Reputational risk: if you know it, you avoid it

Over the last years, perhaps more than ever, the concept of reputation and reputational risk became a part of the mainstream culture.

What is reputational risk and what does it look like?

Because of new attention towards corporate culture and the fact that information spreads more rapidly nowadays, reputation has become a matter of concern, having been investigated and measured. However, since more than a century ago, reputation and the concept of reputational risk has been taken under consideration by economists.

Reputation: historic definitions

One of the first economists to study reputation is the famous Alfred Marshall that, in 1923, started to study the relation between brand recognition and the cost of the offered service/product. It was not until the ‘60s that further elaboration of the economic concept of reputation was available and we owe that to George Stigler, Carl Shapiro, and David Kreps.

This is the definition given by George Stigler:

“Reputation” is a word which denotes the persistence of quality, and reputation commands a price (or exacts a penalty) because it economizes on search”

Therefore, reputation is a public acknowledgment that a particular company knows what it is doing. Reduced to the simplest terms, reputation is a quality label that denotes “legality, good efficiency and healthy competition”. *

Another interesting contribution, rather indirect contribution, is the one from Herbert Alexander Simon (Nobel Economics Prize in 1978), who dedicated his life to studying how people’s choices are not rational, rather they are conditioned by different biases and heuristic; corporate reputation is, of course, an aspect to be considered in order to know how to manage and predict consumers’ choices.

Now we are entering the field of behavioral economics. Specifically: a positive reputation is a positive bias that will influence a consumer to choose one company, while a negative reputation will bring a negative bias. For more information please refer to the relative bibliography (page 270 ss., Business Strategy, Ramusino – Onetti.)

*Jacopo Schettini Gherardini – Reputazione e rischio reputazionale in economia – ed. Franco Angeli, 2011

Corporate reputation: what is the definition?

To provide a single definition of reputation in Economics is not easy. The variables that define it are too many and they are unconnected. For this reason, giving an interpretation of the concept of reputation that fits into the area you are considering (marketing, compliance, accounting), allows to define common aspects, but cannot, at the same time, give a clear and exhaustive answer.
A definition of corporate reputation that we agree on is the one given by Masini, Pasquini and Segreto in “Marketing e comunicazione: strategie, strumenti e casi pratici”:

«corporate reputation is defined as a socially established representation and shared-view about the history and the past performance of the company able to generate (economic and social) value to the multi-stakeholders’ experts».

What about reputational risk?

If a good reputation, in the sense just described, is what persuades stakeholders to choose a particular company, it is certainly true that this socially shared representation can have a negative impact on a company that has a bad reputation. Reputational risk is this indeed: the risk that a bad (socially established and shared) brand reputation affects the brand results.

Where does reputational risk come from?

To answer this question, it is useful to start from consideration and we will take advantage of the definition given by a critic of the so-called corporate reputation theory, Jacopo Schettini Gherardini:

“The reputation of a reputational object is the result, positive or negative, from a vote of confidence – not knowledge-driven – that a reputational viewer adopts through an arbitrary measure different than probability”.

According to this interpretation, therefore, reputation, whether negative or positive, is always a negative bias, an incorrect shortcut that a person takes, to determine their economic choices. Without going any further, here we will just analyze the risk profiles and the effects of a negative reputation on a company.

We already mentioned this topic in “Digital reputation has direct consequences on a company’s profits”. First of all, what is meant by risk in the economic environment? An interesting answer is given by Banks, for example:

“It is the present or expected risk of the decline in profits or in capital coming from a negative perception of the bank’s image by shareholders, customers, counterparts, investors, and supervisory authorities.” (Unicredit, 2008)

Another interesting definition is given by ISVAP (2005) that define the reputational risk for insurance companies:

“The risk of the company’s image loss and the increase of the disputes of policyholders, also caused by the poor quality of the offered services, the placement of inadequate policies, the behavior of the retail networks”.

Fombrun (1996) correctly emphasizes that a company’s reputation, even though it is not related to the corporate balance sheet, strongly influences the success or failure of the enterprise. Moreover, if the risk – as such – can generally be managed, mitigated or transferred, while the reputational risk can only be managed or reduced, not transferred, because it is not insurable or transferable to third parties. (Brady e Honey)

The reputational risk comes from the combined management of other main risks; so, for example, it could come from the operational matrix in the simplest business models, or from the combination of the compliance risk, environmental risk, job security, and so on, in more structured companies. The way these risks are managed and combined, provides a picture of the company, which is, nonetheless, constantly subject to change. That it why the reputation risk is not only important, but intangible and therefore dangerous at the same time.

So, how do we manage reputational risk?

While the risk of accidents at the workplace can be minimized by good practices and insurances that would cover any damages; while the environmental risk can be avoided by analyzing possible scenarios and creating some indices of risk; while the compliance risk can be avoided by rigorously complying with the reference regulations, … there is no one way to manage reputational risk.
The only way we consider valid and applicable in many scenarios would be to do things properly, do well in every sector, in every corporate expression (choice of raw materials, customer care, staff management, business ethical code..) and  this will give a shared view of quality persistency to the stakeholders.
The first step in this direction is certainly to carefully analyze your company, identify the missing cogs and modify the mechanism. Someone who has experienced reputational damage underestimated reputational risk. Understanding and accepting that reputational risk is real and potentially dangerous, allows you to take the necessary measures to evaluate your company’s risk profile and reduce it before it is too late.

Prevention is always the best solution: 

knowing the weaknesses of your company allows you to reduce the possibility of suspected or real critical events and the related reputational damage.

Contact us for a free, no-obligation consultation

Leave a Comment

Your email address will not be published. Required fields are marked *