Do Boards Understand Behavioural Risks to Reputation?

As regular readers know, we have analysed the annual reports of about 40 FTSE100 companies.  Our aim is to ascertain the extent to which boards and their companies demonstrate a good understanding of reputational risk, behavioural risk, organisational risk and cultural risk together with the extent to which the companies show an understanding of learning from errors and experience.  This approach is derived from our research insights, which are explained in more detail in "Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You"**

We have extracted their performance using five criteria.

Regular readers will recall our scoring system:



These disappointing results will represent a combination of accurate reporting of reality and poor reporting of better quality work.  We believe the former is much more likely than the latter: boards that understand these areas and their importance are unlikely to hide their company's strengths.

The least disappointing results emerge from 'cultural risk' with an average score of 2.8 and median of 2.5.  Given the strong emphasis given to culture by politicians and regulators, it is perhaps not surprising that culture has produced the least bad performance.  There is considerable room for improvement.

The worst results, sharing a disappointing average score of 1.7, were 'reputational risk' and 'learning from errors and experience'. Their medians were 1.5 and 2 respectively.

'Learning from errors and experience' was highly skewed: eleven companies scored zero whilst two scored 4 and three scored 3.5. This kind of learning is critical to long term success and stability.  A company has to get many underlying behavioural, organisational and cultural factors right to achieve a justified high score.  That makes this measure a particularly powerful pointer that regulators, investors and D&O insurers can use to differentiate between fragile companies and those that are systemically resilient.

These results also suggest widespread board skill gaps in this risk area.  The FRC anticipated this when it added behavioural, organisational and reputational risks to boards' explicit responsibilities.   The Risk Guidance provides that boards should consider:

“whether it, and any committee or management group to which it delegates activities, has the necessary skills, knowledge, experience, authority and support to enable it to assess the risks the company faces and exercise its responsibilities effectively. Boards should consider specifically assessing this as part of their regular evaluations of their effectiveness”

 These include the explicitly added areas of behavioural, organisational and reputational risk.

 The FRC also recommends that the board should:

"satisfy itself that [its] sources of assurance [on risk] have sufficient authority, independence and expertise to enable them to provide objective information and advice to the board."

Where shortcomings are found, the remedy is clear: arrange board education from people with "authority, independence and expertise".

In the meantime, we are extending our cohort to include regulators while we watch for correlations between bad scores and disastrous performance.  We shall report on results as they emerge.

Anthony Fitzsimmons

Reputability LLP

London

www.reputability.co.uk

@reputability

** You can claim a 20% discount code on a purchase of 'Rethinking Reputational Risk' through this link using code RRRF20.

Finding Future Failures

Our research, summarised in 'Rethinking Reputational Risk', shows that behavioural, organisational and board risks are the root causes of most major crises.  These systemic risks typically lie latent for years encouraging complacency before they trigger a major reputational crisis that typically takes leaders by surprise, shreds shareholder value and often damages careers. 

We have long known that it is possible to identify, in advance, organisations that have systemic weaknesses that make them more likely to fail in this way.  Preliminary findings from our latest research provide indications of a new analytical approach.

Regular readers will recall that recent rules from the UK Financial Reporting Council require companies it regulates to report clearly on important reputational, behavioural and organisational risks.  [Note: since this was written, the FRC has published new Guidance on Board Effectiveness which recommends greater focus on these areas at board level.  We have written about it here.  Our recommendations to the FRC on this are here.]  We have analysed the Annual Reports of about half of the FTSE 100 constituents to discover how they were getting on.

We used a simple scale to score their reporting performance on five axes

The scoring system awarded from 0 to 5 points on this scale.




The five (inevitably overlapping) axes we chose were:

1. Behavioural risk
2. Organisational risk
3. Cultural risk
4. Reputational risk
5. Learning from errors and experience

We added these scores to produce an averaged composite score for each company, also with a maximum of 5.

By way of example our cohort included seven financial services companies.  Plotting their results on a chart reveals the picture below.


 

This picture is revealing even without more information.  You can separate financial services (FS) companies that talk about learning from mistakes from those that do not; evidence of the Financial Conduct Authority and Prudential Reguation Authority campaigns to improve culture is ubiquitous; and two seeming weaklings emerge: FS6 and FS7 with averaged composite scores of 1.6 and 1.1.

To give a little perspective, FS2 was the top scoring company across our entire survey with a composite score of 3.6 that leaves plenty of room for improvement. The bottom company managed to score a zero on all five dimensions.

Annual Reports may portray a company as better or worse than it actually is.  A poor score may reflect poor risk management or inadequate reporting by the board.  Contrariwise a higher score may represent better risk management or exaggeration by the board.  At present we suspect the former more than the latter.

This analysis provides a new and solid starting point for identifying UK companies that are particularly vulnerable to unpleasant surprises.  Huge volumes of differentiating information exist in the public domain.  Our experience is that, with a suitable analytical framework and methodology, this yields revealing and predictive insights into the extent of a company's vulnerability to crises and the nature of its fault lines.  The framework can equally be used to compare and rank companies, identifying both which companies are more and less accident-prone and which are more, or less, likely to survive a reputational crisis.

Our methodology is obviously relevant to leaders of companies both in reducing the risk of being held responsible for the unexpected sudden collapse of their company and to ensure that outsiders gain a fair perspective on risk management in these areas.  With access to inside information the analysis can be made far more granular, robust and revealing, supporting improvements in both risk management risk reporting.  We are talking to a number of companies about this.

Our research insights and methodology are also relevant to:

• Investors who wish to avoid unpleasant surprises;
• D&O insurers ranking board risks;
• General liability insurers ranking operational risks;
• Banks assessing credit risks.

These groups have access to public information.  Armed with a suitable analytical framework, they can ask questions to probe areas that they regard as particularly important.

We plan to report further on our findings in the coming months.

In the meantime you can learn more about reputational, behavioural and organisational risks, and how they destroy seemingly sound organisations, in "Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You" written by the late Professor Derek Atkins and me.  Publishers Kogan Page offer a 20% discount  using code BBLRRR20 to our readers.

Anthony Fitzsimmons
Reputability LLP
London
www.reputability.co.uk
@reputability