Reputation Risk

Reputation risk refers to the likelihood of negative events, as well as public opinions and perceptions, that are adversely impacting an entity’s income, brand, support, and public image. Brand reputational risks are hidden threats or dangers to the standing of a business or entity. Reputational risks pose threats to the survival of the biggest and best-run companies as it can wipe out millions or billions of dollars in market capitalization.

A broader understanding of the reputational and financial impact of environmental, social and governance (ESG) issues has led stakeholders to appreciate the significance of these issues to a company’s financial performance. More companies are being compelled to manage their ESG risks and disclose these activities in their 10-K and 10-Q financial reports. 

These reputational risks cover a wide range that includes climate change, board gender composition, workplace culture, human rights, anti-bribery and anti-corruption efforts and data privacy, among others. From climate change activism to diversity in leadership positions, boards of directors and asset managers are increasingly faced with the question of the extent to which ESG factors are taken into account in their operations.

Failing to observe ESG factors can lead to reputational risk, for both the public corporation and asset managers. Research suggests that taking ESG factors into account increases firm value since the presence of institutional ownership is related to a firm’s environmental and social performance. Ultimately, the reputational risk could threaten the life and longevity of a company when not prevented or properly managed.

Examples of reputation risk

The impact of employers on society is of paramount importance in today’s business world. Social and governance issues like workplace culture, executive behavior and data privacy have an increasing material impact on corporate performance and company reputations. Facebook’s multiple reputational risks have societal and governance aspects. With investigations into the company’s ethical practices, the Facebook brand lost some reputation equity. It didn’t help matters that CEO Mark Zuckerberg and Facebook’s leadership team didn’t handle the matter well in the media. 

Facebook lost about 2.8 million US millennial users in 2017. Its stock price also took a massive dip and is easily the worst daily stock market decline in four years. The breach of trust has caused some ESG-focused investment funds to drop Facebook shares from their holdings.

Another example of reputational risk is the WeWork incident. Valued at about $47bn and with more than 500 locations in 29 countries, the WeWork brand was a unique one in the corporate world. Its then CEO, Mr Neumann built WeWork in his own image. His creation became a buzzy, multi-billion dollar company that was known for an irreplaceable corporate culture: co-working spaces, free-flowing alcohol, and a well-defined mission to “elevate the world’s consciousness”.

Since 2010, the firm has expanded from a single office in New York City to more than 500 locations in 29 countries. Japanese investment giant Softbank valued the company at $47bn (£37bn) in its most recent investment round.

But that didn’t continue for much longer as WeWork decided to sell its shares on the public market. And that was it all went down. Neumann’s “strengths” soon became a tragic flaw. His brash charisma that drew investors in droves once upon a time became a liability. Soon, the firm’s expected valuation sunk to between $10bn and $12bn. Complaints were rife, but they all seemed to have a focal point: Mr. Neuman’s hard-partying lifestyle that blurred the lines of professionalism. Investors felt that he mixed personal finances and the companies to the point where they became uncomfortable and lost trust in the brand. For instance, Mr. Neumann, who had voting control of the company, secured personal loans using company stock as collateral at some point.

A while ago, two black men were arrested in a Philadelphia Starbucks coffee shop for sitting in the store without ordering anything. It turned out that they were victims of racial profiling. The store manager called the police without talking to the men. Subsequently, there was an outcry on social media for a boycott and Starbucks was forced to respond. The company then decide to train its staff on unconscious bias. The immediate cost was millions of dollars lost due to closed stores.

Wells Fargo also had its share of reputation risk issues. Millions of unauthorized accounts were opened by retail bankers. Lots of large customers reduced, suspended, or discontinued altogether doing business with the bank.

Importance of Reputation Risks

In the words of Warren Buffett, “It takes 20 years to build a reputation and five minutes to ruin it”. Clients and consumers have become more aware of social and corporate injustice. The potential damage that this might cause to a company’s reputation has become the top of many a boardroom agenda. Ever since the global financial crash, regulators have pushed for greater corporate transparency, and public companies are now faced with a horde of new reporting requirements. 

Another core reason why reputational risk management is vital is the balance between tangible and intangible assets which has been tipped in the direction of values like trust, reputation, and goodwill, which are not as easy to manage as equipment and staff. Therefore, the valuation of a business can be increasingly found in its intangible assets.

Strong ESG scores lend credibility to brand building. Interest in ESG issues is of paramount importance in today’s business world. Although there is no standardized ESG rating, a lot of research firms have been able to provide investors with frameworks by which commitment to ESG standards can be gauged. Customers and investors expect environmental responsibility, fair treatment of employees, and highly ethical behavior from brand management. A company’s ESG scores are a leading indicator that determines which company meets these expectations.

Takeaway

Reputation risk used to be seen as the outcome of other risks and not a standalone risk in itself. This perspective is gradually changing as reputation is now understood to be critical to the viability of a company. The corporate world is now adjusting its borders to accommodate ESG demands. Those who are yet to align their operations to this trend stand to lose a lot.

ESG Enterprise provides a tool to assist with reputation risk for ESG assessment and ratings.