of the 269 senior risk managers surveyed, 52% agree
that direct threats to reputation makes it a risk category of its own. This proves the
importance of implementing and designing reputational risk procedures through isolating the
concept of reputational risk from other risk management activities, even if it goes a bit in the
opposite of some of the theoretical definitions of academics given before. This result, when
seen in the light of the following figure 10 (see below) that ranks reputational risk as the most
significant (52%) threat to their companies, helps in understanding their categorisation of
reputational risk as a proper risk category, since it is seen as the most menacing risk to the
sound ongoing of their firms’ operations. In fact, categorising and acknowledging
reputational risk as a first order impact will allow more proper risk assessment and
measurement practices unique to reputation to be researched, empirically tested and be fully
implemented in the future.
33
Figure 10 : Threat importance categorisation
Source: Ibid.
4.2 - Concerning reputational valuation
For valuing reputational capital, the RQ quotient seems to be an adequate candidate for a
worldwide use in the future, because it is the most developed index that could be used so far,
the scope of the attributes used is large and the sample size is big enough (although the bigger
the better). The real practicality of the RQ is the fact of it being assessed every year, in a way
offering a solid reputational perception database of the general public for the years to come.
On the other hand, its applications are limited to well known companies only, which reduces
its use. Smaller companies could come up with their own reputation quotient by using a
similar method, if it is indeed permitted to be used, however the costs of such a research
could prove to be a major obstacle.
Still concerning a reputational capital index, another future possibility would be for
companies with minimum visibility to request reputation rankings indices (a reputation
benchmark against the image of its competitors for example) from research agencies,
unfortunately such research will prove costly if done by a single company in the long term.
Fortunately, from the publicised rankings that are available throughout the world, many are
country-specific18. A company would for example gather their ratings from different
published rankings in order to situate itself and its general corporate reputation. Adversely,
the conflict of interest problem that is currently debated with credit rating agencies can be
even more problematic in the case of an intangible asset such as reputation, which no one can
really verify. It is possible that the ratings would then be affected illegally by companies
18 Please refer to appendix 2
34
wishing to boost their scores. Nevertheless, this issue is linked to the great importance that
expectations play in corporate reputation, where it discourages companies to build false
expectations that would ultimately collapse in the long term.
4.2.1 – Quantifying reputational risk
Researchers have yet to come up with models that could be widespread to incorporate in the
company’s risk management routine. Some models might indeed quantify approximately
financial loss due to a reputation affecting event, and might therefore be used in the long
term, but they are mostly restricted to one case study or to one company. It can be said that
the current goal of quantifying reputational loss, according to literature and to practitioners, is
to develop a model as close as possible in use to the Value-at-Risk19 measurement that will
consider reputation as a valued portfolio. For this to happen, a reputational capital “quantity”
in monetary value needs to be determined first, which complicates the issue even more. Even
if the market-to-book values or royalty payments do give a relatively simple image of the
external valuation of a company, it would be unwise to consider them as proper explanations
of external perceptions and thus assign the entire market-to-book value difference as
reputational impact. However, the matter is simpler with listed companies that have their
share price valued continuously, it can approximately trace off the effects of decisions and
announcements on the share price reaction. It remains possible for non listed companies to
situate themselves nevertheless, through comparison with the aforementioned listed ones that
have similar characteristics. Concerning financial institutions, Perry and Fontnouvelle (2005)
suggest that cross bank impact of operational loss announcement may prove to be an indirect
indicators value-affecting reputational events. As a matter of fact, this hypothesis suggested
by the authors is backed by one principal question, whether the stock prices of competitors
will react if a bank announces losses due to internal operation failures, i.e. if they increase, it
might prove a negative reputational impact on the institution with operational losses. If this
hypothesis is affirmed by future solid empirical evidence, it might be possible to extrapolate
it to other industries as a reputational value measurement method. Another very interesting
point that needs further investigation was put forward by Ettenson and Knowles (2008),
claiming that the failure of various researches to correctly correlate corporate reputation with
shareholder value is due to the fact that companies need, in addition to a good reputation, a
strong brand perception. They also argue that reputation only gives legitimacy to a company 19 Value-at-risk is a financial measure that gauges the potential percentage of loss of a portfolio over a period of time based on previous data available. It helps forecasting the possible maximum losses during one day for example.
35
and thus no real competitive advantage (unless it is coupled with a good customer oriented
brand perception) that will make it easy to detect in future shareholder value. Therefore,
further research that focuses on both concepts (reputation and brand) might be able to
successfuly show reputational impact on firm value, thus offering a quantification method.
So far, reputational capital assessments that are based on stakeholder opinion impose
themselves as more logical, practical and constructive to use even if it takes longer to process
and analyse the information gathered. The current limitation is that it can only be applied to
companies that have a minimum of visibility, and enough capital to spare for such research
without it affecting its usual performance. In fact, the emphasis on the resources used is
extremely important, as a one-time qualitative research made by a company will not be of
substantial help unless the research is longitudinal i.e. repeated over time with the same (or a
relatively close enough) sample. It is only then that a deep and useful analysis will be
possible by managers, as it will become easier to assess the impact of decisions and
announcements over a period of time than through a single period assessment only.
Figure 11 : Impact of different factors on reputational risk management
Source: Ibid.Reputational Risk Management will surely gain more attention (and therefore more chances
of establishing generalised efficient practices) following the 2008 financial crisis and the
regulatory changes that will follow as seen in figure 11 above. It will also be very interesting
to look forward to the future Basel III texts and what they might bring in terms of strategic
risk definitions and practices, under which reputational risk is cited. Chances are that there
might not be a substantial improvement over Basel II in this side as the texts are concerned
with regulating banking practices and addressing market failures that were unveiled after the
last global crisis, and that reputational risk was only mentioned as an attempt to list all the
risks that financial institutions are facing and not address it as an issue.
36
BP’s Gulf of Mexico oil spill scandal represented a good opportunity not only to illustrate the
reputation-reality concept as shown earlier in the literature review but also to test the efficacy
of a linear regression model outside its original background. The following model is based on
the multivariate model of Soprano et al. (2009) that was used to quantify reputational loss at a
function of share price volatility in the case of Banco Italease, which was also discussed
earlier. In BP’s case, the time period analysed was before, during and after the heavy media
coverage of the crisis and its respective share price effect, therefore from the 1 st of April 2010
to the 10th of September 2010. The peak of the crisis began in April 20 th, and the coverage
was relentless for the following 3 months. Although Soprano et al.’s model did not yield
satisfying results in the case of Banco Italease, the fact that the decrease in BP’s share price is
tangible, more substantial and more mediatised than Banco Italease might show more
interesting results.
It was possible to use this model to BP’s case by applying the following modifications:
1- The return of the industry variable in the generic formula was represented through the
calculated average return of the 5 biggest oil and energy companies in the world listed
in the NYSE20 thus representing an approximated industry average index that will
help situate BP’s returns with its competitors in order to provide a fair comparison,
and to increase the efficiency of the regression model.
2- The market return variable is represented by the S&P 500 index returns, which
includes the largest 500 publicly owned common stocks that are listed under both the
NYSE (New York Stock Exchange) and the NASDAQ (National Association of
Securities Dealers Automated Quotations) stock market exchanges.
3- In the case of the dichotomic reputational variable, 59 observations were attributed
“1”. These observations were between April 20th and 13th July 2010. After which the
share price stopped dropping and somehow stabilised. Before and after this interval,
the variable was given “0” to specify that no reputation affecting event occurred. This
is illustrated with the graph below. Attributing “1” to that interval is the approach by
which it can be possible to put forward the reputation-damaging effects in the
regression model as an attempt to come up with an explanation of the share price
fluctuations through reputational loss. On the other hands, doubts remain concerning
the proper use of such a variable, it is not certain whether it is better to attribute “1”
only to the days in which harmful events happened or to the whole period (which is
20 Respectively Chevron Corp., ConocoPhillips, Royal Dutch Shell plc, Exxon Mobil corp. and Total SA.
37
the case here, 59 periods were attributed “1”), therefore including other days in which
nothing happened save the continuation of the consequential decrease. Figure 12
below illustrates this concept.
Figure 12 : Attributions of the Reputational dichotomic variable in BP's share price data
Source: Google Finance, 2010 (dates and additional notes are my emphasis)
Therefore the multivariate regression model after calculations becomes the following:
RBP ,t=α t+β1 R(SP 500, t)+β2 R( IndAvg,t )+β3 R(Rep ,t )+ϵ t
Where
RBP ,t is the return of the BP stock at time t. Time t is the daily share price observations during the selected period and translates into 173 observations, therefore t goes from 1 to 173 for this model.
α is the intercept coefficient, it has no tangible economic value in this case besides improving the precision of the regression model to make it represent closer values to reality.
β1…3 is the sensitivity coefficient relating BP’s return on share price RBP ,tto the factorsR(SP 500, t),
R(IndAvg, t) and R(Rep , t) respectively.
R(SP 500, t) is the return at time t of the S&P 500 market portfolio.
R(IndAvg, t) is the tailor made average of the returns of the 5 biggest oil and energy companies, in other words the industry in which BP operates in.
R(Rep , t) is the dichotomic dummy variable that equals 1 when a reputational loss event occurs and 0 otherwise.
ϵ t is the residual term of BP’s stock at time t, represented in the regression analysis through the Standard error.
After conducting the regression analysis, the model becomes the following21 :
RBP ,t=0.0573−0.7595 R(SP 500 ,t )+1.5922 R(IndAvg ,t )−0.5809 R(Rep , t)+ϵ¿
21 Please refer to Appendix 2 for more details.
38
With an R square of 0.249222, it can be said that this regression model is able to correctly
explain 24.92% of BP’s share price fluctuations. In the case of any stock price, it is
impossible to come up with models that correctly explain (and therefore able to predict)
fluctuations, therefore a high R square when modelling share price is purely statistical and
will probably have no practical use in effectively predicting the exactitudes of its movements
due to an event affecting reputation. The fact that this model is able to explain almost 25% of
the fluctuations shows that reputation indeed has a numerical representation within the share
price, otherwise it would have been much closer to zero. In fact, what this model really shows
is that a reputation-damaging event is able to decrease BP’s stock price by 35 %23 in the
whole reputational crisis period. In a sense, this result is a very approximate reputational loss
quantification through share price fluctuation, even if it remains very limited.
Obviously such a model has its limitations. First, the reputation variable’s beta coefficient is
statistically insignificant at the 95% confidence level24, which means that the chances of the
model predicting reputational impact with success are less than the generally used 95%. This
relatively shows the difficulty of correctly separating and estimating reputational impact from
other variables. Second, this model is by no means able to gauge the severity of any
reputation-damaging event and puts them all in one case, as the reputation “detector” in this
case remains only a simple dichotomic measure. As a matter of fact, a fraudulent activity by
an employee does not have the same effect as a publicised affront or criticism caused by a
famous public figure for example. The third limitation is that, in Soprano et al.’s model, the
reputational dummy variable was given “1” only in 3 dates that are supposed to trigger share
price decrease, while in the model currently used, the dummy variable is attributed “1” on a
range of dates that cover the whole share price decrease period. While this model’s R square
shows that it covers more than Soprano et al.’s attempt, it remains impossible to claim that
this method of managing the dummy variable is the correct one. The fourth limitation is the
relatively small number of variables used in this model or the absence of more detailed
reputation factors that could have allowed a more precise estimation. A fifth limitation would
be that the regression analysis could have covered a wider range, for example a 10 year study
22 Idem.
23 0.35 was obtained by dividing the beta coefficient of the variable R(Rep , t) by the average returns on BP’s share price before the crisis (representing 72 periods, more or less 90 days since weekends are not taken in consideration).
24 The Reputation variable’s P-value is 0.189746, which is more than the statistically desired 0.05 which represents the 95% confidence interval. Please refer to Appendix 2 for more details.
39
of historical share price data correlated with the various reputational events that BP faced
over that period. The events are significant enough to establish a more precise model.
4.3 - Concerning further research
As it is seen from the generally unfruitful results, further research is therefore mandatory in
this field due to the fact that literature and empirical tests concerning reputational risk
management is relatively still in an infancy stage compared to other risk management
practices that include proper quantifications and acknowledged techniques. The motive that is
pushing researchers to come up with indices and measurement methods related to reputation
is to provide management and stakeholders with a single number that can facilitate
comparison between companies, progress measurement and reputational damage evasion.
The latter through identifying specific events or course of actions whose effect can be traced
in one’s own or other companies’ indices for example. Figure 13 below represents the main
obstacles to a sound management of reputation. In fact, these findings can greatly help direct
future research efforts in the field by tackling each problem separately.
Figure 13 : Reputational Risk Management’s common barriers
Source : Ibid
Therefore, further research concerning reputational risk is welcomed in general but also in the
following specific directions, some purely theoretical, others more empirical :
Official “textbook” definitions and explanations of what exactly constitutes reputational risk;
The generalisation possibilities of an already established index like the Reputation Quotient (RQ);
40
A reputational quantification method that can be generalised ;
The inter-firm impact of reputational events i.e. gauging the changes in value of competitors in the case of a crisis affecting a certain company within the same industry;
The convergence (or divergence) of corporate communication efforts and their effect on corporate reputation through a reduction of the expectation-reality gap.
The coordination between risk management practices and public relations.
The effectiveness of brand and reputation insurance policies in protecting corporate reputation.
Exploring the feasibility and possibility of a reputational Value-at-Risk measure.
The identification of relevant variables and factors in regression analysis that will help in quantifying reputational loss through stock fluctuations and therefore increase its tangibility.
4.4 - Research Limitations
Due to the time constraint of 3 months in the making of this business report, more specific
subjects within corporate reputation were not covered, namely the efficiency and impact of
the new brand and reputational insurance that is being offered to companies, namely Dewitt
Stern’s Reputation Risk Insurance, where a quantitative and qualitative research could have
been made about this specific insurance type, during the early stages of data gathering for the
business report, Dewitt Stern were contacted for more information concerning this specific
insurance package but with no answer whatsoever.
Also, quantifying a reputational loss (or impact) using extensive econometric regression
models could have been covered in more depth giving a more empirical analysis of the issue
and by exposing in more detail the problems quantifying reputation faces.
41
5 - ConclusionIn this study, the current state of Reputational Risk Management was examined. It shows that
it is a promising risk management practice that will certainly help companies stabilise
themselves, especially during turbulent times where each and every decision made in
company board rooms is bound to have a reputational impact. This study focused on two
main areas. First, the different views concerning the definition and boundaries of what
reputation and reputational risk management really are. Second, quantitative and qualitative
attempts at reputational valuation methods. The data collected for this study consisted of a
senior management survey done by the Economist Intelligence Unit, academic articles
gathered from well reputed sources whose variety covers a span of 10 years on reputation
literature and historical share price datasets in order to provide the reader with a tangible
example of reputational quantification.
The study shows that, in general, managers are still hesitant as to how to exactly tackle
corporate reputation beyond a crisis managment perspective. Indeed, most managerial efforts
done nowadays in this field translate to damage mitigation and coordination of the
communication efforts in order to regain what reputation was lost. The preferred general
direction that corporate reputation management should take is a more substantial
implementation within risk management practices. On the other hand, in order for it to be
recognised as a risk management practice it urgently needs more quantitative assessments,
which in the case of an intangible is rather complicated. Quantitative reputation attempts are
relatively rare within the literature, and they all spark off divided opinions. In fact, if one
method is in fact capable of capturing the monetary value of corporate reputation and of
losses that are directly attributed to it, it seems to focus only on a single case, therefore
attempting to generalise a quantification method will more than likely prove to generate
blurry results.
The findings of this study are that there exists a prominent lack of properly defined practices,
guidelines and frameworks in order to include reputation in risk management. In addition,
quantitative assessments are still in a stage of infancy, statistical models of reputational
valuation should be more researched in the future in order to be more precise and help
improving what is to be called Reputational Risk Management. There is a lot that needs to be
done in this field of study, and further research is not advised, but mandatory.
42
43
Appendices
Appendix 1 : BP’s illustrated timeline of media coverage
Source : Eccles, Robert G.; Newquist, Scott C.; Schatz, Roland (2007). BP’s Sinking Image diagram from Reputation and Its Risks. Harvard Business Review. February, p 107.
44
Appendix 2 : Country-Specific and Global Reputation Rankings
Source: Fombrun, Charles J (2007). Table 1: Country of Origin of Reputation Rankings
diagram from List of Lists: A Compilation of International Corporate Reputation Ratings.
Corporate Reputation Review; Vol. 10 Issue 2, p145
45
Appendix 3 : Detailed results of the regression analysis performed using Microsoft Excel
46
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