Oil company reputations in deep water

Investors in oil companies have learned that drilling oil wells in deep water can be like 'betting the company' on every well, even for oil majors.

Ceres is coordinating an initiative to persuade oil companies to manage the risks in offshore drilling. It seeks better disclosure, better incentives and higher industry standards. And Ceres recognises that the weakest performer matters because a bad accident can easily cause collateral damage to the entire industry.

These are good intentions, but they miss an important ingredient. BP's direct financial losses were huge.  The current figure, $40.9 billion, represents almost three times 2009's profit, and is leading to a smaller BP. Insurance would have been insignificant for losses on this scale.

But what brought BP uncomfortably close to its knees was the the scale of the reputational damage, which came close to destroying BP's 'licence to operate'.

Oil companies need to get a grip on reputational risk. Reputation is a valuable, strategic asset even though it is not even mentioned in most balance sheets.  For a well regarded company, reputational capital represents a large proportion of the share price.  As Warren Buffett put it, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.”

Failure to identify reputational risks means that the opportunity to manage and reduce risks to this valuable strategic asset is lost. Unfortunately, traditional risk analysis techniques miss large swathes of reputational risk. And by revealing some reputational risks, they lull practitioners into thinking they have found them all.  The truth is that many are very hard to find.

So it is no surprise that BP seems to have been unaware of important risks to its once-valuable reputation. Yet looked at with the right analytical approach and experience, it is now predictable whether (and why and how) a serious accident for a large company is likely to mushroom from a crisis into a reputational catastrophe.  Timing is of course something else.

Unfortunately these new analytical tools, designed systematically to uncover and assess risks to reputation, were not widely available before the crisis struck.

Better, independent, safety regulation is essential, but it is not enough. Oil companies need to understand their reputations, systematically find and catalogue their reputational risks and fix the foundations. Otherwise the next oil spill to hit global headlines won't just damage the company involved. It could set back the whole industry. 

Activist investor groupings such as Ceres, Calpers and Hermes should encourage investee companies to understand their reputations, systematically analyse and understand the risks – and take a proactive approach to making their reputations sustainable.

As Bill Margaritis of FedEx put it, “A good reputation can be a life saver in a crisis and a tail wind when you have an opportunity.”  But the best reputation won't save you if it is built on hope and good intentions.  You need solid foundations.

Anthony Fitzsimmons

www.reputability.co.uk

RNIB risks undermining its reputation

In a move that will increase risks to its reputation, the RNIB is taking a line that supports Genentech and Roche, drug companies that market and make Avastin.

Avastin is a drug licensed for treatment for bowel cancer.  It has been discovered that Avastin can also stem wet macular degeneration, a condition that condemns many elderly people to blindness.  And Avastin is much cheaper than alternative treatments.

Nice is considering appraising Avastin as a treatment of macular degeneration because it is more cost-effective.  Genentech and Roche are resisting NICE's efforts to appraise Avastin for this use.  The RNIB is reportedly running the same argument as the drug companies, essentially that NICE should not seek out cheaper treatments by using existing drugs for new purposes.

This argument seems counterintuitive but for one additional fact reported by the Guardian.  Both drug companies give money to the RNIB.

Whatever the truth, many will perceive that the RNIB is dancing to its donors' tune.  Whilst this episode on its own is unlikely to cause serious damage, the accumulation of episodes like this will erode the reputation of RNIB as a trustworthy advocate for blind people. 

This is a common problem for charities.  Big business likes to buy their endorsement and the charities like the money.  The danger for charities is that they come to be seen as just another advocate of their commercial sponsors.  With that comes the loss of a valuable reputation that has taken decades to build.

Anthony Fitzsimmons
www.reputability.co.uk

Accountants and lawyers - how much does reputation matter?

It takes years to build a reputation and minutes to lose it. Since it gives a company its 'licence to operate' as a respected citizen of the world, its loss can be devastating. BP is a topical example of an asset rich commercial company that lost a large part of its market capital over a sustained period. Only a proportion of the fall can be attributed to liabilities.

Things are far starker for pure service providers such as lawyers and accountants.  They have few assets beyond human wits and their reputation.  Their ability to attract clients and to borrow depend on it.  It is by far their most valuable and important asset.  The redoubtable Lex now suggests that regulators should attack accountants' reputations.

Paradoxically, the value of reputations rarely appears in balance sheets.  Neither are they given attention or protection in proportion to their value or importance.  The reasons for this are not clear but seem to include both a lack of understanding of how reputations are made and broken and much too narrow a view of what puts a reputation at risk.  This matters.  

The largest accountants still hope they are 'too big to fail', but in reality their future depends on three questions.  Is audit still an essential service for larger companies?  Is it still a valuable service?  And can they still afford to offer audit services given the audit liabilities they bring?  Many wonder whether the answers are increasingly No, No and No.  If this feeling grows, the willingness of regulators to attack accountants will grow and the comfort of being 'too big to fail' will decline.

For a firm that is not 'too big to fail' - which means all law firms and most, perhaps all, accountants, a substantial loss of reputation will be devastating. All should fear the fate that befell Arthur Andersen, including the biggest accountants and their regulators.  The question is what action they should take - and whether they will take it.

Update: See now  "The demise of audit" - the Big Four seem to recognise the extent of their vulnerability

Anthony Fitzsimmons
www.reputability.co.uk

Bonuses: Does size matter?

Would you expect that larger bonuses lead to better or worse performance than smaller bonuses? The results of an experiment carried out by Dan Ariely and collaborators suggests that bigger bonuses may produce worse performance of tasks needing thinking skills.  These counter-intuitive results were discussed on this morning's Today programme. 

This experimental result, if confirmed, will become an important factor in assessing corporate reputations because bonus levels are so easily visible from the outside.  Very high bonus levels for those using cognitive skills may become a predicter of poor performance and thus a poor reputation. 

More work is needed to confirm the experimental result. But as it happens, the world's biggest investment banks are overhauling their pay structures to differentiate between European and other bankers.  This will neatly create, the experimental conditions needed to confirm, refine or debunk Professor Ariely's initial results.  Particularly when it comes to the relationship between base pay and bonuses.

In the meantime the results are food for thought for everyone involved in designing or considering the effects of bonus systems.

Anthony Fitzsimmons
www.reputability.co.uk