Reputational Risk: How Important is it to a Firm and its Stakeholders?

Reputational risk is a phrase heard more and more often in the corporate world. So how important is it?  And how much does it come into your own thought processes as a business stakeholder?

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What is reputational risk?

Before considering the issues around reputational risk we need to be clear on what it means? A quick Google search gives the following definition:

“Reputational risk, often called reputation risk, is a risk of loss resulting from damages to a firm's reputation, in lost revenue; increased operating, capital or regulatory costs; or destruction of shareholder value, consequent to an adverse or potentially criminal event even if the company is not found guilty.”

How should reputational risk be approached?

Given this definition is mitigating reputational risk a serious consideration for the successful operating of a firm? Or, is it just a nice to have for firms to state they’re “mindful” and “aiming to achieve certain milestones”?

Moreover, are firms genuinely transparent enough with stakeholders (customers, employees, investors, partners, regulators and communities etc) to let them make an informed decision on whether to support them financially, strategically, morally and ethically?


Where are we now?

Reputational risk is hard to ignore. You can look at it on a macro level – the 2008 Credit Crunch was damming for the entire financial services industry. Or, you can be more granular, for example a single trader, in one investment bank, committing fraud. Either way, reputational harm occurs, and the fallout can be incredibly detrimental.

A very hot topic within Insurance (and other industries) is “Cyber Security”. Cyber-attacks are increasingly common, sophisticated and damaging. That’s why insurance carriers have recently introduced reputational harm insurance which covers financial losses suffered because of cybercrime.

There is another element of reputational risk that only sometimes gets appropriate attention – the environment. Take palm oil. Until recently, financial services firms wouldn’t have needed to disclose their policy on palm oil. Now, they do.

Irresponsible sourcing of palm oil has led to the loss of 5.6 million hectares of forest and the destruction of endangered orangutans’ habitats and therefore the orangutans themselves.

The step forward in transparency and acknowledgement is a great thing. Some financial services firms have gone even further. Many will not offer services to a client that impacts a forest negatively. They also have requirements that clients must hold certain accreditations, memberships and commitments.

Unfortunately, deforestation is still happening – and firms in other sectors are yet to take the same ethical stance. To them, the risk is worth it. Time and again, firms will take the gamble on reputational risk, just as they do with the risk of fines and sanctions for non-compliant business practices.


Is there a solution?

Surely, the obvious solution is for all firms to operate in a highly responsible, moral and ethical manner in all aspects of their operations? Simple. However, we all know that this is open to huge disparity in interpretation. Different things matter to different people – what counts as ‘highly ethical’?

Many firms will be asking whether reputational risk should be a priority on the Board’s agenda? Or, should it slide quietly into the wider risk agenda and sit there as operational, market and credit risks annoying little brother?


Conclusion

Reputational risk is a difficult topic, with solutions still feeling embryonic at this point. In particular, the question of how to balance economic and environmental targets is dividing stakeholders, and rightly so.

Some firms continue to put profit far ahead of sustainability. And yes, in some cases stakeholders will react negatively, likely leading to the loss of a loyalty or even a total disassociation. Frankly, that should be one of the penalties of poor corporate behaviour.

But, there are always more stakeholders out there and also insurance policies to help business recover their financial loss from the fallout. So, the question remains how much does averting reputational risk really matter? I’d be interested to hear your thoughts.

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