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Compliance Reference

An introduction to reputational risk

Contemporary organizations face a myriad of challenges, not the least of which are emerging considerations related to an organization’s reputation. While organizations have historically devoted more attention to mitigating risks associated with financial, operational, legal and regulatory considerations, the emergence of broader concerns predicated on the concept of corporate social responsibility (“CSR”) have forced corporations to pay heed to rapidly evolving societal norms. Consideration of reputational risk—broadly defined as any factor with the potential to adversely affect the organization’s holistic health—is thus a central element of a contemporary compliance program.

Factors that influence an organization’s reputation

While reputational risk is relatively easy to define, it is impossible to enumerate all of the circumstances that might adversely affect the public’s perception of an organization as a whole. Nonetheless, common examples of reputational risk include, but are not limited to: (a) an organization’s complicity with actual or perceived human rights abuses (e.g., the use of forced labor, contributions to human trafficking, reliance on child labor); (b) an organization’s contribution to environmental degradation (e.g., excessive carbon and greenhouse gas emissions, water contamination, and failure to adopt a sustainability strategy); (c) an organization’s actual or perceived indifference to workplace quality and equity issues (e.g., gender-based pay disparity, lack of flexibility in working arrangements, no parental leave); and (d) broader concerns related to an organization’s participation in political activities (e.g., lobbying, industry group involvement, party and candidate contributions).

Regardless of its form, reputational risk poses a real threat to an organization’s continuity of operations. For instance, an organization found to be complicit in human rights abuses not only faces stiff criminal and civil penalties, but exposure to public ridicule and stakeholder frustration as well. For organizations that are heavily influenced by consumer perceptions, even the slightest exposure to scandal carries the risk of catastrophic economic consequences in the form of rapidly declining revenues, irreparable loss of brand value, and eventually, financial insolvency. The most compliant-conscious organizations thus prioritize the constant monitoring and mitigation of reputational risk as a core component of their risk management responsibilities.

A framework for managing reputational risk

A primary consideration in the effective management of reputational risk is shifting the organization’s focus from a reactive posture to a proactive stance. While crisis management can and should play a role in the execution of an effective risk mitigation strategy, the vast majority of risks to an organization’s reputation can be managed if appropriately identified and monitored in advance. To that end, organizations should establish a cross-functional team of risk management experts drawn from its core operational units (typically, although not always, finance/accounting, human resources, supply chain/procurement, sales/customer relations, contract administration/business development, and legal/compliance). Collaboratively, the cross-functional team should identify the major risks posed to the organization from a reputational perspective and propose concrete ways those risks can be managed by the organization before materializing into a tangible threat. For instance, a manufacturing company that identifies environmental concerns as a major driver of reputational risk should consider ways that traditional manufacturing processes can be refined, within budgetary and operational constraints, to reduce or altogether eliminate negative environmental impacts. Similarly, an organization that identifies forced labor as a material risk factor due to the nature of outsourced operations in regions with a reputation for abusive labor practices like China should consider whether the benefit derived from continuing to operate in those regions is outweighed by the financial, legal, and reputational risks attendant to that activity.

But identification and mitigation efforts are ultimately fruitless if management commitment is lacking. To that end, a virtual prerequisite for the adoption of an effective reputational risk mitigation strategy is board buy-in and senior management commitment. Because senior leadership is more likely to be acquainted with more traditional risk factors than the rather amorphous concept of reputational risk, the cross-functional team—led by the legal and compliance function—should endeavor to both educate and persuade senior leadership of the need for a cohesive reputational risk mitigation strategy. Here, the effective utilization of concrete examples in the form of case studies can be particularly helpful in assisting senior leadership with understanding the ramifications of leaving reputational risk unaddressed.

Finally, it goes without saying that reputational risk factors should be monitored and revisited frequently to accurately capture a current picture of the organization’s overall risk profile and gauge the effectiveness of risk mitigation efforts. As such, reputational risks should be considered in the context of any risk assessment. Additionally, internal controls designed to address reputational risk factors should be tested routinely for efficacy purposes. These exercises are particularly important in light of the rapidly evolving nature of reputational risk factors. Only a decade ago, factors that today seem significant were on the periphery of compliance practice. Simply put, failure to keep abreast of emerging issues with CSR implications is a recipe for disaster.

Consideration of reputational risk factors is of increasing importance to legal and compliance professionals overall. While managing reputational risk is arguably more complex than managing other more tangible risk factors, it is incumbent on contemporary organizations to adopt flexible and cohesive strategies for addressing emerging CSR concerns. An organization-wide strategy for dealing with reputational risk factors—taking into account the sensitivities of internal and external stakeholders—is the best defense against potentially devastating repercussions.