Strategies for surviving corporate catastrophes go beyond the presence of insurance and deep into reputation management, according to a recent report by Rory Knight and Deborah Pretty.
Man-made corporate problems are increasingly hitting the headlines. Whether it be the Firestone tyre recall last year, the Mercedes A-class ‘moose test' debacle or the corporately lethal Perrier benzene contamination, the world is aware of corporate catastrophes, and financial markets' responses are now the make or break of an organisation.
Understanding what those responses are predicated upon is a key factor in protecting an organisation in times of crisis, and reputation becomes a major issue in these circumstances. It is this relationship which is explored in the report ‘Reputation & Value: the case of corporate catastrophes'.
The report has four objectives:
Value of brands
According to a recent survey, 85% of firms consider their brands to be their most important asset. Of course, the corollary of this is that loss of reputation can be viewed as the greatest risk facing an organisation. Measuring an organisation's success by shareholder value gives a long-term view of the company's performance, taking tangible value, premium value and latent value into account.
The premium value element includes the organisation's reputation, its brands, intellectual property, innovation, potential growth, global reach, and managerial and workforce expertise. According to the report, “in the majority of cases ... there is considerable reputation equity beyond that generated by the corporate brand.” In fact, reputation equity is premium value plus latent value – the potential value within an organisation which may include factors such as under-leveraged assets, unrealised operating efficiencies, under-promoted brands and an unmotivated workforce. “Effective corporate governance and superior management expertise will enhance the reputation assets of the firm and aid the release of latent value,” comments the report. “Of course, reputation comprises many different factors. Ultimately, however, it represents the confidence investors place in the future of the business.”
This means that CEOs must be able to respond to certain key questions about their businesses' reputation equity and value:
Managing reputation risk
The occurrence of a corporate catastrophe appears to result in a re-evaluation of the affected organisation's management. From an analysis of 25 corporate crises (see figure 1), it became clear that all organisations suffer a significant, negative, initial impact on stock value, irrespective of whether the organisation carries catastrophe insurance or not. On average, an organisation affected by such a calamity will return to usual market expectations in less than five months. But looking beyond the average scenario, there are two distinct categories of businesses affected by corporate catastrophes; recoverers and non-recoverers.
Recoverers initially show an average of 3% slip in stock value compared to 12% on average for non-recoverers. By the 50th trading day after the event, recoverers show a 5% increase in ValueReaction (see break-out box) from the date of the event, while non-recoverers continue the downward trend, suffering a net negative impact of more than 15% up to a year after the event occurred.
Organisations within the recoverers category seem to do better post-catastrophe when they have a strong reputation equity. However, those with a strong reputation which do not efficiently recover value post-crisis become extreme non-recoverers.
When a corporate catastrophe occurs, the initial impact is the immediate economic loss. Although this often takes some time to accurately identify, the stock market frequently forms a collective opinion. Generally, this leads to a negative impact on stock pricing, though this is to some extent cushioned by insurance recoveries reducing cash outflows. The next factor, however, is management's ability to deal with the crisis, and it is here that resides the ‘make or break' of an organisation's future. “Although all catastrophes have an initial negative impact on price, paradoxically they offer an opportunity for management to demonstrate its talent in dealing with difficult circumstances,” comments the report. “A re-evaluation of management by the stock market is likely to result in a re-assessment of the firm's future cash flows in terms of both magnitude and confidence. This in turn has potentially large implications for reputation equity and shareholder value. Effective management of the consequences of catastrophes would appear to be a more significant factor in value recovery than whether catastrophe insurance hedges the economic impact of the catastrophe.”
This means the management team needs to prevent and mitigate the effects of the catastrophe, responding “honestly and rapidly in a non-defensive way. Ultimately, they should be able to demonstrate their ability to deal with challenging circumstances. Success in this regard gives investors confidence in managers' ability to manage risk and ultimately will create value for shareholders.”
With the complexities of the modern-day business world, it is not just the crisis-struck organisation itself which is impacted by a corporate catastrophe. Now, there is likely to be a strategic stakeholder – a key supplier, customer or partner – which also feels the repercussions of the event. As more and more business is transacted through strategic alliances – alliance activities of US firms are estimated to account for 35% of their total revenues by next year – the exposures of these ‘allies' increases as well, and this can translate into reputation exposures. For example, when one of Ericsson's key suppliers suffered a fire at a semiconductor plant, it was Ericsson's reputation on the line.
At the same time, businesses' reputations are also affected by public perception. An example of this was the Coca Cola health scare in 1999. A number of Belgian schoolchildren suffered from similar symptoms of headaches, nausea and cramps, and all appeared to have a common denominator in their consumption of Coca Cola. In addition, not long before Belgium had been host to a dioxin food contamination, resulting in poultry, eggs, pork and beef being banned. Coca Cola withdrew the offending product from Belgian supermarket shelves, and extended the recall to its branded drinks as well. Governments then intervened, withdrawing cans and bottles in France and Luxembourg, as well as other countries such as Saudi Arabia, the Netherlands, German, Latvia and Ivory Coast banning all drinks manufactured in Belgium. The recall cost Coca Cola $250m, with 17 million cases of products destroyed, despite the fact that a group of toxicologists identified the original symptoms as “a collective psychosomatic reaction,” at least partly influenced by people's lack in trust in food quality following the dioxin contamination.
As the report points out, “The public responds not only to the perceived physical threat and its potential consequences, but also to the perceived credibility and trustworthiness of senior corporate management. Any betrayal, real or perceived, sensed by the public will translate into lower expectations of future cash flow by investors.”
Ultimately, the report comes up with five key results:
This leads to five policy implications for management teams: