What is Reputational Risk? How To Recognize It and Prevent It From Impacting Your Organization

Harm to a company's reputation can have a significant overall financial impact. While other forms of risk are easier to identify and mitigate against, reputational risk can appear random and impossible to prevent. Recent developments in AI-powered risk intelligence are changing that and making preventing reputational damage increasingly possible.
By Peter Gorne
October 21, 2021

Why the possibility of reputational risk is increasing

Technology has increased businesses’ ability to prosper around the globe. In a world where everyone is a Zoom call away, technology increases a company’s access to the capital markets and talent necessary to execute an organization’s goals. No longer is the success or failure of a company’s initiatives dependent upon the available pool of employees in one location.

But as organizations become more comfortable with team members collaborating across time zones and with less direct oversight, the risk to their systems, confidential information, and physical assets increases.

Types Of Risk and Definitions

Risk to an organization manifests itself in several ways. There is operational risk, which financially impacts a firm’s ability to produce and deliver on its promises. There is financial risk that has a direct impact on the balance sheet. Then there is compliance or regulatory risk which are the lapses in processes, safety measures, or oversight requirements that can bring fines or sanctions against a company.

Each of these types of risk are well known and organizations generally take proper measures to ensure continuity of operations, healthy financial procedures, a commitment to safety, and proper adherence to government or industry regulations.

One thing these areas of risk have in common is that organizations typically mitigate or rectify the issues once they occur, and establish governance procedures to better ensure that a repeat does not happen. Organizations often emerge stronger, without long-term impact.

However, one type of risk that companies often fail to plan for is Reputational Risk. This type of risk is often less predictable, harder to quantify, and unlikely to fade from memory within a few months later.

Reputational Risk occurs through actions by employees that bring the reputation of the company into question. Frequently, it is through actions committed by company leaders but even those tangentially connected to a company can harm the public standing or perception.

In this article we explore how reputational harm happens, the corresponding damage it can do to an organization, and how to best prevent it from happening in the first place.

How To Repair Reputational Damage…Once It Happens

A cottage industry has emerged to help individuals and employers manage reputational risk. Many for-profit companies do this through Search Engine Optimization (SEO). For a price, firms can create enough positive internet activity that negative content is pushed downward on search engine rankings.

There are even law firms specializing in filing lawsuits or removing incendiary internet content against individuals whose character or reputation has been defamed online. This is extremely useful for people who are innocent despite the suggestions otherwise.

While these solutions are applicable to mitigating damage to one’s reputation after the fact, they are inadequate risk management solutions in the preventative sense. True reputation risk management strategies must start with the goal of avoiding such an incident.

How do you identify and assess reputational risk?

Reputational risk is both a challenge to quantify and hard to avoid, but when the risk is properly understood steps can be taken to mitigate the risk.

The worst-case scenario is a so-called black swan event, an unpredictable event with disproportionately negative consequences. An employee committing murder would be a fine example. The fact that it is so rare tends to offer comfort that it is unlikely to be repeated.

However, as organizations grow, black swan events occur more frequently. The risks, while small, increase in number, requiring organizations to pay more and more attention to pre-identifying, and protecting against them. The success of a company counterintuitively increases the probability that something will occur that creates damage to the long-lasting image of the brand and the balance sheet.

Unfortunately, the inability to conclusively determine the reputational damage in terms of dollars means many organizations theoretically understand that risk can occur…and then take few to no concrete action to prevent it.

Best-in-class organizations know they must start somewhere. The starting point is assessing the damage that could be done. As a hypothetical example… Imagine what sort of event could materially affect a business, to the tune of a 1% drop in sales. What could cause this? Social media posts? Client misconduct? Each organization has a higher or lower likelihood of those things happening, based on their business.

Now take that 1% and turn it into a number. A 10M company is faced with a 100,000 hole. A 100M company, a 1M hole. Then, determine the effective solutions that would prevent reputational harm in the first place. Workplace Code of Conduct policies. Social Media policies. Whatever the solution, assess the cost of creating it to prevent future action. A $100K risk management solution to prevent a 1M hit to the bottom line sure seems like a wise investment.

Managing reputational risk is an investment to protect what has been created, both to prevent damage in the present, but also, to not hinder future financial growth.

Related reading: Why political contributions can affect your investment profile?

How to proactively manage reputational damage?

Simply put, the best way to prevent reputational damage is to stop it from occurring in the first place. The investment spent on preventing reputation damage pales in comparison to the damage future actions can create. The first step is to know as much as possible about the people and the organizations you are hiring or investing in before doing so.

Thorough background checks are one of the most powerful tools in proactively combating reputational risk. While many firms perform perfunctory background checks as part of their hiring process, it is important to go beyond the surface level if you wish to uncover all potential risk factors.

With the advent of automated and AI-powered risk intelligence systems, an unprecedented level of data can be reviewed for potential problem areas. For example, Intelligo’s platform reviews legal filings at the federal, state, and county levels; regulatory listings such as PEP lists, sanctions, and watchlists; as well as social media and other online sources. With such a thorough review of tens of thousands of data points, companies are able to receive a comprehensive understanding of an individual’s past and current activities.

Types of reputational damage

We can identify 4 types of reputational damage, and provide some examples:

1. Damage Caused By A Person’s Decisions

Your company’s employees are human and sometimes they make bad choices, but those choices can reflect badly on a company’s reputation, especially if it calls their moral judgment into question. For example, David Sokol was once viewed as a contender to take over Berkshire Hathaway once Warren Buffet retired. But then he acquired $10 million of Lubrizol shares only weeks before he suggested that Berkshire Hathaway purchase the company. Although David Sokol wasn’t charged with a crime or brought up on ethics charges, his actions called his moral standing into question. As a result, he was no longer considered to be suitable to become Buffet’s successor.

2. Damage Caused By A Person’s (Alleged) Criminal Actions

Criminal actions committed by employees can be some of the most damaging. Extreme examples include former Amazon Mexico CEO, Juan Carlos Garcia. Garcia was accused of murdering his wife after previously being convicted of domestic violence against her. To avoid even more negative damage to the Amazon brand as a result of the crime, Amazon suspended their Google AdWords campaigns to avoid being tied too closely online.

3. Damage Caused By Your Partner(s)

Similar to the Amazon case, Best Buy’s reputation was similarly damaged after a delivery man brutally murdered the grandmother whose Best Buy washing machine he was delivering. Best Buy came under severe criticism both for using 3rd party contractors and for failing to their employees. It’s an open secret that retailers and big-box stores contract out delivery, service, and support; but outsourcing the work, combined with a lack of due diligence, caused Best Buy reputational damage in the millions.

4. Damage to the Brand by Associated Influencers

Brands often work with key opinion leaders and online influencers to add prestige to their brand. If this backfires and the same personality is seen to have spoken against the brand or in support of a competing brand, it can have a direct impact on sales.

Imagine if a fashion influencer you used had a history of trashing your apparel line in the past? Or a doctor paid to recommend a drug spoke at a conference last year questioning its effectiveness? The harm done to your brand would be considerable. A due diligence investigative report could uncover those past statements, preventing lasting damage to the company’s reputation.

Invest in an ‘early warning’ system

Thorough and rigorous background checks and due diligence pre-hiring provide companies with a level of security about the past actions of employees. However, as we have seen, actions performed during their tenure at a company can be an even greater reputational risk. Even with a full background check, at any time new information could come to light that would significantly alter the impression of an earlier background check. One way that companies work to mitigate the impact of an employee’s future actions is to implement ongoing employee monitoring.

The Intelligo Clarity Live service provides companies with real-time monitoring and alerts if any adverse or sensitive data becomes available on that individual. This allows companies to react immediately, distancing themselves from the event and taking the necessary legal, disciplinary, and public relations measures to respond to the risk.

Reputational risk, and the damage that comes from what are assumed to be black swan events, will always be a possibility. But they are far less likely to occur to organizations that have the foresight to recognize it as a manageable problem, one that is be mitigated by proper due diligence and monitoring solutions.

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