Reputational risk, often called reputation risk, is the potential loss to financial capital, social capital and/or market share resulting from damage to a firm’s reputation. This is often measured in lost revenue, increased operating, capital or regulatory costs, or destruction of shareholder value. Reputational risk is consequential of an adverse or potentially criminal event even if the company is not found guilty.
Adverse events typically associated with reputation risk include ethics violations, safety issues, security issues, a lack of sustainability, poor quality, and lack of or unethical innovation. Corporate trust and relations often have an impact on the degree of reputational risk a business will experience.
This type of risk is often informational in nature, and may be difficult to realize financially. However, extreme cases may lead to bankruptcy (as in the case of Arthur Andersen). The reputational risk may not always be the company’s fault, as per the case of the Chicago Tylenol murders after seven people died in 1982.
From an accounting point of view, reputation it is kind of intangible assets; reputational risk turns the concept of materiality upside down. Traditionally but not exclusively thought of in terms of financial magnitude, reputation means that even seemingly small events or losses, such as a minor regulatory fine, can have larger repercussions. The impact of reputational damage can be minor at first, however issues that are amplified by external social processes (including the media and legal systems) can lead to severe impacts on the firm’s position.
Examples of reputational risk
Reputational risk was apparent in 2016 when Wells Fargo was exposed for opening millions of unauthorized bank accounts. This was done by the firm’s retail bankers, who were encouraged or coerced by some supervisors.
The CEO (John Stumpf) and other executives were dismissed. Regulators subjected the bank to fines and penalties, and a number of large customers reduced, suspended, or discontinued altogether their business with the bank. Wells Fargo’s reputation was tarnished, and the company continues to rebuild into 2019 after suffering heavy financial losses as a result of the damages to their reputation.
Wells Fargo suffered further reputational risk when new legislation was introduced and passed in the 2019 house of representatives exposing Wells Fargo’s practice of offshoring thousands of american jobs overseas and forcing soon to be unemployed workers to train their foreign replacements.
Toyota recalled 8 million vehicles worldwide and froze the sales of eight models in the U.S. in January 2010 amongst pressure from the public, industry regulators and the media. By company estimates, Toyota lost approximately US$2 billion due to the recalls and subsequent lost sales. Additionally, Toyota was fined US$16 million for failing to report the issues promptly and endangering lives. More tangible financial harm became evident in 2014, when Toyota and the U.S. Justice Department agreed on a settlement of US$1.2 billion and a public admission of guilt from Toyota for neglecting the defects. The reputational aftermath of these events were measured by Rasmussen, who found that despite 59% of Americans finding Toyota at least somewhat “favourable”, there was a significant portion (29%) who found Toyota “very unfavourable”.
Reputational risk management
Many theorists have proposed ways to manage reputational risk effectively. Some of these include:
- Systematically tracking evolving stakeholder expectations.
- Identifying stakeholder risk factors as part of a general risk management process.
- Transforming risk management processes to become more proactive rather than reflexive.
- Regularly auditing the catalysts of corporate reputations using the most recent reputation monitoring technologies and services.
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Ofer Abarbanel is a 25 year securities lending broker and expert who has advised many Israeli regulators, among them the Israel Tax Authority, with respect to stock loans, repurchase agreements and credit derivatives. Founder of TBIL.co STATX Fund.