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    Reputation risk Reputation risk Presentation Transcript

    • REPUTATION RISKAlso known as the Cinderella Asset!Michel RochetteMay 9 2007 Enterprise Risk Advisory, LLC
    • 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 2
    • 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 3
    • 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 4
    • 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 5
    • 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 6
    • 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 7
    • Reputation and Financial Impact: CorporateReputation Watch by Harris Interactive©Enterprise Risk Advisory, LLC 8
    • 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 9
    • 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 10
    • 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 11
    • 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 12
    • Value of Corporate Reputation: Drivers Long-term Financial Performance Client Service Corporate Governance New products Regulatory Compliance New services Pricing Reputation External factors Communication Social/Environmental Disclosures Responsibilities Crisis Management Pressure Groups Human Capital/Talent Culture Corporate Ethical Values©Enterprise Risk Advisory, LLC 13
    • 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 14
    • 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 15
    • 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 16
    • 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 17
    • 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 18
    • Reputational Risk: A Risk by Itself or aConsequence (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 19
    • 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 20
    • 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 21
    • 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 22
    • 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 23
    • Reputation Risk: Model Quantitative Financialand 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 24
    • Reputational Risk: Importance of companies’actions on Historical Reputation Events. Long-term Financial Performance Client Service Corporate Governance New products Regulatory Compliance New services 66% Pricing 47% Reputation External factors Communication Social/Environmental Disclosures/Security Breaches Responsibilities 57% Pressure Groups Crisis Management Human Capital/Talent Culture Source: Economist Intelligence Corporate Ethical Values Unit, 2005 58% % of respondents.©Enterprise Risk Advisory, LLC 25
    • 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 26
    • 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 27
    • 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 28
    • 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 29
    • 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 30
    • Example in the insurance industry: AFLACJapan 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 31
    • Example in the insurance industry: AFLACJapan Reputation impact on Alfac:  New sales dropped by 5% and 10%.  Slow recovery  Share price drop in early March 07:©Enterprise Risk Advisory, LLC 32
    • 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 33
    • Management of Reputation Risk 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©Enterprise Risk Advisory, LLC 34
    • 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 35
    • Framework for Governance of ReputationalRisk 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 organizations 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 36
    • 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©Enterprise Risk Advisory, LLC 37