Is Reputation an Exposure—or a Consequence of an Adverse Event?

Is reputation itself an exposure, or is reputational damage merely a consequence of an adverse event and, therefore, part of the resulting financial impact?

My opinion is that reputation is an intangible exposure that can be damaged by a defined peril or adverse event and whose impairment can be measured through changes in stakeholder behavior and financial performance.

Let's start by defining an exposure: I define an exposure as an asset, resource, relationship, capability, or other interest of value that is subject to loss or impairment. An exposure may be tangible, such as property or equipment, or intangible, such as intellectual property, human capital, customer relationships, or reputation.

For a loss to occur, the exposure must encounter a definable peril which is an adverse event or cause of loss. The likelihood or severity of that loss may be influenced by physical, moral, morale, and legal hazards. Furthermore, we should be able to identify and, at least within a reasonable range, measure the financial consequences of the adverse event on each exposure involved in the event.

Enterprise Risk Management (ERM) treats risk as an interrelated, enterprise-wide portfolio of risks tied directly to an organization's strategic goals and underlying operational objectives. A single peril or adverse event may, therefore, affect multiple exposures simultaneously.

Consider the fire peril: The immediate event may damage property and equipment, injure personnel, interrupt operations, and disrupt the supply chain. But the same event may also damage the organization's reputation if stakeholders believe the organization failed to prevent the fire, protect its employees or customers, communicate effectively, or recover appropriately. In other words: An adverse event causes reputational damage when there is a change in stakeholder perception and change in stakeholder behavior which causes a financial impact.

This brings us to the difficult question: How do we measure the financial impact of reputational damage?

I would define reputational loss as the incremental economic loss attributable to changes in stakeholder perceptions and behavior following an adverse event, separate from the direct losses caused by the event itself.

One possible framework is: Reputational Impact = Lost Revenue Attributable to Stakeholder Behavior + Increased Operating Costs Needed to Mitigate Damage to Reputation + Increased Cost of Capital/Risk Transfer Caused by the Insurance and Financial Markets Loss of Confidence + Lost Strategic Opportunities

For example, reputational damage could result in:

• Customers leaving or purchasing less;

• Employees leaving or becoming more difficult and expensive to recruit;

• Suppliers, business partners, or other counterparties changing the terms on which they will do business;

• Investors and lenders demanding a higher return for perceived operational issues;

• Insurers or reinsurers increasing pricing, reducing capacity, or imposing more restrictive terms;

• Regulators increasing scrutiny; and

• The organization losing acquisitions, partnerships, contracts, or other strategic opportunities.

  
  

This approach avoids trying answering the difficult question, "What is our reputation worth?" Instead, the useful ERM question is: "How did this adverse event change the behavior of our stakeholders, and what is the financial impact of that change?" That is a question a firm can model, stress-test, manage, and even finance.This distinction is important because reputation is not simply the amount of negative press an organization receives. Nor is reputational loss necessarily the decline in a company's stock price immediately following an event. These variables may be the key risk indicators of changing stakeholder perceptions, but they are not necessarily the economic loss itself.

The economic impact of an adverse event to reputation emerges when these perceptions noted above change stakeholder behavior. Therefore, reputation is an exposure, or an intangible asset or organizational resource that may be impaired by a defined peril or adverse event. Reputational damage is the consequence, and its financial impact can be measured through the resulting changes in stakeholder behavior.

What do you think?