Magazine article Strategic Finance

Managing Reputational Risks: Using Risk Management for Business Ethics and Reputational Capital

Magazine article Strategic Finance

Managing Reputational Risks: Using Risk Management for Business Ethics and Reputational Capital

Article excerpt

Lapses in business ethics can lead to enterprise costs, damaged relationships with key stakeholders, and lost opportunities that significantly harm financial performance. Conversely, an enterprise's reputation for ethical conduct can be a crucial asset for achieving its strategic and financial objectives. It's surprising, therefore, that the role of ethics and reputational capital are the least developed aspects of enterprise risk management (ERM).

The Enterprise Risk Management--Integrated Framework and guidelines from the Committee of Sponsoring Organizations of the Treadway Commission (COSO) are fast becoming standards for best practices in organizations ( there are many varieties of ERM in practice today, all recognize that ethical values underlie a firm's ability to accomplish enterprise objectives. Yet much of the current discussion about ethics focuses on corporate culture, conduct, and compliance in a post-Enron world of the Sarbanes-Oxley Act (SOX) and corporate sentencing guidelines. Though important, these dimensions don't directly examine the value of ethics as an asset to build trust in important business relationships. As a consequence, most people's understanding of best practices to manage business ethics is limited.

Here we explore stakeholders' perceptions of ethics in order to bring reputational capital more clearly to the forefront of ERM. We do so by extending the ERM paradigm to identify and assess risks to reputational capital. First, we suggest a process to identify the scope of ethical principles and behaviors that are most appropriate for building reputational capital by illustrating this process with the IMA Statement of Ethical Professional Practice. Second, we account for differences in enterprise context that systematically narrow the focus of ethics governance. Third, we describe a framework that integrates ethics with the COSO ERM components to elicit stakeholders' assessments of enterprise reputational capital.

What's at Stake?

The foundational role of ethics in ERM isn't surprising. Business misconduct can lead to direct costs of legal fees, monetary fines, sanctions, and operational recovery. Given a choice in partnering, stakeholders--relationship partners such as employees, customers, suppliers, community groups, and owners--are likely to prefer a relationship with an enterprise that has a reputation for integrity. For the enterprise, a reputation for poor ethics can lead to costs of replacing lost partners or going it alone. Labor, operating, and overhead costs may increase if the enterprise is perceived to be so unprincipled in its conduct toward employees that its recruiting and retention of skilled personnel are at risk. Similarly, purchasing, logistics, and overhead costs may increase if suppliers judge the enterprise to be unfair or dishonest.

In our post-Enron/WorldCom/Tyco era, reputations of large, publicly traded companies (for better or worse) are likely to be broadly known. Public reaction to notorious lapses in business ethics has increased worldwide legislative, regulatory, judicial, and media demands for visibility into corporate governance of business ethics. In this context, an enterprise reputation that fosters goodwill has economic value. Unethical conduct puts reputational capital--and economic value--at risk.

Traditionally, the practice of ethics management has focused on corporate ethical values within the organization and sequential activities to prevent, detect, report, and respond to misconduct. But this focus on misconduct limits people's understanding of ethics as a form of reputational capital that has value in important business relationships. Moreover, the focus on misconduct makes it difficult to integrate traditional ethics programs within the ERM framework.

Given such a consequential role for ethics and the momentum of ERM in current business practice, it's surprising that ethics isn't more developed in the ERM discussion. …

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