In the first of our new series asking corporates to consider various situations, Treasury Today takes a closer look at how companies can prepare for the worst. When news of a scandal hits, much of the focus gathers around the main offenders, but what about those left holding the reins? Managing the short-term reputation is just the start, as the treasurer is relied upon to keep on top of the reverberations in a rapidly changing environment.
As the recent plight of German automobile maker Volkswagen reminds us, the potential financial consequences that can be wrought when a scandal erupts are very severe. When the company admitted, in the autumn of 2015, that it had falsified US emission tests the headlines looked bad and the numbers even worse. In just a matter of days, the company’s share price had plunged by almost 20%, the company’s credit rating outlook was cut by Moody’s to negative leading to higher borrowing costs, and anticipating weaker cash flow and higher leverage metrics.
What began as a scandal emanating from Volkswagen’s research and development (R&D) function, therefore, soon became a matter the company’s CFO, treasurer and other financial executives had to address. As Shannon Wilkinson, CEO of Reputation Communications, a leading online reputation management firm comments: “Reputation impacts every area of a company’s value from profits to opportunities.”
But while, in such circumstances, corporate finance teams may feel as though they are at the mercy of events, history tells us that how they and the rest of the corporate leadership respond will play a big role in determining the company’s fate. When scandals hit, the outlook in the near-term is inevitably gloomy. Companies can – and do – bounce back though. In this article, we will look at a few of the things that can make the difference.
Who is at fault?
Often transgressions come to light in business which are confined to the actions of a few, culpable individuals. Clearly, the onus then falls to the rest of the company to show that this behaviour is not widespread and will not be tolerated. This means cooperating with authorities to ensure the efficient prosecution of those involved. As Ed deHaan, Assistant Professor at Stanford Graduate Business School, tells Treasury Today, in scandals where senior executives find themselves implicated, “getting new leadership at the helm is critical in setting a new tone for the company.” It does not always work. American Apparel has just gone bankrupt in the US over a year after ousting Dov Charney as the CEO.
Naturally, the corporate workforce often find their working world turned upside down when those at the top are stripped of all authority amongst claims of malevolence. Re-establishing lines of trusted communication, uniting departments and maintaining brand value, each present challenges. “Scandals create internal turmoil which can in turn prevent action. The longer an organisation takes to address this, the more likely it is that they will see a hornet’s nest forming,” says Reputation Communications’ Wilkinson.
The aim is for the whole company to avoid being defined by the mistakes and offences of a few ‘bad apples’. All eyes will be on the top executives’ first public appearance; Michael Horn, Volkswagen’s Chief Executive in the US, took the opportunity to admit that the company “totally screwed up” by cheating on vehicle emissions tests, for example. Expressing genuine contrition and setting out, unambiguously what measures will be taken to redress the situation goes a long way to restore public confidence – something which holds true even in scandals that don’t originate from within the company itself.
Restoring trust
There have been countless examples down the years of companies whose reputations have been undermined by events beyond their influence. Back in 1982, for instance, the leading pain-killer (Tylenol) Johnson & Johnson (J&J) were selling in the US at the time had been tampered with; an unknown suspect or suspects having added 65 milligrams of cyanide into the capsules. Seven people in Chicago died, allegedly as a result of taking extra-strength Tylenol capsules. Once the connection between these deaths and Tylenol was made, J&J were left to solve the crisis, in a way they hoped would minimise any financial or reputational damage.
Following prior-established guidelines, the company assumed responsibility for the product, ensuring the safety of consumers and medical professionals using its products as well as the employees and stockholders by conducting an immediate product recall. This amounted to around 31m bottles and a loss of over $100m for the company. That may have been a heavy financial burden to bear, but the measures were key to the restoration of public confidence in the brand.
Indeed, the influence trust levels between companies and consumers have on commercial success should not be underestimated. “There is asymmetry of information where the general public doesn’t know what type of people the managers are, what their intentions are and whether the company intends on following through with the things they’ve committed to – whether it be delivering high quality products or financial statements. We have to trust companies on these sorts of things,” says deHaan. If that company is highly reputable and the public believes it will ensure the delivery of its commitments – whether this involves third parties or not – then they get a premium in the market, he explains.
The weak link
J&J managed to re-introduce the Tylenol product by having triple-seal tamper resistant packaging, offering promotions and conducting presentations to restore confidence within the medical community. The tale does highlight, however, the need for corporates to take a proactive role in ensuring products that are associated with their company meet international safety and quality standards.
This isn’t a problem of the past, as numerous examples from within the last ten years attest: lead paint found in Mattel’s children’s toy in the US, Nike’s association with sweatshops, illegally-sourced plywood produce sold in Wickes and B&Q UK stores and contaminated milk in China. Supply chains today are increasingly large and opaque and, as such, reputational risks are increasingly elevated.
Wherever products are manufactured, it is the corporates’ responsibility to understand the origin of products and minimise the risk of supply chain scandals. Knowing who your partners, suppliers and employees are is a necessary part of due diligence and taking every precaution when evaluating prospective business partners is essential.
When operating in countries which are less transparent, a heightened awareness about the potential pitfalls to avoid and local practices and laws is going to be necessary. Knowing what is (and isn’t) required within a country will eliminate the chance of unwelcome surprises. In other words, the potential of product scandal necessitates greater vigilance and active management at all points of the supply chain. “To the extent that you can take steps to avoid having a scandal to begin with, clearly that is going to produce a better outcome. Prevention is the best medicine,” explains deHaan.
Riding the storm
Should the worst happen, investors will be weighing up the costs of staying in or joining the stampede that could be destroying their assets. Not only that, but the larger public will be rapidly forming opinions which could create a much broader fallout. Acting responsibly during this time is crucial for businesses. A 2014 study, ‘Reputation Repair after a Serious Restatement’, by Jivas Chakravarthy, Ed deHaan and Shivaram Rajgopal explored the financial importance of repairing a company’s reputation with what the report calls “softer constituencies” – customers, employees and local communities, for instance. The results: people care when a tarnished company attempts to rebuild its reputation with goodwill gestures.
After announcing intentional accounting misreporting, the 94 companies in the study sharply increased the amount of reputation strengthening actions aimed at investors. This included: improving internal controls, a change in incentive programmes and announcing replacement of senior executives. But what the study found was that companies also reached out to non-financial stakeholders – in fact, 51% of efforts were focused on these softer constitutions. And the rewards were substantial; the researchers estimated that announcements of actions to repair and enhance the reputation of companies lifted share prices by 2% on average. “You must take a multi-stakeholder view of your company. A common mistake is focusing too narrowly on satisfying the regulators, investors and lenders,” says deHaan. Researchers describe ‘reputation capital’ as a genuine – albeit intangible – financial asset that is embedded in a company’s market value.
Reputation Communications’ Wilkinson says that ‘transparency’ and ‘authenticity’ are the key when it comes to protecting one’s reputation in the midst of a scandal: “Immediately acknowledge the scandal and share as much information as you can. Investigate what led to the crisis and share your findings with the public, as well as the steps you are taking to resolve the underlying issues. According to her, there are lessons to be learnt from the examples of the past. “Study the strategies of companies who have successfully navigated a major crisis, as well as common downfalls.” Whereas J&J quickly responded with a plan of action, Exxon was very slow and inefficient in its management of the notorious 1989 Exxon Valdez oil spill in Alaska and it had a (well-reported) devastating effect on the company. Exxon’s chairman at the time, Lawrence Rawl, didn’t fly to Alaska until two weeks after the event. He sent a succesion of lower ranking executives and efforts to help the local community were delayed. Such occurrences suggest to the public that a company doesn’t consider an incident a genuine concern. As corporate scandals go, this is often referred to as one of the worst. The problem for companies seeking to avoid similar damage to reputation is: “Even very large organisations that have communications departments don’t necessarily have five or six crisis managers sat around waiting for the next crisis. They are not going to have the current knowledge of how a scandal is best managed,” says Nigel Pearson, Global Head of Fidelity at Allianz Global Corporate & Specialty (AGCS).
In the public eye
Part of the problem is that companies are often slow to react, then. And, in a digital age where news spreads like wildfire, quicker and quicker responses are necessary. This is evidenced from research from legal firm, Freshfields Bruckhaus Deringer, which revealed that news of more than one-quarter of crises – including senior employee misconduct and bribery and corruption – spreads to international media within an hour and over two-thirds within 24 hours. As Kweku Adoboli, a trader convicted of fraud after losing $2.3bn at UBS, remarked in a letter dated June 2014 to a journalist at the Financial Times: “No-one in finance ever realises how close they are to the imaginary, transitory red line until they cross it and get smashed in the face by a million camera lenses.”
Behavioural crises (illegal or questionable by the company or employees, like the Adoboli example) were the fastest to spread through social media, over 40% within the hour. And because, as Wilkinson explains, “consumers, investors, prospective partners and journalists now conduct their research about companies, products and industry leaders online,” the role the media plays has an increasingly immediate knock-on effect on the value, revenue and operations of business which can be felt for a considerable time afterwards. According to Freshfields, 53% of companies had not seen share prices regain pre-crisis levels.
“If you wait until the media are leading the charge then you are going to be playing catch up when what you should be doing is establishing the message, rather than responding to it,” explains Stanford Graduate Business School’s deHaan. The interest in crises is certainly growing too as The Wall Street Journal’s ‘Crisis of the Week’ column illustrates only too well. Here, experts comment on current high-profile crises stories.
The recent TalkTalk scandal in the UK inovolved financial details of subscribers being hacked. There was zero transparency in the immediate aftermath and this is a good proof of the effectiveness of Wilkinson’s advice – had they have been more open more readily with their consumers it would have lessened the crisis.
Counting the cost
For the treasurer, the direct impact of a scandal means there is a need for tools to assess levels of financial impact, and, ultimately, to work out where the money will come from to cover legal fees, damages incurred, the potential use of other external experts, severance packages and so on.
When these sums become very substantial they can wreak havoc on cash flow and forecasts. Referring back to the recent example of Volkswagen, it is reported that the company has set aside €6.5bn to cover the costs of the scandal. Some analysts have claimed it could cost more, however. Credit Suisse’s most conservative estimate, for instance, is around €23bn – and according to the company’s latest earnings statement, it has €21.5bn cash on hand. It has been suggested that the group may sell off some brands (for instance, its supercar brands, Bugatti and Lamborghini) to raise capital; although Volkswagen has a fairly robust balance sheet, a capital raise is likely. What’s more, companies embroiled in scandal must brace themselves for a hit to sales and prices.
Referring to deHaan’s earlier comment that prevention is the best medicine, for some companies with the resources to do so, it may be possible, to an extent, to prepare oneself in advance for a scandal. Allianz, for instance, offer a stand-alone reputation insurance product. Pearson describes the approach as “aggressive mitigation.” Rather than trying to value a reputation, discover how much it’s been damaged and then indemnify for the damage. “The solution tries to deal with the reputational crisis as its developing and aggressively manage it in such a way that we can limit the downside,” he says. “There’s no consensus on how you value a reputation globally anyway.” Allianz Reputation Product works with global partners who are professionals at managing crises (expertise which can be of value since crises, by their very nature tend to be intermittent, isolated events and therefore those responsible for dealing with are often inexperienced). “Large media organisations that have reputational management divisions will help our insureds when crisis happens and we are looking for them to do that within the first 24 hours.” The value being, that corporates gain access to people who are used to managing ten or more crises a year, as well as a €10m limit towards media spending.
Although by and large they are unpredictable events, corporates can also take steps to think about the risks their company faces. “BP, for instance, could imagine the possibility of another major oil spill so they can produce a contingency plan including information such as who will be leading the recovery. There is some amount of pre-emptive work that can be done when it’s an obvious risk,” explains Stanford Graduate Business School’s deHaan. It does depend on the nature of the company’s business however, but can you afford not to explore the possibility?
As Pearson concludes, “if companies genuinely stress tested their response plan, they might be surprised and they might also look at what’s available for them in terms of aggressive mitigation.” Forces beyond our control have a habit of manifesting themselves, from time to time, but we can still determine how well we respond when such nightmare scenarios become a reality.
