Thursday, April 10, 2014

The Cost of Reputation Risk

I came across a great presentation on Reputation Risk from Martin Davies of Causal Capital. It outlined the many dimensions of this onerous corporate threat. It offered a definition, a list of risk factors, its impact on a company’s financial condition and proposed frameworks to mitigate its effects.

In the pantheon of risk factors, reputational risk is the classic riddle wrapped in a mystery. Its obtuse nature is due in part because it can spring from a multitude of internal and external factors. This makes predicting the occurrence of a reputational risk event difficult to assess and near impossible to quantify making ROI mitigation funding decisions a perplexing task. 

Reputation risk seems to loom as a phantom menace that inhabits the dismal swamp of innumerable asymmetric risk factors. Its appearance is rare but potentially catastrophic in nature because it strikes at the heart of brand value and corporate integrity. 

The dissolution of Arthur Andersen due to its failures to detect fraudulent business and accounting practices at Waste Management, Worldcom and Enron destroyed the firms reputation for honesty and integrity. Though some argue the cause of this spectacular corporate collapse was due to the contradictions of an attestation/consultancy business model, AA’s pattern of high profile failures in its attestation business made it impossible to continue in business as a firm with unimpeachable standards for audit and accountancy excellence. 

Though corporate dissolution is the worst case scenario resulting from a catastrophic reputational risk event, larger firms with the financial wherewithal and organizational resource to underwrite corporate resilience strategies are best positioned to overcome the severe shocks of a reputation risk event. Mitigation initiatives must be more than a PR exercise in damage control. Senior management must take ownership of the event and implement a strategy that allocates resources to the problem to assure stakeholders that an optimal return on capital employed will be realized to the benefit of a sustainable enterprise.

Though reputational risk seems to arise from a kismet of asymmetrical factors, which are difficult to foresee and nearly impossible to plan for due to the limitations of linear causation and factor biases of quantitative based risk models; reputational risk is best addressed by striving for GRC (governance, risk compliance) excellence throughout the corporate enterprise.

This is particularly important for SME’s who lack an expansive balance sheet, financial reserves and organizational resources to ride out and overcome the profound impact of a reputational risk event.

Quantification of reputation risk is difficult to measure. The cost of mitigation initiatives and the expected loss realized from a reputational risk event must be funded through the GRC culture of the enterprise. The above slide caught my attention because it graphically displays the impact of a reputational risk event on the equity value of a publically traded company. Though equity exchanges are good barometers to determine monetary impact of a risk event, the managers of privately owned firms are beholden to a different set of expectations of closely held corporate stakeholders. 

Amorphous performance standards of idiosyncratic investors, the close coupling of corporate goodwill, shareholder identification, corporate identity and product branding concentrates and magnifies the intensity of reputation risk. 

SMEs mitigate reputational risk factors by developing a vigilant GRC culture that encourages the engagement of all employees in the mission of the enterprise. In so doing, all company stakeholders are deputized as vigilant risk managers; all wholly invested in the protection of corporate goodwill and the creation of long term sustainable value of an extended enterprise. 

Sum2 believe this to be the case as well. Our clients engage risk as a daily cost of doing business. We design risk management products for small business managers that empower them to lower the odds and consequences of damaging risk events while positioning themselves to be the beneficiaries of opportunities changing market conditions produce. 

Get risk aware and protect your business with the S3 an SME Seismograph, a risk detector and an early warning and opportunity discovery app on Google Play. 

Risk: reputation, Arthur Andersen, sme, macro, catastrophic, Black Swans, facilities, business interruption, transportation, contagion risk, infrastructure risk, S3, GRC, Martin Davies, Causal Capital

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