Reputational RiskA threat or danger to a Business's reputation

You can find some of the factors that affect a company’s valuation in its financial statements.

There’s the balance sheet that shows the company’s assets, liabilities, and equity.

Then there’s the income statement that shows the profit generation of the company.

However, there are also factors that you cannot find in the financial statements.

Among these is the company’s reputation.

Reputation isn’t something that is quantifiable. It’s also hard to put a value on it.

Hence, while it’s essentially an important asset for a company, you cannot find it on any balance sheet.

Nonetheless, it’s important that a company maintains its reputation.

A company’s reputation will affect its ability to grow and earn revenue after all.

Naturally, companies that have a positive reputation will have an easier time earning revenues and profits.

Investors and analysts tend to value these companies higher.

On the other hand, a company with a negative reputation may find it hard to earn profits. It may incur losses instead.

On top of that, it’ll be valued lower than the ones that have a positive reputation.

As a business owner, you wouldn’t want your company to have a negative reputation.

Maintaining and protecting a company’s reputation is important.

It helps greatly in the company’s growth.

However, there will be always the risk that a company’s reputation will be tarnished.

We refer to this risk as reputational risk.

In this article, we will be talking about reputational risk.

How can it affect a company?

Is it avoidable?

What are the factors that contribute to reputational risk?

Can a company manage reputational risk?

Is it important for a company to manage reputational risk?

We’ll try to answer these questions as we go along with the article.

We will also be looking at some real-world examples of reputational risk.

What is Reputational Risk?

Reputational risk refers to the threat or danger to a company’s reputation.

It is often unpredictable and can come from many places.

If left unattended, it can have devastating effects on a company’s operations, especially its revenue and profit generation.

It can occur either:

• Directly – as a consequence of the actions of the company itself
• Indirectly – as a consequence of the actions of the company’s employee or employees
• Tangentially – as a consequence of the actions of other peripheral parties (e.g. joint venture partners, suppliers); it can also be because of the actions of the company’s customers

A company’s reputation is one of the things that it should protect.

A positive reputation can facilitate the growth and revenue generation of the company after all.

On the other hand, a negative reputation will do the opposite: it will stunt the growth of the company. Even worse, it may result in losses.

The thing about reputation risk is that it is often hidden and unpredictable.

Also, it doesn’t discriminate – it can affect companies of any size. In fact, one can argue that the bigger and more well-known companies are more exposed to it.

If left unattended, reputational risk can negatively impact a company’s profitability and valuation.

It has the capability to wipe out millions or even billions of dollars in potential revenues and or market capitalization.

In some cases, it may even necessitate a change in the company’s uppermost level of management.

It’s scary to think about the effects of reputational risk, right?

However, just like any other type of risk, a company can manage reputational risk with the right tools, good controls, and proper knowledge.

Practicing good governance and transparency is one example.

Being aware of its social responsibility could also go a long way toward minimizing reputational risk.

Causes of Reputational Risk

In order to effectively manage reputational risk, it’s important to be aware of what causes it.

As mentioned above, it can occur directly, indirectly, or tangentially. Additionally, reputational risk happens when there’s a disconnect between the expectations of a company’s shareholders and what the company can actually deliver.

For example, a company’s customer may expect a better service than what the company can feasibly deliver.

The following are some examples of what causes reputational risk:

Due to the actions and practices of the company itself (direct)

• Failing to comply with regulations (e.g. federal laws, state laws, industry regulations)
• Improper treatment or exploitation of employees (e.g. not allowing overtime pay, not paying properly)
• Poor working conditions such as not having proper ventilation
• Not having enough data security which results in constant data breaches; this jeopardizes the security and safety of customers and employees
• Publicly known legal cases against the company
• Internal scandals that become public knowledge
• Substandard quality of services and/or goods
• Consistently unable to meet the expectations of customers
• Inability to deliver goods or services on time
• Unable to adapt to the changing needs and want of the company’s customers

Reputational risk due to the actions or practices of the company is probably the most manageable of all the causes.

Since the company has direct influence over them, it can directly rectify them by doing the proper actions.

Due to the actions of the company’s employees (indirect)

• Employees engaging in unethical conduct that become public knowledge
• Individual employees improperly treating customers
• Business leaders that have negative reputations. It could be before they joined the company or it could have developed after joining the company
• Employees misrepresenting the company’s brand (e.g. giving negative reviews)
• Negative social posts by those who are directly connected to the business (e.g. employees, executives, etc.)
• Public scandals involving employees

While not as easily manageable as the direct actions of the company, employee actions are still manageable.

The company can make policies that penalize inappropriate actions of the employees. In the worst case, a company may fire an errant employee.

Due to the actions of partners and/or suppliers (tangent)

• Partners or suppliers speaking negatively about the company
• Public scandals involving the company’s partners or suppliers
• Partners or suppliers experiencing disruptions in their service; this is more pronounced if the service or goods that they provide are essential in the company’s operations
• Legal cases against partners or suppliers

Unlike employees, a company doesn’t have control over its partners and suppliers.

If the effects are becoming intolerable, the company may have to cut ties with its partners or suppliers.

Due to the actions of customers or other external parties (external)

• Negative reviews made by customers on public review sites; in the worst case, these reviews may have been made with malicious intent
• Negative and malicious articles and press by news outlets
• Reputation sabotage by critics and competitors of the company
• Negative social media posts by customers that involve the reputation of the company
• Activists protesting against the company

While some customer reactions are due to the actions of the company or its employees, some just happen even without direct involvement from the company.

To minimize the effects of these causes, a company may employ an individual or a team to manage the company’s social media.

Real-World Examples of Reputational Risk

Nokia and its failure to quickly adapt to the growing smartphone market

Nokia is once known as a giant in the phone market. It used to hold 35% of the phone market pie.

Customers often view Nokia phones in a good light. Because of this, Nokia was confident in its position.

When Apple introduced its first smartphone, Nokia wasn’t rattled.

The executives thought that it wouldn’t make a dent in their position. And they were right… at first.

The smartphone market grew and soon, more competitors entered the market.

Still, Nokia did not innovate and just continue doing what it was doing. When it finally tried to catch up with the evolving market of phones, it was too late.

Now, Nokia barely has any presence in the phone market.

The Case of Gerald Ratner (an inappropriate action of the CEO)

It’s one thing to have critics attack a company’s reputation.

It’s another when the company CEO does it himself.

This is the case with the ex-CEO of the jewelry chain Ratners Group, Gerald Ratner.

In a speech in front of influential industry stakeholders and media, Ratner made a joke about the company’s products.

The joke states that the company’s products are low-quality and a terrible value for money.

The effects of the joke were not funny though – they were catastrophic and immediate.

As a consequence of the joke, the value of the company’s shares when down hardly (about £500 million). Ratner was promptly let go as CEO.

Because of this case, the phrase “Doing a Ratner” was born.