What is Reputational risk?
Reputational risk, often called reputation risk, is a risk of loss resulting from damages to a firm’s reputation, in lost revenue; increased operating, capital or regulatory costs; or destruction of shareholder value, consequent to an adverse or potentially criminal event even if the company is not found guilty. Adverse events typically associated with reputation risk include ethics, safety, security, sustainability, quality, and innovation. Reputational risk can be a matter of corporate trust.
Reputational risk is the risk that a company will lose potential business because its character or quality has been called into question. For example, if it revealed that a company has been cheating customers out of money for years, this risk would become a stronger possibility due to the company’s tarnished reputation.
Reputational risk can occur through a number of ways: directly as the result of the actions of the company itself; indirectly due to the actions of an employee or employees; or tangentially through other peripheral parties, such as joint venture partners or suppliers. In addition to having good governance practices and transparency, companies also need to be socially responsible and environmentally conscious to avoid reputational risk.
Reputational risk may be defined as the risk of possible damage to firm’s brand and reputation, and the associated risk to earnings, capital or liquidity arising from any association, action or inaction which could be perceived by stakeholders to be inappropriate, unethical or inconsistent with the firm’s values and beliefs.
This type of risk can be informational in nature that may be difficult to realize financially. Extreme cases may even lead to bankruptcy (as in the case of Arthur Andersen). Recent examples of companies include: Toyota, Goldman Sachs, Oracle Corporation, NatWest and BP. 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.
In risk assessments, reputation risk is often considered as a risk event. However, it can be the end result of more specific risk events that can have a number of impacts.
Sources of Reputational risk
Several business elements can leave the company exposed to the threat of reputational risk:
- Health and safety incidents;
- Operational crises and events (e.g. pollution);
- Product recalls and quality control errors;
- Busiiness and service interruptions;
- Financial losses and irregularities;
- Negative associations with third parties;
- Management and governance topics;
- Legal and regulatory investigations;
- Allegations over business practices;
- Ethical violations and challenges.
Managing Reputational risk
10 keys to managing reputation risk
1. Effective board oversight;
2. Integration of risk into strategy-setting and business planning;
3. Effective communications, image and brand building;
4. Strong corporate values, supported by appropriate performance incentives;
5. Positive culture regarding compliance with laws and regulations;
6. Priority focus on positive interactions with key stakeholders;
7. Quality public reporting;
8. Strong control environment;
9. Company performance relative to competitors;
10. World-class response to a high-profile crisis.
5 steps to get a grip on managing reputational risk:
- Start monitoring for reputational risk;
- Assign responsibility for reputational risk;
- Build reputational risk reporting into governance;
- Allocate resources;
- Conduct a reputational risk audit.