What Is Reputational Risk?

Reputational risk is a threat or danger to the good name or standing of a business or entity. Reputational risk can occur in the following ways:

  • Directly, as the result of the actions of the company itself
  • Indirectly, due to the actions of an employee or employees
  • Tangentially, through other peripheral parties, such as joint venture partners or suppliers

In addition to having good governance practices and transparency, companies need to be socially responsible and environmentally conscious to avoid or minimize reputational risk.

Understanding Reputational Risk

Reputational risk is a hidden danger that can pose a threat to the survival of the biggest and best-run companies. It can often wipe out millions or billions of dollars in market capitalization or potential revenues and can occasionally result in a change at the uppermost levels of management.

The biggest problem with reputational risk is that it can literally erupt out of nowhere

´╗┐Reputational risk can also arise from the actions of errant employees, such as egregious fraud or massive trading losses disclosed by some of the world's biggest financial institutions. In an increasingly globalized environment, reputational risk can arise even in a peripheral region far away from home base.

In some instances, reputational risk can be mitigated through prompt damage control measures, which is essential in this age of instant communication and social media networks. In other instances, this risk can be more insidious and last for years. For example, gas and oil companies have been increasingly targeted by activists because of the perceived damage to the environment caused by their extraction activities.

Example of Reputational Risk

Reputational risk exploded into full view in 2016 when the scandal involving the opening of millions of unauthorized accounts by retail bankers (and encouraged or coerced by certain supervisors) was exposed at Wells Fargo.

The CEO, John Stumpf, and others were forced out or fired. Regulators subjected the bank to fines and penalties, and a number of large customers reduced, suspended, or discontinued altogether doing business with the bank. Wells Fargo's reputation was tarnished, and the company continues to rebuild its reputation and its brand into 2019.

Key Takeaways

  • Reputational risk is a hidden threat or danger to the good name or standing of a business or entity and can occur through a variety of ways.
  • The biggest problem with reputational risk is that it can literally erupt out of nowhere and even without warning.
  • Reputational risk can pose a threat to the survival of the biggest and best-run companies and has the potential to wipe out millions or billions of dollars in market capitalization or potential revenues.