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Enterprise Risk Advisory, LLC
May 9 2007
Michel Rochette
REPUTATION RISK
Also known as the Cinderella Asset!
©Enterprise Risk Advisory, LLC 2
Presenters
Dr. Leslie Gaines-Ross, Chief Reputation Strategist at Weber Shandwick in NY where she leads the firm’s consulting services and proprietary thought leadership in reputation risk management. She is the creator of www.reputationRX.com, a web site dedicated to reputation issues
Mr. Scott C. NewQuist, Managing Director at Perception Partners, which specializes in providing advice on identifying and managing reputation risk, corporate governance and reporting.
Michel Rochette, an ERM consultant at Towers Perrin in NY who specializes in ERM and the management of non-tradeable risks!
©Enterprise Risk Advisory, LLC 3
Reputation Risk
Context: Why is it important to financial institutions?
What is reputation? Definitions and comparisons
Value of reputation: Drivers and evaluation measures
Reputation risk: Definitions
Reputation risk: Qualitative and quantitative measures
Examples of reputation risk
Reputation risk: Management approaches
Reputation risk: Framework
Rating agencies and regulators’ points of views
Case studies
Questions.
©Enterprise Risk Advisory, LLC 4
Citations by Warren Buffet & Goldman Sachs
―It takes twenty years to build a reputation
and five minutes to destroy it.‖ (W. Buffet)
―If you lose dollars for the firm, I will be
understanding. If you lose reputation, I will be
ruthless.‖ (W. Buffet)
―Our assets are our people, capital and
reputation. If any of these are ever
diminished, the last is the most difficult to
restore.‖ (Goldman Sachs Business
Principles)
©Enterprise Risk Advisory, LLC 5
Importance of Reputation and Trust
Information asymmetry
Outsiders don’t know as much about a company as insiders, so a good reputation alleviates and allow customers to make a choice.
Important for all companies but crucial and vital to insurers as we sell distant promises.
Important for insurers that have one global brand: AIG, ING, Aegon, Met Life, Sun Life, Manu Life, AXA, Allianz, Zurich, etc.
In essence, we exchange money for a promise to pay in the future. (Money for Paper!)
More important in a period of rapid changes, globalization, internet blogs, activism, mass media.
©Enterprise Risk Advisory, LLC 6
Importance of Reputation to Stakeholders
Employees: Are more loyal to a company with good reputation. Help with recruiting
Investors and business partners: Will take risk in a company that they can thrust based upon its reputation. (More than 90% think about reputation in investment decisions: 40% care about reputation, 50% care partially).
Lawmakers and regulators: Reputation can help lessen the legal burden on a company.
Public at large: Preserve ―social license‖ to operate
Customers and suppliers: Support loyalty to company
Competition: Barrier to entry
©Enterprise Risk Advisory, LLC 7
Reputation Risk: Number 1 Risk for CROs
Reputational Risk
(52)
Regulatory Risk
(40)
Human Capital Risk
(40)
IT RISK
(35)
Financial, Market, Credit and Insurance Risk
(30)
Crime, security, political, natural hazard, FX, Terrorism, Country Risk
(20)
Source: Economist Intelligence
Unit, 2005
Max Scale: 100
©Enterprise Risk Advisory, LLC 8
Reputation and Financial Impact: Corporate
Reputation Watch by Harris Interactive
©Enterprise Risk Advisory, LLC 9
Value of Reputation: National Corporate Survey
Microsoft: 1st place
Johnson and Johnson: 2nd
Google: 4th
Berkshire Hathaway Inc. 21st
American Express Company: 34th
Wells Fargo & Company: 36th
State Farm Insurance: 42nd
Allstate: 51st
No Life companies included. Have your companies rated!
Consult Fortune’s annual survey of America’s Most Admired
Companies.
©Enterprise Risk Advisory, LLC 10
What is Reputation: General Definitions
A corporate reputation is a collective representation of
a firm’s past actions and results that describe the
firms’ ability to deliver outcomes to multiple
stakeholders. It gauges a firms’ relative standing both
internally and externally. (Fombrun/Foss: Developing a
Reputation Quotient, 2000)
Reputation is public information regarding a players’
trustworthiness. A players’ reputation reflects the
information that third parties have on how trustworthy
his behavior has been in the past. ( Ripperger 1998)
©Enterprise Risk Advisory, LLC 11
Comparison of Reputation and Image
Reputation:
Corporate Actions and Conduct that
Create Trust
As Experienced by different Stakeholders.
Serves as a reservoir of goodwill in time of crises.
Image
Belief and personal evaluation of a firm
Tied to the firm directly, not to actions by the firm.
If image is positive, reputation will improve
However, reputation evolves more slowly than
image because it is tied to actions.
©Enterprise Risk Advisory, LLC 12
Comparison of Reputation and Brand
Brand:
What differentiates us from the competition
Marketing of the company including advertising and
publicity
Refers to logos and names of companies
Reputation:
Cannot be enhanced by just a name change.
Larger concept as it includes other elements as we
will see.
Often referred as ―Emotional Capital‖ of the firm
Thus, if capital, it is subject to risk.
©Enterprise Risk Advisory, LLC 13
Value of Corporate Reputation: Drivers
Client Service
New products
New services
Pricing
External factors
Social/Environmental
Responsibilities
Pressure Groups
Human Capital/Talent
Culture
Corporate Ethical Values
Communication
Disclosures
Crisis Management
Corporate Governance
Regulatory Compliance
Long-term
Financial Performance
Reputation
©Enterprise Risk Advisory, LLC 14
Value of Reputation to the Firm
A good reputation encourages consumers to buy products and
services.
Suppliers are willing to do business with you, thus expanding
opportunities.
Top notch employees want to join and stay with your organization,
thus enhancing its innovation capabilities and value.
Favorable outlook from regulators and rating agencies, thus
decreasing financing cost and increasing value.
Investors want to hold shares, thus increasing value.
Positive feedback from media and pressure groups increase
value.
In a crisis mode, investors give the company the benefit of the
doubt, thus easing short-term decrease in value.
©Enterprise Risk Advisory, LLC 15
Value of Reputation: Qualitative Measures
It is the sum of how all constituencies view and
perceive the organization.
National Corporate Reputation Survey by Harris
Interactive
Specific company’s reputation survey: Ex. Swiss Re
does one every 2-3 years.
Media evaluation of public opinions. Ex. Media
Tenor International reports, % of negative/positive
reports, Awareness Threshold of 3%( Below 3%
leads to higher risk), Value Reporting of company’s
value drivers.
©Enterprise Risk Advisory, LLC 16
Value of Reputation: Quantitative Measures
An Intangible asset which doesn’t show up in the balance sheet. It
is sometimes referred as ―Emotional Capital.‖
It has a current value and influences future value of the firm.
Best approach is by the Court of Financial Opinion: Stock Market!
Estimated value of reputation = Market Value of Company -
Balance Sheet Value - Intellectual Property – Brands( Cos like
Brandz, Core Brand) – Copyrights - other Intangible Assets.
Usually, reputation is the largest component of intangible assets.
Reputation reflects the rise of the ―non-physical economy‖,
especially in the developed world. Some surveys have shown
ratios of market value to balance sheet value between 10 and
100.
©Enterprise Risk Advisory, LLC 17
Reputation Risk: Regulatory Definitions
FSA: The risk that the firm may be exposed to
negative publicity (Trust) about its business practices
or internal controls (Actions), which could have an
impact on the liquidity or capital of the firm or cause a
change in its credit rating. (Affecting its stakeholders).
US Federal Reserve(2004): ―Reputation risk is the
potential loss that negative publicity regarding an
institution’s business practices, whether true or not, will
cause a decline in the customer base, costly litigation,
or revenue reductions (financial loss).
©Enterprise Risk Advisory, LLC 18
Business Definitions of Reputation Risk
US Federal Reserve(2004): ―Reputation risk is the potential loss that negative publicity regarding an institution’s business practices, whether true or not, will cause a decline in the customer base, costly litigation, or revenue reductions (financial loss).
ADD other business elements:
Loss value of key employees.
Loss value of key suppliers.
Increased cost of regulatory actions.
Financial impact of rating agencies’ decisions.
Financial impact of new products
©Enterprise Risk Advisory, LLC 19
Reputational Risk: A Risk by Itself or a
Consequence (Second tier) of Other Risks?
According to Economist Intelligence Unit(2005) survey,
―52% consider reputation risk as a risk by itself, while
48% consider it as a consequence of other risks‖ like
operational risk – people, process, systems and
external events – compliance and financial.
Appears that if first risks are more quantitatively
analyzed – market, credit, operational … -
Reputational risk appears as a second tier risk –
mostly within financial institutions – while it appears as
a risk of its own in the corporate world – like Hilton,
Cruise companies where emphasis is on their
products/services -.
©Enterprise Risk Advisory, LLC 20
Reputation Risk: Qualitative Measures
Complaints by all stakeholders act as an early warning system: Monitor and analyze trends.
Identify and monitor your company’s HOT SPOTS in relation to all your stakeholders’ interests, particularly in periods of rapid change. Ex. Organizational changes, new products/services.
Compliance/Audit functions. Are they proactively identifying and following-up on issues?
Assess flows of risk information in the institution.
Assess the link between compensation programs and desired behaviors.
Is reputation risk part of the new product approval process?
Is there a Code of Ethics? Reward ethical behavior? Penalize misbehavior?
Evaluation of media coverage of companies
Monitor internet blogs
©Enterprise Risk Advisory, LLC 21
Reputation risk: Indicators
Rate your organization:
Low if
— Management anticipates well changes in market and
regulatory nature
— Franchise value minimally exposed
Moderate if
— Management adequately responds to changes in market
— Franchise value is controlled
High if
— Management doesn’t anticipate reputation risk
— Weaknesses are present
— Franchise value substantially exposed to in litigation,
consumer complaints.
©Enterprise Risk Advisory, LLC 22
Reputation Risk: Quantitative Measures
Measured as the market value impact of an event which is above
the direct value of the event itself, the excess is qualified as the
reputational impact.
Ex. Federal Reserve Bank of Boston measured Reputational
impacts of operational events:
Internal Fraud: The market value impact was more than 6
times the value of the internal fraud itself, which is due to lack
of control by the company and lack of confidence in actual
management.
Externally caused events: No reputational impact.
Thus, seems to confirm the initial definition of reputation as
being based on ACTIONS by company.
Fines account for less than 10% of total market value loss.
©Enterprise Risk Advisory, LLC 23
Reputation Risk: Quantitative Measures
Failures by companies that have a reputational impact have a lasting financial effect on the market value of companies:
1/3 of financial analysts say that their evaluation of a company will take into account the impact of a failure in reputation up to 3 years after the event. (Hill/Knowlton 2006 survey)
Companies take up to 3 years to recover from a crisis that affected their reputation. (Burson/Marstelle Market research)
Model developed by UK-Based OxFord Metrica called ValueReaction Model: Analyze impact of reputation crisis on company stock price. Will company recover from a crisis? If management handles crisis badly, investors conclude that management cannot handle unexpected events.
Set up Loss Data Base of operational events and their reputational impacts.
Scenarios modeling of major threats using expert judgment
©Enterprise Risk Advisory, LLC 24
Reputation Risk: Model Quantitative Financial
and non Financial Impacts of Damage: Factors
Stock decline
Run on the bank
Spike in policy surrenders
Outflow of assets under management
Drop in sales, decline in market share
Ratings downgrade
Regulatory investigations, license withdrawal, fines
Shareholders’ litigations and class-actions
Political fall-out, discontent in communities
Negative media coverage
Pressure groups and public opinion
Employees and contractors withdrawals.
©Enterprise Risk Advisory, LLC 25
Reputational Risk: Importance of companies’
actions on Historical Reputation Events.
Client Service
New products
New services
Pricing
47%
External factors
Social/Environmental
Responsibilities
Pressure Groups
Human Capital/Talent
Culture
Corporate Ethical Values
58%
Communication
Disclosures/Security Breaches
57%
Crisis Management
Corporate Governance
Regulatory Compliance
66%
Long-term
Financial Performance
Reputation
Source: Economist Intelligence
Unit, 2005
% of respondents.
©Enterprise Risk Advisory, LLC 26
Examples: Non financial Sectors
Catastrophe: Three Mile Island
Safety Issue: Union Carbide chemical leak in Bhopal in 1984.
Environmental issue: Home Depot promising to stop selling wood from protected forests after Rainforest Group Action intervention, Exxon Valdez
Catastrophe: Concorde crash and impact on both Air France (less impact ) and British Airways (larger impact due to slow response).
Product Recall:
Tylenol tampering scare in 1982 due to cyanide. Limited impact due to Johnson and Johnson quick responses in the end. In fact, Johnson and Johnson has been rated top in reputation by Harris Interactive.
Perrier suffered longer from toluene traces found in its waters due to lack of crisis management.
©Enterprise Risk Advisory, LLC 27
Examples: Financial Sectors
Scandals/Fraud:
Arthur Andersen co. fell almost entirely due to its
damage to its reputation after Enron’s scandal in
2002.
Interesting case in the field of reputation. Similar to
Barings in the field of operational risk.
One year earlier in 2001, the Chief Executive was
saying: ―There is extraordinary power in our name
because it stands for time-tested values, a unique
one-firm global operating approach and recognized
superior performance.‖
©Enterprise Risk Advisory, LLC 28
Examples: Financial Sectors
Fraud: KPMG paid 456 million dollars but escaped indictment that
could have crippled the firm.
External events: SARS had huge impact on tourism both in
Toronto and China.
Market Timing/Fraud in 2003/2004 at Putnam Investments
Paid 4 million in fines.
Fired top management of international funds.
Lost 14 billion of assets under management in a week (5%).
Assets under management from 272 billion (03) to 192 (07).
Never recovered from institutional clients.
Putnam sold to Great-West Life in Feb. 07 ending a history
dating back to 1937.
©Enterprise Risk Advisory, LLC 29
Examples: Financial Sectors
Accounting Scandals at Fannie Mae:
Direct impact: 400 million dollars in fine to SEC and
OFHEO.
Indirect impact: Fannie Mae ordered to limit
mortgage holdings at 727 billion dollars. Thus,
company cannot grow anymore. This situation will
last until ― it has implemented internal controls and
risk management. We are talking years…‖
Scandal at Marsh. Stock declined by 40%, Moody’s
downgraded company due to decline in reputation.
©Enterprise Risk Advisory, LLC 30
Example in the insurance industry: AIG
Following investigations in a finite reinsurance, investigations led
to other investigations in accounting and fraud.. starting in March
2005
Result:
Paid 1.6 billion in fines in February 2006
Share decline by 10 billion dollars in absolute terms when
investigations began.
Relative share value destruction of 40 billion dollars
considering the insurance sector performance between March
2005 and February 2006 when settlement occurred.
Share price still hasn’t recovered in spite of increased
profitability. Will take time to get back the reputation of the
―world’s leading, rock solid insurance company.‖
AIG didn’t have a reputation recovery plan in place.
©Enterprise Risk Advisory, LLC 31
Example in the insurance industry: AFLAC
Japan
Situation: Following investigations by the Japanese Regulator
about non payment of valid supplemental medical claims over 5
years– 10 cos. - Aflac and others had to review claims processes.
Clearly an operational risk event.
90% of companies on Tokyo Stock Exchange offer Aflac products!
Continuous media coverage of the investigations.
Operational impact on Alfac:
Process and IT events: 19 169 errors
Direct additional cost: 16 million dollars in additional claims.
Represented .45% of all benefit payments, .01$ per share
Possible fine by the FSA
Costs to investigate, correct situations, publicize results.
©Enterprise Risk Advisory, LLC 32
Example in the insurance industry: AFLAC
Japan
Reputation impact on Alfac:
New sales dropped by 5% and 10%.
Slow recovery
Share price drop in early March 07:
©Enterprise Risk Advisory, LLC 33
Management of Reputation Risk: Align with
Risk Drivers
Crisis Management (80%)
Unplanned events but not necessarily unexpected.
Mismanagement of crisis can seriously damage a reputation.
Media attention is high.
Crisis team made of Board and technical people.
Different from business continuity planning.
Need to make strategic decision with little information.
Ex. Katrina was a crisis mismanaged by all from President,
FEMA to insurance companies. September 11 was better
handled by former NYC mayor. His reputation was enhanced.
Quote from Madeleine Albright: ― ..Being prepared for a crisis
is never a waste of time.‖
Source: Economist Intelligence
Unit, 2005
©Enterprise Risk Advisory, LLC 34
Develop Corporate Social Responsibility programs:
Build ―goodwill‖ vis-à-vis stakeholders.
Enhance internal ethical programs. (61%).
Establish Code of Conduct by employees.
AXA established a Sustainable Development Department in 2001 to coordinate a variety of environmental, community, educational and charitable programs.
Integrate environmental impact studies in investment decisions and publicize.
Monitor external perceptions of company by all stakeholders (61%)
Proactively monitor external threats. (56%). Ex. Sales practices, bid rigging, failure of insurers, regulatory investigations, market timing on competitors and determine our possible reactions to them. Reactive or proactive and how to face the issue?
Source: Economist Intelligence
Unit, 2005
Management of Reputation Risk
©Enterprise Risk Advisory, LLC 35
Management of Reputation Risk
Establish Group Issue Processes. Ex. Swiss Re
Establish an internal whistle blowing approach. A crisis
or an attack on reputation never come at a surprise.
Someone knew something within the organization.
Integrate communications strategies: right message,
delivered by right people to right audiences via a mix
of channels is critical.
Economic capital: Integrate reputation impacts into the
calculations of other risks, in particular operational
risks. In financial industry, 30% feel that they can’t
quantify while 66% feel that they can quantify in the
energy sector.
©Enterprise Risk Advisory, LLC 36
Framework for Governance of Reputational
Risk
Is reputation risk part of the overall risk policy?
―Traditional Approach‖: CEO is in charge (84%)
Reflects focus on crisis management only, reactive
Reputation is focused only on organization's own
operations.
Dedicated personnel or dedicated task force
CRO, head of business units, communications
manager (42%). Reputation risk management is
more than PR.
External parties expect dedicated resources like for the
other risks. Source: Economist Intelligence
Unit, 2005
©Enterprise Risk Advisory, LLC 37
External Views
Rating agencies
AM Best bases it evaluation on 3 criteria:
— Balance Sheet Strength
— Operating Performance
— Business Profile: Affected by reputation now and in the future. Affected by all reputation risk drivers.
— Bases its rating on trust in management, enhanced by strong reputation, which is intrinsically linked to its capacity to manage its risk profile.
Insurance regulators
Reputation is a strategic asset of insurers. Each institution should manage it proactively involving the Board and senior management as part of its overall ERM framework.
US Banking regulators
OCC expects that reputation risk management will not be done in isolation but will involve CRO, Board, Audit, Compliance, Customer complaint, HR
OCC expects that compensation programs will support desired behaviors