Crisis preparedness and its impact on shareholder value

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Published: Monday, 21 August 2017 07:26

Robert McAllister looks at the ways that crises can damage the three components of shareholder value and describes the crisis prevention and preparation steps that organizations can take to ensure resiliency.

All commercial organizations operating in the digital era exist within a challenging landscape. Underlying trust is weak; expectations of good, transparent governance are high; and acceptance of failure is low.

At the same time, communicating with stakeholders is becoming more complex as traditional addressable audiences fragment into ever-evolving, always-online socially-connected communities, guaranteeing that issues and crises play out very publicly and swiftly.

To navigate these challenges successfully and to protect value for shareholders as companies grow, it’s vital to enhance business resilience. Reducing risk and building trust should be as important as innovating and pursuing operational excellence.

What is a crisis?

The British Standard for Crisis Management (BS 11200:2014) defines a crisis as “An abnormal and unstable situation that threatens the organization’s strategic objectives, reputation or viability.” Understanding this definition is vital in helping an organization to prepare itself to deal with a crisis. Through worst-case scenario planning, organizations can identify what abnormal events they could be exposed to, the impact of abnormal events on the ability to execute strategic objectives, and the damage that could be caused to reputation and viability.

If worst-case-scenario planning indicates viability or reputation are threatened, organizations need to consider developing and implementing mitigation strategies that can increase their resilience.

How a crisis can directly impact shareholder value

Shareholder value is considered to be the best long-term indicator of company performance. As defined by economics consultancy Oxford Metrica (1), shareholder value has three components: tangible value, premium value and latent value.

Tangible value is often referred to as the book value of the company. It can include manufacturing facilities, buildings, equipment and inventory etc. The impact of a crisis on such physical assets is readily understood, for example fire or natural disaster can damage or destroy a factory and its contents.

Premium value represents the value above book value at which the firm trades in the open market. This element of value is the source of a firm’s competitive advantage, relating to its reputation, brand(s), intellectual property, innovation, potential growth, global reach, managerial expertise-and, of course, the skills and experience of its workforce. Premium value can be damaged by crises in many different ways depending on the nature of the event and the characteristics of the organization affected. Corporate and product brands can be affected; managerial expertise and operational workforce may be lost, the global reach of the business may be affected and customers may cancel orders as the consequence of a crisis.

Finally, an organization’s latent value is its potential value, value that may be realised by making better use of assets, improving operational efficiencies, better promoting brands etc. Crises can all too easily reduce such latent value.

Taken as a whole, crisis damage to one or more of these value types may affect the reputation of the organization or affect its ability to meet strategic objectives. This will have a direct impact on the future viability of the organization and its future potential-indeed, its business resilience.

Turn back the clock to 10th April 2017 and United Airlines were under the glare of the media spotlight, after videos were posted by passengers on social media of security officials dragging a bloodied 65 year old grandfather (David Dao) from one of its flights due to it being overbooked. The crisis saw United’s share price drop 4.3 percent which is equal to nearly $1bn loss in market capitalisation in the hours after the crisis struck. A poor initial crisis communications response by the CEO, where United referred to David Dao as being “belligerent” and tried to place blame on the customer, helped to fuel the drop in share price and further damage United’s image. The drop in share price, however, is only a short term consequence. The long term damage to United is still being assessed, and could involve brand damage, a drop in customers or impact its ability to complete future business deals. The United crisis serves as an example of how the tangible value of a company can be damaged in the short term and potential/ latent value can be damaged in the long term.

Prevention is better than cure

Crisis management is, of course, a reactive process. Yet even the most robust companies will be challenged by managing a crisis. So it makes sense to invest ahead of the curve in being as well prepared for a crisis as possible.

Figure one: Instinctif Partners’ risk management framework

Good preparation can be underwritten by the use of a risk management framework (see figure one) that joins up proactive areas (such as risk identification, assessment and mitigation) with reactive response aspects. Often a non-routine event will start out as an incident-defined by BS 11200:2014 as an “adverse event that might cause disruption, loss or emergency, but which does not meet the organization’s criteria for, or definition of, a crisis”. Over time, incidents can escalate to become crises and vice versa.

But the key point is that good proactive risk assessment, implemented in a regularly-reviewed prioritised risk register, can be used to identify the most likely and impactful areas of crisis. This, in turn, guides the development and embedding of effective, well trained, well-tested crisis management processes and procedures - including contingency plans.

On this basis, crisis management and preparedness can be seen as truly strategic functions that need board level endorsement and engagement - ideally from the CEO. Senior-level sponsorship facilitates an organization developing a holistic approach to identifying, assessing, prioritising and mitigating strategic, operational and reputational risks.

Not only that, it also ensures there is a corporate imperative to ensure the organization collectively shares and learns from its experiences during a crisis, however painful they may seem at the time.

By joining up proactive risk reduction with preparation for reactive response to immediate threats, an organization improves its ability to protect shareholder value, reputation, viability and long term potential, often becoming more adaptive and agile as a result. In short, it improves its business resilience.

Issues management and crisis avoidance: crucial roles for the IR function

The Investor Relations (IR) function has a key role in improving crisis preparedness, by continuing to demonstrate good corporate governance and regulatory compliance. Reporting must be accurate and public disclosures should be made in real time as required. By doing this IR will help the organization develop a ‘peacetime’ reputation for transparency which, in turn, boosts trust among stakeholders and shareholders.

As part of crisis avoidance activities IR should also manage issues proactively as they arise. Issues are separate from incidents and crises, being characterised as a situation or emerging trend, real or perceived, that attracts the attention and concern of an organization’s stakeholders, including the media, and poses a non-acute risk to the organization’s strategic, commercial or reputational interests. If left unresolved or if ignited by a ‘trigger event’, issues can easily escalate into crises.

Managing issues effectively requires a collaborative approach with other business functions such as operations, communications, human resources, health and safety etc. IR is best placed to take the lead in identifying and responding appropriately to business issues which may have the potential to impact investors. By identifying and intervening at an early stage, there’s a good chance of preventing a full-blown, damaging crisis.

However, if a crisis does strike, IR will have a crucial role to play in the response, normally as part of the execution of a wider crisis communications strategy. IR should aim to be intimately involved in the development of this strategy, setting realistic response objectives and monitoring their progress and effectiveness.

IR should try and establish itself as the only credible source of financial information regarding a crisis. This will be much easier to achieve if the IR function has gained the trust of analysts, markets, regulators, investors and stakeholders during business as normal before the crisis. During the response, IR would be expected to reduce uncertainty and perceived risk associated with the crisis to shareholders, markets and investors. IR should try to shape the market’s perception of the crisis and help manage realistic expectations about future performance. This entails the communication of both good and bad information. In order to develop and maintain transparency and trust gained in the pre-crisis phase, IR communications need to be credible, accurate, timely and reassuring. 

Taking the first steps

The first step in developing a robust risk management framework is developing an awareness of the potential impacts a crisis can have on an organization. Crisis avoidance should be regarded as a high priority activity and organizations need to have a holistic view of the risks faced by the organization to help prevent these risks becoming issues or crisis.

If an organization does find itself managing a crisis its likelihood of successfully navigating this challenging situation is greatly increased if robust contingency measures and response plans are in place. The effective use of these plans will be improved if the organization has developed a culture of crisis preparedness through effective training and exercise rehearsals, during which staff can practice a crisis response in a safe environment and learn from the experience.

If a crisis is not managed well it can affect the viability of an organization and will certainly have an immediate negative impact on its share price, and potentially a longer-term impact on its shareholder value.

Organizations that manage a crisis badly may never recover and often see their shareholder value slowly decline in the medium term. This opens up the organization to additional threats, for example hostile takeovers. On the other hand organizations that manage a crisis well often quickly regain their pre-crisis share price and even see their share price increase in the medium term.

The author

Robert McAllister is Senior Consultant, Instinctif Partners. Contact: robert.mcallister@instinctif.com

Reference

(1) Reputation & Value, Oxford Metrica 2001.

CrisisOptic

Despite evidence pointing to the benefits of strong crisis preparedness as part of overall business resilience, organizations often struggle to initiate improvement programmes. Often this is due to the difficulty of finding a suitable starting point in what is usually a complex and extensive subject area.

A solution to this problem is the CrisisOptic service developed by Instinctif Partners. This secure online benchmarking tool enables senior managers to quickly assess all facets of their organization’s crisis preparedness using a question-set distilled from international best practice. The result is a ‘red, amber, green’ dashboard showing areas of greatest need and, therefore, potential points of entry to a business resilience improvement programme. These findings can be used to inform policies, procedures and capabilities, to strengthen risk and issues management, and of course enhance crisis preparedness. CrisisOptic can be used as either a stand-alone diagnostic tool or as part of an in-depth assessment of business resilience incorporating qualitative methods. More details at https://optic.instinctif.com.