Effective Reputation Protection Strategies Can Deliver Real Benefits

Companies that have environmental, social, and governance (ESG) and reputation protection strategies in place at the time of a reputational crisis can actually see their stock prices increase following the event, according to a recent study.

The study by Steel City Re, an ESG and reputation insurer, found that companies with ESG and reputation protection strategies experienced a 5 percent increase in their stock prices within 2 weeks of a reputation-threatening event.

Companies that additionally managed, validated, and publicized those strategies gained an average of 9.3 percent over the 7 months following the event, Steel City Re reported.

Conversely, companies that failed to institute, validate, and communicate their ESG and reputation risk management strategies lost 13.2 percent of their stock value over those 7-month periods, and underperformed their peers by an average of 23.3 percent, according to the report.

"Investors appear to reward firms that actively manage reputational risks as operational strategies and not just potential [public relations] problems," Nir Kossovsky, Steel City Re's CEO, said in a statement. "Our study makes the case for ESG-focused firms to take a more structured, substantive, and comprehensive approach to risk governance and management.

"The data show that instituting, validating, and communicating risk management strategies can both fulfill the goals of stakeholder-centrism and meet shareholder expectations," Mr. Kossovsky said.

Steel City Re's findings are based on an examination of the experiences of 7 firms that took direct action to publicize their reputation risk management and governance, 20 firms whose protection strategies were assumed by shareholders to be in place because of their response to external events, 20 firms whose strategies were shown to be insufficient over 7 months, and, from among that group, 22 firms whose reputational impairment and value losses were measured against peer competitors.

All the reputational crises the firm studied were public events that occurred over the past 15 years, in addition to Johnson & Johnson's two Tylenol-related safety events of the 1980s.

Companies' individual gains and losses were calculated after normalizing for changes in the Standard & Poor's 500 index, with the date for the underlying ESG and reputational events determined by a surge in stakeholder interest studied in a related Steel City Re white paper.

In that 2020 white paper, Governance and Finance Professionals Can Protect Share Price after a Reputation Crisis, Steel City Re notes that during a reputational crisis, companies' stock prices are particularly sensitive to investors' cognitive biases. The paper argues that while crisis communication is an important tactic in addressing a reputation-threatening event, positioning risk management and reputationally relevant corporate financial information—corporate asset structure and share repurchasing volume—front and center in a visible way, can have an impact of up to 80 percent on the direction and magnitude of a company's stock price changes following the event.

Among Steel City Re's suggestions for mitigating the impact of reputation crises and reducing the potential effect on stock prices are managing enterprise reputation risk and the company's reputational value volatility and using financial instruments such as insurance as a means of communicating government and enterprise risk management strategies to stakeholders in simple and credible terms.

In an article in the July 2021 issue of Captive Insurance Company Reports (CICR), Mr. Kossovsky suggested that there's a very real opportunity for captive insurance as part of that effort to address reputation and ESG risk.

In that article, Mr. Kossovsky explained, "Reputation risk is a family of material perils of economic harm from angry, disappointed stakeholders, often exacerbated by media and through social media amplification. For the typical firm, these stakeholders are customers/clients, business partners, employees, vendors, creditors, equity investors, regulators, policymakers, social license holders, activist groups, and the media.

"The mechanisms of economic harm vary," Mr. Kossovsky wrote. "Customers' purchases decrease, employees become disengaged, vendors create more onerous terms, capital becomes dearer, regulatory burdens rise, social license holders extract premia at will, and jury verdicts may become meteoric."

The Steel City Re CEO noted the growing pressure on companies to address ESG issues, with that pressure bringing additional risk of reputational issues.

"Captives can help mitigate reputational risks associated with ESG activities," Mr. Kossovsky's CICR article suggested. "First, they provide an arm's-length structure within which a reputation risk management framework can be executed. Because reputation risk lurks in the gap between stakeholder expectations and operational reality, reputation risk can thus be managed by (1) adapting corporate operations to meet stakeholder expectations, (2) managing stakeholder expectations to operational realities, and (3) building capacity to absorb losses."

The first steps toward successfully managing this reputational risk, according to Mr. Kossovsky, are internal organizational awareness of the nature of the risk, its various perils, the identity of the stakeholders involved, and the range of their expectations.

In the current reputation and ESG risk environment, captive insurance allows businesses to stand out among their peers, Mr. Kossovsky wrote, in addition to managing reputational risk, reducing directors and officers exposures, and creating enterprise value.

Given the potential impacts of reputation-threatening events on businesses' cash flows and stock prices, the value of having strategies and preparations in place to address such events and mitigate their impacts can have significant benefits, according to Steel City Re's research. Captive insurance can be a valuable element of those strategies and preparations.