Why does reputation matter? Investors
Updated: May 19, 2020
As a reputation consultant, often I am brought into a boardroom or committee where not everyone is on the same page about how much reputation matters. Sometimes even my direct client is interested in measuring reputation not because they see it as a priority but because their boss asked for it. Scepticism abounds. This series is for you sceptics and for the people who need to convince them. In each blog, I will be explaining how reputation impacts the relationship that you have with one key stakeholder group: employees, investors, consumers, regulators, and so on. Each of these provides compelling reasons to care about the reputation of your organisation; taken together it would be disastrous to ignore.
Last time we focused on consumers, today we are taking a look evidence about the way that reputation impacts investors.
Investors play a major part in the success of plenty of businesses. For some companies the relationship with investors will be direct and personal, others are mediated by the stock market and media. All are impacted by the reputation of the company.
How so? Surely professional investors only care about the hard numbers in the business case? But investment is about far more than just the numbers – it is about how the numbers are interpreted, and here reputation makes a significant difference. One study by German researcher Sabrina Helm found that 12% of investor loyalty was driven by their assessment of a firm’s reputation. In turn, investor loyalty is a factor in reducing volatility in share price and in reducing the cost of capital.
Investors need to trust the people running the company and the strategy they have laid out, and they need to believe that others – consumers, regulators and investors – will trust that company too. The ability to trust is based upon reputation. Let us break it down into three categories: trust in the management, trust in the strategy, and belief that others also trust.
Do I trust the people I am investing in?
When conducting a reputation audit, it is standard practice to ask stakeholders what they think of an organisation’s leadership. Sometimes this can feel a bit pointless. Not all CEOs can be or want to be Elon Musk or Steve Jobs; most are content to remain anonymous and some pride themselves on doing so. That means that few commentators will have much of an opinion about them. But this part of the interview is important because of the assumptions that the respondent reveals. “I don’t see the leadership out and about,” an interviewee might say, “but that’s ok because I know they are getting on with the job.” Another interpretation of the same situation might wonder whether the board are up to something “shady” or are too crisis-stricken to be out pressing the flesh.
These differences are crucial to how much you trust an organisation with money from your fund or your pocket. We know from looking at consumer data (and never forget that investors are consumers too!), that the difference between a seller with no track record and one that has a good reputation can command price premiums of 8% or more. To put this number in context, 8% is more than the profit margin in many industries and enough of a share price movement to make it into the top 20 most dramatic days on the FTSE 100 or Dow Jones.
The reputation of a management team can therefore make a big difference to the readiness of investors to back your firm.
Trusting the strategy
As well as trusting the management, investors need to believe that the corporate strategy in place is sound. A big part of this is ensuring that the strategy takes account of the greatest sources of risk - both unlikely risks that could have big impacts, and more common or inevitable problems. Risks, for example, like major lawsuits (think: tobacco industry, pharmaceuticals, Volkswagen…), risks like the regulators capping your prices because of public cries of profiteering (hi energy sector! Hello payday lenders!), risks like activists targeting your products (cotton buds, straws and coffee cups, oh my).
Each of these risks can be moderated through reputation. Governments are more likely to penalise companies and sectors with a poor reputation: it makes election sense (more on this next week). Shifts in public attitudes on broader issues are often powered by their feelings about a particular company: think Starbucks and tax, Amazon and employee conditions, Sports Direct and zero hours contracts.
All of this is to say that investors have to believe that your organisation has investigated, measured and prepared for umpteen risks. Many of those risks will be reputational in nature, like the bad taste imparted by big bonuses during a series of redundancies. In other cases, your ability to bounce back from an upset will be affected by how strong your reputation was at the start. The public, government and activists are more prepared to forgive a company that slips up once than one with a reputation as an habitual offender. For your investors, a good reputation acts as a guarantor that can be drawn against in emergency. Your organisation is less likely to swiftly become soiled goods if you started with the benefit of the doubt.
ESG as a proxy for reputation risk
As awareness of these reputational risks has risen, many investor and management teams have tried to quantify and assess exposure. The most common method for doing so is to implement an “environmental, social and governance” framework – ESG for short. The term “ESG investing” is often used synonymously with sustainable investing, socially responsible investing, mission-related investing, or screening. But even companies that aren’t focused on environmental or social outcomes have started to use ESG ratings as a proxy for measuring risk.
As a result, companies with the top ESG rankings now trade at a 30% premium to the poorest performers and a poor ESG record is increasingly seen through the lens of business risk, rather than a matter to be considered only in a corporate social responsibility policy. Investors last year moved a record $21bn into socially-responsible investment funds in the US, almost quadrupling the rate of inflows in 2018, and there are now signs that these flows are being accelerated by existing funds switching to ESG principles and designations in order to meet demand for ethical and reduced risk products.
In the latest McKinsey Global Survey of C-suite executives and investment professionals, 83% say they expect that ESG programs will contribute more shareholder value in five years than today. Respondents also said that they would be willing to pay about a 10% median premium to acquire a company with a positive record for ESG issues over one with a negative record. Perhaps as a result, in April 2020, the S&P 500 ESG Index was outperforming the S&P 500 benchmark, ESG funds maintained more of their value during the Covid-related volatility, and HSBC research comparing the performance of individual company stocks before and after the Covid effect found that “climate-focused stocks outperformed others by 7.6 per cent from December and by 3 per cent since February. The ESG shares beat others by about 7 per cent for both periods.”
Further signs of the importance of such rankings abound: just last week Morningstar – an influential investment research and asset management firm who I quoted in the last paragraph – confirmed that it had acquired the $288 million ESG ratings and research house Sustainalytics. At the same time, ratings agencies have increased their interest in the area. For example, Fitch last year published an ESG ‘heat map’ to highlight the areas that present the biggest risks for a range of industries and “help users understand how relevant individual ESG topics are to credit ratings across different sectors”. These kinds of publications mark an increase in nuance, an acknowledgement that concerns over air quality, for example, are a bigger risk for auto manufacturers than for the hotel industry, which instead might focus on labour practices and privacy concerns around customer data. And as the sophistication of ESG frameworks improves, it seems likely that their influence will also.
The bottom line
This brings us back to the decisions made by investors. We know that they are influenced by the reputation of management teams and also that reputation forms a vital part of risk assessment. A further element – implicit within the ESG approach – is that investors want to know that other people trust your company. It is not enough to have good policies and risk management. Investors need to know that the government trusts you enough to give you a license to operate, that consumers trust your goods and trading practices, and that the media respects your reputation enough that you will not be hounded into the ground. These facts will show up in sales figures, sure, but the best way to troubleshoot problems early is to carefully steward your reputation.
A healthy reputation contributes to investor loyalty which in turn reduces share price volatility and the cost of capital.
As well as influencing investors directly, a good reputation reduces the risk of investments by acting as a shield from government intervention and a guarantor of the company's ability to bounce back after a problem. This makes your company a more attractive proposition.
Environmental, Social and Governance frameworks are often used as proxy for reputation in the investment world.
Organisations with better ESG records show strong share price performance and are increasingly popular - in part because they are viewed as less risky than other investments.
Find the whole of this series here
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