During reputational crisis, equity pricing is especially sensitive to investors’ cognitive biases. According to a survey published in early 2020, global executives attribute 63% of their stock value to their company’s overall reputation. Informational and behavioral economic principles, along with the findings of a study of a dozen reputational crises, suggest how insurance and other risk management strategies can protect share price.
Reputational risk is the peril of impaired cash flow due to behavioral changes by angry and disappointed stakeholders, usually following an adverse event. When emotionally charged, people often make very different decisions than they would otherwise. While the emotional intensity may diminish, the economic effects of decisions made in the heat of a crisis can persist for weeks, months and even years.
A recent Steel City Re study shows that while crisis communication is an important tactic, positioning risk management and reputationally relevant corporate financial information (such as corporate asset structure, reputation value volatility and share repurchasing volume) before and during a reputational crisis can impact up to 80% of the direction and magnitude of a company’s equity price change following an adverse event. The high-profile cases studied included Boeing, Bausch Health, BP, Equifax, Facebook, Johnson & Johnson, Samsung, Target, United Airlines, Volkswagen, Wells Fargo and Walmart, all of which suffered from a crisis that threatened their reputation at some point in the last decade.
Managing reputational risk is both a governance and enterprise-wide endeavor involving all aspects of a firm’s risk management apparatus. Our study found that more than 60% of equity damage can be mitigated through the following governance and risk management strategies:
- Using financial instruments such as insurance to communicate governance and enterprise risk management strategies to stakeholders in simple and credible terms
- Reducing the percentage of the firm’s balance-sheet assets that are intangible to minimize equity losses in the first days after a crisis occurs
- Buying back shares with some of those liquidated assets to minimize equity losses in the first year after a crisis occurs
- Managing enterprise reputational risk and the firm’s reputational value volatility to mitigate risk and reduce equity losses by the second year after a crisis
Corporate leaders often make the mistake of thinking that reputation is a product of media coverage. It is not – and marketing is not risk management. Trying to manage crises purely through marketing is rarely effective, and companies that delegate their reputational risk management to marketing are doing themselves a disservice.
That’s not to say that the marketing department shouldn’t be involved in the aftermath of a reputational crisis. Crisis communication can help mitigate the consequences of a reputational crisis. But as critics have observed, post-event marketing/crisis communication alone is not risk management. Any and all marketing efforts should be deployed in concert with strong risk management, finance and governance controls.
We are in an age when information – both accurate and inaccurate – can be spread instantaneously and a generalized sense of anger and distrust in large institutions makes stakeholders quick to lash out with unease, disappointment and fear. Now more than ever, it’s imperative that companies constantly monitor the ever-changing expectations of stakeholders.
While the speed at which information travels may make the collapse of a company’s reputation appear sudden, it’s actually the result of numerous compromises to governance protocols that gradually changed company culture over time.
Governance and risk management professionals can take this message to the bank. For effective reputation crisis prevention and reputational risk mitigation, leaders must implement pre-emptive strategies that are keyed to the protection of corporate cash flow.
Dr. Nir Kossovsky is the CEO of Steel City Re, which analyzes the reputational strength and resilience of companies and provides tools and insurance to mitigate financial losses when reputational crises occur.