shareholder returns

My good friend Bob Eccles, professor of management practice at Harvard Business School, wrote an article (The Performance Frontier) that just appeared in the Harvard Business Review.  Here is a PDF. I’ve been extremely interested in his work on integrated reporting for awhile now. What is integrated reporting? Essentially it is One Report that combines financial and non-financial information interactively into one document. A good example of a company that has done this is Natura. Although integrated reporting is voluntary today, it is required of all companies on the Johannesburg Stock Exchange. But integrated reporting is much more than an online CSR showcase. When it is done right, it is an authentic and innovative two way conversation where a company convenes its stakeholders to discuss its progress meeting its financial and nonfinancial goals. For example, Natura does this through Natura Conecta where the public is invited to have a discussion on environmental and social issues related to the company. It is a living exchange, not a static one that is one-way and more push than pull.

Bob’s article has an interesting slant which he points out in the introductory sentence . . .”But a mishmash of sustainability tactics does not add up to a sustainable strategy.” He argues, along with his co-author George Serafeim also at Harvard Business School, that we need a solid framework for simultaneously boosting financial performance as well as doing good. Tactics alone won’t do the trick. They provide a model for identifying the most environmental, social and governance (ESG) factors that drive shareholder value so that both financial and ESG performance are enhanced, not just one. A company that focuses on sustainability without paying attention to the financial costs is not going to have a genuine sustainability strategy that meets everyone’s interests. Similarly, a company that focuses solely on financial performance to the exclusion of good ESG performance will lose out as well in terms of public opinion and support. A major component of reaching this perfect balance, according to them,  is by identifying major innovations in products, processess and business models that achieve these improvements and accomplishes superior financial and sustainability performance. A good example is the one with Natura mentioned above. They also cite innovative business models from Dow and Hong Kong-based CLP Group. And then, of course, Bob argues that these activities are ideally communicated through integrated reporting.

What fired me up was the SASB (Sustainability Accouting Standards Board) Materiality Maps that have been created for 88 industries in 10 sectors.  Each industry has its own map that prioritizes 43 ESG issues and ranks them in terms of materiality. Not all the maps are complete but take a good look at this one for the health care sector. It shows which ESG factors impact financial performance so that a company knows what to prioritize. It’s a great contribution to understanding ESG factors as well as what drives strong corporate reputation. Don’t miss it.

And congrats to Bob and George for raising an important question about how to better balance financial costs and sustainability costs so that they complement one another instead of taking away.

What spooks markets the most? If you closely follow crises, you probably think about how many different types of crises there are. For example, how do the markets react to a crisis that is due to the questionable behavior of the company or employees? What about product recalls? Or litigation? What about loss of customer data? All good questions to ask about reputational damage. International law firm Freshfields Bruckhaus Deringer decided to investigate how the markets react to different crises and how long the crisis lingers. This chart below is from their study:

Behavioral crises (company or employees acting questionably or illegally) have the greatest short-term impact on shares and the only type where the companies have the possibility of regaining their market share after six months. However, they spook the markets the most and can cause shares to crash by 50% or more on  the day they become public, according to the researchers. Investors, however, forgive these types of crises more quickly than others.

Operational crises (when the company’s functioning is halted due to a major product recall or environmental disaster) have a modest impact in the first two days of the crisis breaking but the greatest long-term effect on share price…down almost 15% after six months. One quarter are still down one year later. These type of crises strike fear in companies and reputations are hit for the longest period of time.

Corporate crises (companies where the financial wellbeing is affected such as liquidity issues or material litigation) made up more than one quarter of companies experiencing a share drop on day one. Most often, these companies recovered quickly.

Informational crises (when companies IT such as system failures or hacking) were of moderate concern to the markets. They did not fall more than 3% on day one. According to the research, none saw shares fall more than 30% within a year of when the crisis struck. Possibly, investors figure these can be resolved and its everywhere today, not necessarily at the core of the company’s business.

As the research states, “Our research shows that directors typically benefit from a window of 24 to 48 hours, during which financial market reaction to news of a major reputational crisis will be relatively constrained.”  In the public relations world, we often refer to the first hour after a crisis breaks as the “golden hour.” According to Freshfields, it sounds like there is an even longer” golden window.”

The natural question to raise is why does operational crises do the worst? Freshfields answers appropriately, “Crises that strike at a business’ core have a greater long-term impact on share price as markets are more likely to lose faith in a management team that cannot resolve a crisis that is intrinsic to its operations.” As Oxford Metrica’s research in 2012 for AON showed, management response is showcased for all to see when crisis strikes. The kind of  CEO or executive response can make or break reputations and create reputation loss of great magnitude if done poorly. To prevent such reputation loss, prepare!

Another reason for why CEOs matter. Today’s story in the WSJ focused on how investors are increasingly demanding CEO face time in order to get greater insights into the company’s strategy and future and determine whether it is worth their investment to take a stake. One of the CEOs complained said that meeting with investors and analysts is taking up too much time. This should not come as such a surprise. The job of CEOs today is not to only run the business but be that communicator-in-chief with its portfolio of stakeholders which I grant is expanding by the year. The article seems to point out that these meetings are getting more granular than the larger-sized ones of years past and taking up more and more time. One CEO says he meets groups of 50 investors in batches, one after another, or in private 30 minute sessions.

The article provides a few interesting stats on the pressure on CEOs to make time for investors…

• C-suite executives in North America attended 70% of private investor meetings over the past 12 months, up from 64% one year earlier.
• CEOs and finance chiefs spent 14 days and 17 days, respectively, on these meetings.

The article provides many different reasons for why meeting the CEO is important but one that wrapped it all up for me was when a president of Fidelity Investments said that meeting the CEO provided “nuances” about the company that does not come through in an earnings call and helped him “put the entire mosaic together.” I thought that the “mosaic” idea was useful in understanding what role the CEO and his or her reputation does actually play. Although the CEO is just one part of the picture or mosaic in this case, the CEO’s leadership, transparency and credibility helps  glue together the partial perceptions of a company we all have and fit them into a pattern that yields a reputation. Getting to meet the CEO and gauge his or her character through the whites of his/her eyes is a critical piece to the puzzle of reputation that adds to a valuation about a firm’s future performance. After all, isn’t that part of the CEO job description today — to balance the external and internal?

I was pleased to be alerted to a copy of Reputation Review 2012 by Rory Knight, chairman of Oxford Metrica. Years ago I used some of their research in my book on CEOs and particularly on how CEOs can build their reputation or kill it when crisis strikes.  Knight just completed his annual reputation review for AON, the global risk management, insurance and reinsurance company, and as I expected, the report has insightful and timely information for those seeking to better understand the impact of crisis on a company and its bottom line.

Knight reviews the top crises of 2011 such as TEPCO, Dexia, Olympus, Research in Motion, Sony, UBS and News Corp, among others.  His company looks at the recovery of shareholder value following crisis. Among 10 crisis-ridden companies in 2011, only News Corp found itself in positive terrain afterwards. In fact, what they found was that 7 of the top 10 lost more than one third of their value. Two companies lost nearly 90% of their value. These companies clearly had to put big restoration processes in place afterwards and I would suspect paid good dollars to firms to restore their good names and overlooked other everyday business to move forward.  Oxford Metrica says: “Managing the restoration and rebuilding of reputation equity is an essential part of the value recovery process following a crisis. Reputation equity is a significant source of value for many companies and a coherent reputation strategy can be the difference between recovery and failure.”

The big takeaway from the report, or at least what seems to resonant with me, is that there is an “80% chance of a company losing at least 20% of its value (over and above the market) in any single month, in a given five-year period.” Those odds are not good and as Knight says, screams for having a careful and well thought out reputation strategy in place before a minor event turns into a raging crisis and monopolizes headlines, offline and online.  A solid reputation strategy will also help guide the reputation recovery process which is often too hurried.  This is the kind of advice that I write about in my book on reputation recovery and underscores having a strategy so you do not find yourself in this situation in the first place. Additionally, Weber Shandwick’s stumble rate of 43% for the world’s most admired companies tracks with Knight’s high rate of expectant reputational downfalls. It is not good at either rate.

The report outlines a process for managing a company’s reputational equity. They are 1) Measure your reputation through benchmarking and vis a vis your peers; 2) Identify the drivers of your company’s reputation in order to allocate resources properly; 3) Prepare a strategy for recovering your company’s reputation; and 4) monitor your reputational equity often and respond accordingly when risk emerges.

The report analyzes the reputational losses of Olympus and Research in Motion after their reputation-damaging events. It is worth reviewing.  It also takes a look at the financial results from TEPCO after the tsunami hit Japan. Apparently, 90% of TEPCO’s value was lost, over $US37 billion.  Oxford Metrica estimates that events associated with mass fatalities have double the impact on shareholder value than do reputation crises in general.  I believe they are right. BP’s Gulf of Mexico tragedy which involved over two dozen deaths wiped off substantial shareholder value off their books.

Where I wholeheartedly agree with Knight is when he talks in the report about the impact of senior management on crisis and the need for that management to lead with transparency and openness.

“For mass fatality events particularly, the sensitivity and compassion with which the Chief Executive responds to victims’ families, and the logistical care and efficiency with which response teams carry out their work, become paramount. Irrespective of the cause of a mass fatality event, a sensitive managerial response is critical to the maintenance and creation of shareholder value.” One of the takeaways from the report is that winners and losers, reputationally, can be determined by how the CEO responds to the crisis.

The report contains an article by Spencer Livermore, Director of Strategy, at Blue Rubicon, a reputation consultancy. He quotes a stat that is dear to my heart, “Oxford Metrica’s analysis shows that companies which open up more following a crisis and tell a richer, deeper story are valued more highly, increasing share price by 10 per cent on average over a year.” He calls it the communications dividend which comes from investing in communications. Years ago I wrote an article for Ernst & Young’s Center for Business Innovation called Communications Capital and the idea was similar – the right communications can increase market value and strengthen reputation.  As Livermore says, “We can make communications worth hundreds of millions more simply by making them better understood.” Having the right compelling narrative built on a well thought out reputation strategy is worth its weight in gold today.

Barron’s World’s Most Respected Companies came out last week.  It is a highly coveted list for companies and must please CEOs and boards.  Barron’s lists are definitely worth following because the ratings are gathered from money managers, not consumers which seem to be the stakeholder of choice these days. Apple was number 1 this year which is not a great surprise.  Interestingly, the writer mentions that the problems Apple has faced with FoxConn appear to only be a distraction for now. As always, the ups and downs of company reputations are revealing, particularly among this money-centric set.  As much as I like the list, I like the write up more because there are usually interesting nuggets of information.  This year, these stood out:

·         Investors gave more thumbs ups to US based multi-nationals.  Barron’s says that this is because of the outperformance of domestic stocks in a year of global tumult and the outperformance of quality mega-cap shares as global growth expectations diminished.  Six of the top 10 are among the 30 members of the DJIA.  This was more pronounced than usual.  Even though the money manager sample is US based, Nestle managed to sneak into the top 10 which says a lot for that company’s prospects.

·         What drives perceptions of the world’s most respected companies among this select set? Strong management and sound business strategy top the list, followed by business ethics, product innovation and then financial performance.  In the past two weeks, it seems that I have had more conversations about Ethics and reputation than I usually do. I have been asked to define business ethics, trust and reputation and how they are interchangeable and need better defining.  And as you see below, ethics ranks #3 among money managers in their respect for companies.

·         Russian and Chinese companies did not perform well in the rankings. Clearly there is a perception of “untrustworthiness,” says Barron’s.

·         They predict that the global healthcare companies might be due for a reputational upgrade.  Barron’s says that right now all the pharma companies are cast into one big “ugly” bucket of drug-patent expiration, reimbursement head winds and weak development pipelines.  “Funny, it would seem a forward-looking investor could make the case that aging populations in the developed world and growing medical spending among the emerging middle-class could boost these giants’ fortunes in the coming years.”

CEOs get the importance of corporate responsibility. At the recent Board of Boards CEO Conference in New York where heavyweight CEOs from around the world meet annually, the discussion on doing well by doing good was front and center. In an article on that meeting in Barron’s, the attending author said,

“How the times have changed. Whether investors like it or not, this era’s consumers do care deeply that the products they purchase are both cheap and do no harm to the environment, or, better yet, positively contribute to the state of the world. A full 59% of the queried CEOs felt consumers were “demanding greater levels of transparency regarding their companies’ community engagement initiatives;” 69% claimed such efforts on their part were “rewarded by consumers.”

Because consumers care, investors should care. Fact is, when a company’s cool and progressive spirit—it’s intangible goodwill— is undermined by the firm’s community-damaging business practices, investors often wind up paying the price.”

I was glad that CEOs noted that consumers care because that is what we found in our recent The Company Behind the Brand: In Reputation We Trust. Consumers are no longer passive about the companies that make the products they buy. They care and do not like being surprised if they find that the product they adore is made by a company they detest.

At the meeting, CEOs were asked whether their company’s community and social engagement was “rewarded” by its shareholders and I agree with the author that the response was positive. More than one-half (56%) believe shareholders reward firms for their corporate citizenship. And yes, we all know that it comes down to having the right metrics. It is awfully hard to pin down.

What is most interesting to me over the next 12 months is seeing how Apple’s reputation fares as the Foxconn issue of employee mistreatment stays in the news. I believe that companies get just so many chances to soar above the damaging reputational news and then it reaches the tipping point where it surely matters. I often refer to the BP Effect. BP had three chances to make their reputation right — the Texas City refinery episode, the Alaskan pipeline debacle and then the Gulf of Mexico oil spill. The third one did them in.