<<

. 42
( 131 .)



>>



As regards risk management and good corporate governance procedures, includ-
ing non-financial risk in particular, of key importance as a reference tool is the
Combined Code (revised) on corporate governance, which resulted from the
merging of recommendations offered by the Derek Higgs review (released in
January 2003) as well as those offered by the Turnbull, Cadbury, Greenbury and
Hampel committee reports. The Code has been incorporated into the listing
rules for all UK listed companies and applies for reporting years beginning after
1 November 2003.
Sites that offer guidance on the most appropriate corporate governance
best practice for UK companies are the Institute of Chartered Accountants in
England and Wales (www.icaew.co.uk) and the Association of British Insurers
Institutional Voting Information Service (IVIS) website at www.ivis.co.uk (see
Bibliography).

SERM criteria
A SERM system is interested in the following indicators which are considered
to be elements of corporate governance best practice:
The following criteria can help determine the robustness of a board:
That there are an equal or greater number of non-executive directors than
executive directors;
The non-executive directors are independent of the directors (e.g. not related
or previously employed by the company or executive directors);
The chairman and CEO are separate roles;
The CFO is operationally independent from the CEO; and
The CFO is a strong and respected member of the board.
The functions of the board in promoting risk management are improved by:
A clear governance structure for the organisation, including the major com-
mittees in operation;
Mission statements, internally developed codes of conduct or principles, and
polices relevant to environmental, health and safety and social performance;
An outlining of the process for determining the expertise of board members,
including issues related to environmental, health and safety, and social risks
and opportunities; and
Board-level processes are present for the overseeing of the organisation™s iden-
tification and management of economic, environmental, and social risks and
opportunities.
Part B “ Overview of the Economic Aspects of Business Risks
206



The following criteria can help determine the effectiveness of the non-executive
directors:

Roles are clearly defined;
They are required to be re-elected at the end of their term; and
They are perceived to be independent.

Remuneration and share options: some of the criteria for determining the effect-
iveness of a share options scheme:

Linkage between executive compensation and the achievement of the organ-
isation™s financial and non-financial goals;
The strike price is within similar range to current share price, to discourage
artificial engineering of volatility;
Options should be staggered over a range of periods, not merely one large
amount; and
CEO and CFO awards should be based on company performance rather than
market performance, to reduce merely sector gains.

The following criteria can help determine the effectiveness of auditors:

The separation of audit from consultancy;
The auditing firm should not be undertaking any, or at least minimal, levels
of consultancy for the organisation;
Well-respected audit firm;
The auditors have not been given professional indemnity insurance; and
The auditors™ fees are stable (no increase of more than 10% year on year).

Stakeholder engagement: ensuring there is a provision of mechanisms for
shareholders to provide recommendations to the board. This is covered in the
following section in more detail.


Stakeholders
SERM™s starting point for a company to assess reputational risk and how it
interacts with the intangible value is to list its key stakeholder groups. These
can be broken down under several main categories.
The SERM stakeholder template:

Academic and research organisations;
Business partners, suppliers and trade bodies;
Customers and their representatives;
Direct actions groups and NGOs;
Employees and their representatives;
Financial institutions (banking, investor and insurance criteria);
Chapter 9 “ Shareholder value and reputational risk 207



Governmental organisations;
Local and regional governmental organisations;
International governmental organisations;
Journalists and media organisations;
Key competitors; and
Local communities.

As is mentioned further below, the list should then be expanded to show the
key individual stakeholders under each category. Agreeing exactly who their
key stakeholders are can be a challenge to most boards. The key stakeholders™
trust and high regard for the company is paramount to the company™s sustain-
able growth. As is illustrated below stakeholders can have a direct impact upon
the value of a company:

Actual and potential shareholders of a listed company will decide what they
think the value of a company is with the prices they are willing to buy and
sell at; and
Regulated industries can have their prices set by government departments or
regulators, or are taxed by the government, thus affecting the demand for
their offerings (e.g. alcohol, tobacco, oil, etc.).

There are numerous indirect risks and stakeholder pressures which can dam-
age an organisation™s reputation. These can include changes to the company™s
operating environment through regulation; for example, imposed restrictions,
loss of licence, likelihood of government intervention, etc. These may also be
closely related to environmental, health and ethical concerns. The government
as a key stakeholder has raised the pressure on pension funds to help protect
the reputational value of UK plc; for example, amendments to the Pensions Act
1995, which became law in July 2000, implemented a requirement for pension
funds to declare their ˜social, environmental and ethical policies, where they
exist™ in their Annual Statement of Investment Principles (SIPs statements).



Stakeholder management
The link between the companies and their key stakeholders are the issues
that the company has the ability to manage/influence and thereby improve
the position for the stakeholder. For each of the stakeholders the company
should consider the pertinent issues that could enhance or destroy their
relationship. The issues™ impact varies from stakeholder to stakeholder as
their expectations are not necessarily the same.


It has already become evident that, to be complete, an institution™s operational
risk profile should reflect intangibles such as reputation which are acknow-
ledged to be central to the success of an institution. Listed companies in
Part B “ Overview of the Economic Aspects of Business Risks
208



particular are under increasing pressure from external ratings agencies, index-
ers, investment advisors and others over their safety, environmental and social
performance. Poor communications or communicators can attract media inter-
est or outrage. As part of a reputational risk analysis it is necessary to capture
stakeholder sentiments about the organisation. This is part of the reputational
risk assessment reviewed in the following sections.


Reputational risk
It is now generally recognised by most organisations that without risk there is
no reward and, as a general rule, the higher the potential reward the higher the
potential risk. Those organisations which have struck the optimum balance
between risks and rewards are the modern-day heroes. Indeed many organisa-
tions are assessed upon the basis of their risk appetite and how far they are risk
averse.
Achieving a balance between risk and reward is becoming more and more
difficult, as there is now an increasing and often unrealistic expectation from
stakeholders that reward can be delivered without risk. In order to build and
retain a good reputation, these unrealistic expectations need to be expertly
managed through transparency, education and inclusion.
Therefore from the SERM perspective the starting point for any company is
to have a clear understanding of the key issues surrounding its ˜risk versus
reward™ strategy:
How could its reputation be damaged?; or
How, if managed well, could it enhance its reputation over that of its
competitors?
The organisation needs to work closely with all of its stakeholders by:
Discussing with them the wider implications of their expectations, the man-
agement and deliverability of their expectations; and
Ultimately, agreeing with them how their interests can be aligned with those
of the other stakeholders.
In essence, the company and its stakeholders should be working together har-
moniously. The issues are dynamic and need to be continuously reviewed.
Expectations these days mean that even good surprises can be unacceptable.


Reputational damage
Media interest and non-governmental organisations (NGOs) activities work
together to create public awareness. If an issue is newsworthy and a stakeholder
launches a campaign about the issue, it will keep gaining momentum and lead
to ever-increasing public awareness. This is a key area of risk management.
Companies need to assess the current and potential damage or value the
issue could have. How sustained could the coverage be? ˜Does the story have
Chapter 9 “ Shareholder value and reputational risk 209



legs?™ A negative, one-off headline can be fairly damaging but a long drawn out
campaign can severely undermine a company™s reputation, even if it is only in
the local press. The issue could potentially centre on a major accident, leading
to a public enquiry and class action for compensation. The whole process will
ensure maximum media coverage.
This can increase public awareness of the issues; the company should con-
sider the public™s reaction on the basis that they are aware and have an under-
standing of both sides of the argument surrounding the issue. Will the issue
lead to anger, outrage or fear? The media and NGOs will only be able to create
and sustain public awareness if the issues, which they are promoting, are likely
to lead to a high level of anger and outrage among the general public. ˜Bad news
sells newspapers.™ Industry lives with these issues and often comes to accept
them as being part and parcel thereof. The public perspective can be very dif-
ferent, however, and a company should try to understand how angry the public
could be if it fails to manage the issue.
It is generally the case that once a company is in the spotlight over a cer-
tain issue; a strategic option to try to limit the damage is to convince the press
and public that it is a sector issue rather than a company specific issue. For
instance, Shell™s reporting of their known retrievable oil and gas reserves under
the US Securities and Exchange Commission™s (SEC) guidelines was a well-
documented example. Shell appeared to be successfully turning it into a sector
issue, but the subsequent disclosure of the board™s damning internal emails
turned the focus of the blame clearly back onto the company. This resulted in
fines of $151 million (£83 million) to draw to a close the dispute with the SEC
and UK™s Financial Services Authority (FSA) over its wrongly booked reserves
(Financial Times, 30 July 2004).
Some issues can be quickly addressed and, if carefully managed, can even
enhance a company™s reputation, such as in the case of product recalls if the
company initiates the recall prior to media exposure of the risks. Others just
simply will not go away; these are issues which the company has to live with
and are, therefore, an inherent part of a company™s operations. General and spe-
cific examples include:

Oil companies that are active in parts of the world where their staff and oper-
ations are at risk from saboteurs and media exposure of environmental dam-
age; and
J.P. Morgan Chase setting aside an extra US$3.7 billion to cover investor law-
suits in relation to its ˜alleged role in corporate scandals such as WorldCom
and Enron™ (Financial Times, 22 July 2004).

The media and NGOs have long memories and will continue to make examples
of a company™s poor management of an issue. Once a company has entered this
territory it is very difficult to reduce the onslaught of adverse publicity. For
instance, in the UK Jarvis plc provided a case in point as their loss of reputation
over safety incidents was then compounded by the loss of contracts and the
resultant cash flow problems and redundancies.
Part B “ Overview of the Economic Aspects of Business Risks
210



Intangible risk
The extent to which a range of intangible risk factors influence share price is
vital information. These risk factors include:
Corporate reputation and individual brand values;
Regulatory regime and government reaction to public pressure;
Media and NGO interest; employee morale; and
Investor, lender and insurer confidence.
Some of these are considered below.
Corporate reputation: the organisation™s reputation. This reflects key stake-
holders™ perception of the company™s strength and corporate governance; this
is a function of size and visibility. It includes the credibility, reliability, trust-
worthiness and responsibility of the organisation;
Individual brand values: the product™s reputation. This reflects the relevant
customer™s perception of brand name and resultant loss of sales/increases in
returned goods/inventory costs; related to visibility; and
Stakeholder value:
Academic and research organisations: vital to some sectors that need scien-
tific approval for their products;
Business partners and suppliers: reflects the effect on voluntary or imposed
partnering due to operational structure;
Customers and their representatives: not only the demand for products and
services, but also brand loyalty, quality and product safety perceptions;
Direct action and NGO interest: reflects the likelihood of NGO campaigns
against some aspect of the company™s operations (e.g. internet-based cam-
paigns). This also includes the actions of militant action groups and reflects
the adverse pressure (often unlawful direct action) against the company
over perceived malpractice (i.e. anti-vivisection protestors);
Employees and their representatives: employee morale and industrial rela-
tions are included. This reflects the damage which could occur, resulting

<<

. 42
( 131 .)



>>