Dr. Nir Kossovsky, Steel City Re John J. Kelly, CPCU, Hanover Stone Partners Peter J. Gerken, CPCU, Steel City Re December 2016

Reputation Risk Explosion: Weaponization of Social Media, False News and Outsized Expectations Causing Increased Damage to Corporate Reputations

The spotlight on corporate America is hotter than ever, with the public, the media and elected officials from the White House to Congress to City Halls around the country, more focused than ever on the behavior of companies that have been essential parts of the fabric of our economy for years.

This increased focus comes amidst an historically unique convergence of several factors:

• A breakdown in trust by the public of societal institutions, including banks, Wall Street and large corporations;

• Diminished influence of traditional media, which has acted in the past as an arbiter of accuracy and importance;

• Social media vehicles that allow for the democratization of communications – any individual citizen or interest group has the capacity to become a “media source;”

• The difficulty in differentiating between accurate and false information when receiving it through social media;

• A heightened level of generalized anger in our country, seeking direction and outlets;

• Market forces and a business environment generally that has led investors to have expectations for corporate performance that are not always aligned with reality.

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Reputation-Linked Losses Have Increased by 461% Over Five Years Steel City Re, which offers proprietary solutions for protecting companies, directors and officers against reputational risk, has conducted an actuarily sound analysis of reputation-related losses for approximately 7,500 companies over the five-year period from 2011 to 2016. That analysis included more than 60 million data points and also included publicly available information gathered through Google and Twitter. That analysis concludes that:

• Reputation-linked losses at public companies have increased by 461% since 2011;

• Losses experienced due to reputational issues or attacks directly correlate to increases in generalized public anger as demonstrated by angry posts on social media;

• That heightened level of anger, constantly seeking outlets, combined with the speed and penetration of social media, has allowed for the weaponization of social media – the ability of individuals or small groups to mount devastating campaigns with the potential of destroying reputations with unprecedented speed, whether or not the attacks are accurate or factual;

• Outsized expectations by investors about corporate performance have created increased vulnerability and potential for losses when attacked;

• Corporate directors and executives are personally at greater risk than ever before when detractors swarm and seek vulnerable targets;

• To protect the reputations of both companies and their leadership in these asymmetrical battles for the hearts and minds of stakeholders – exploding at Internet speeds – defenses need to be deployed strategically and preemptively before the first strike.

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To protect the reputations of both companies and their leadership…defenses need to be deployed strategically and preemptively before the first strike.

Definitions and research methods Reputation, risk, and loss Reputation:• is an expectation held by stakeholders that

can be changed through news, rumors and malicious fabrications.

• is an intangible asset that affects all corporate revenues, expenses and market capitalization.

• is a strategic corporate asset Board Directors have a fiduciary duty to protect.

Reputation risk • forms when stakeholder expectations

greatly exceed a company’s operational capabilities

• manifests when stakeholders believe a company has failed to meet expectations

• loss is measured by the economic consequences of stakeholder disappointment.

Reputation loss• usually begins with news (or false news) of

an adverse operational event for which disappointed stakeholders deem management culpable.

• Is the “cost of disappointment” as stakeholders becoming disloyal customers, disengaged employees, distracted suppliers, distrustful creditors, dismissive investors, and determined litigators & regulators.

• will amplify operational losses by 200 to 700% with immediate recognition in enterprise value (stock price) and going-forward impact recognition in the statement of profits and losses..

Actuarial measurements Indicators of reputation value

In our world of quantitative risk management, reputational value is an indexed value that, like the consumer price index, is based on a basket of quantitative indicators of stakeholder expectations. Normalized by sector, these indicators impact the P&L through their effects on sales cycle times, unit volumes, and pricing power; terms from employees and vendors for services, and terms for capital from creditors and equity investors.

Indexing and parametric analysisSteel City Re has amassed an actuarial database by indexing such values for approximately 7500 public companies each week since late December 2001. Using tools developed for operations and quality management, the value and volatility of this parameter, the reputational value metric, provides upper and lower control boundaries. Material sustained deviations below the lower control boundary constitutes objective evidence of reputational value loss. The magnitudes of such losses are quantified in terms of standard deviations from the mean value of the control boundaries, and are reported colloquially as Loss Severities ranging from 1 (minimum) to 5 (maximum).

2011-2016 dataWhat follows is an analysis of 60 million data points representing more than 700,000 years of loss experiences for approximately 7500 companies between 2011-2016. 

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Reputation-linked losses increased 461% since 2011 The costs to a company from a significant loss of reputational value have increased 461% since 2011, and have almost doubled since the last major jump in 2013 (Fig 1). These losses result from a progressive increase in both the frequency and severity of adverse events (Fig 2).

Internet-borne anger, false news, and a growing gap between expectations and reality are likely explanations according to a regression analysis of principle variables (Fig 3). The former is evidenced by the Google Trend plot for the joined terms “Twitter” and “Anger” that indicates a population-based response to a perceived phenomenon.1 The latter is evidenced by the growing gap between the S&P500 Index and the median reputational value due to share buy-back regimens heavily promoted by activist investors.

Regressing these two variables over time against the frequency of loss yields a statistically significant model (F test p<.001), statistically significant intercept and variables (p<.001), with meaningful explanatory power (adjusted r2=0.59).The association of other potentially relevant extrinsic macroeconomic and environmental variables are not statistically significant.

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(1) Relative cost of reputation damage, 2011-2016

(2) Frequency and severity patterns of reputation events, 2011-2016

Peak anger, false news, and outsized expectations complicate reputation management

Mitigating reputation risk has always involved both managing stakeholder expectations through effective communications, and meeting expectations through flawless operations.2

This challenge is much greater in 2016 owing to the level of anger in society, prevalence of false and exaggerated news and the often purposeful weaponization of social media.3,4

Using the number of racial slurs as a proxy for anger, the monthly rate of expressions through Twitter increased 3800% faster than the number of users between 2012 and 2015. The number of monthly racial slurs increased by 4800% according to the Demos' Centre for the Analysis of Social Media, while the number of monthly Twitter users increased by only 124% over the same time period.5,6

Internet-borne anger has been exacerbated by false news.7 False and exaggerated news-based attacks may be launched by actors of different types for a diversity of personal, economic, political or social reasons. These

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(3) Anger in social media and the expectation gap explain about 60% of the variance in reputation losses, 2011-2016

…racial slurs…through Twitter increased 3800% faster than the number of users…

attacks typically cause damage quickly because the reactions times of traditional crisis communications are not sufficient to prevent significant and lasting damage. As Winston Churchill reportedly said, "A lie gets halfway around the world before the truth has a chance to get its pants on.” False and exaggerated news—if perceived to be credible--can lead to economic consequences that are no different than if such a failure were true.8

Businesses are also culpable in contributing to anger by fostering unrealistic expectations. Since 2009, companies in the S&P500 have invested about 95% of their earnings—more than $2.5 trillion—into share repurchases and dividends.9 Projections are that S&P 500 buyback spending will total $780 billion just in 2017.10 The unintended consequences of rising stock prices from share buybacks have been exaggerating expected earnings.

Governance, risk management and compliance going-forward

In the battle against false news, the best defense is strategic preemption. Presenting the truth through credible authorities before doubt is sewn by false news and exaggeration works because partisanship biases the acceptance of new information.11 Securing the benefit of doubt is what Steel City Re means by its tag line, "forging reputation resilience."

Over the past century, financial instruments and actions have played an important role countering false news. For example, to dispel rumors of a poor future, companies will buy back shares; and to dispel rumors of illiquidity, companies will issue or raise dividends.12

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…unintended consequences of…share buybacks have been exaggerating expected earnings.

…financial instruments and actions have played an important role countering false news…

To quash in the 1930’s highly damaging allegations of pending banks failures, the Federal Government created federal deposit insurance. The expressive force of this instrument communicated strategically, and preemptively, that a third party was attesting with indemnification (the instrumental force) to the governance and integrity of a banking institution. Federal deposit insurance was a “warranty” on a bank’s governance.

Reputation risk solutions from Steel City Re Steel City Re’s Reputation Assurance, an innovative financial instrument, has similarly been described as a “warranty on governance.” As a National Association of Corporate Directors Directorship magazine article noted earlier this year, “ . . . these reputation-based indemnification instruments, structured like a performance bond or warranty with indexed triggers, communicate the quality of governance, essentially absolving board members of damaging insinuations by activists.”13

Like Federal deposit insurance, the indemnification features communicate unambiguously that a third party is underwriting the integrity of what drives a company’s reputation: its governance, risk management, and compliance processes specifically with respect to ethics, innovation, safety, security, sustainability, and quality.

In a world where anger, false news, and unrealistic expectations all battle with truth for the minds of stakeholders, Steel City Re’s Reputation Assurance is an ever-ready strategic defense protecting a company’s reputation before the first strike from hostile forces.

Reputation risk solutions from Hanover Stone Hanover Stone Partners works through a network of highly experienced risk management professionals to advise organizations on how to effectively implement governance, risk and compliance best practices and execute and enhance enterprise risk management programs.

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… underwriting the integrity of what drives a company’s reputation: its governance, risk management, and compliance processes.

Federal deposit insurance was a “warranty” on a bank’s governance

About the authors’ firms Steel City Re

Steel City Re is the leading provider of quantitative business solutions for corporate reputation value. Steel City Re’s solutions help companies use their reputations to discover fair market value, mitigate market volatility, blunt regulatory opprobrium, quell investor activism, and protect directors and officers from frivolous claims. Steel City Re is the Overseas Specialty Broker/Advisor to syndicates comprising various underwriters at Lloyd’s and various insurance companies led by Kiln Tokio Marine Group. www.steelcityre.com

Hanover Stone Hanover Stone Partners is the first network of recognized and accomplished risk management advisors and specialized risk management services firms. The firm assembles multi-disciplinary, cross-industry teams that work collaboratively to help clients identify, analyze, manage and finance enterprise risks. This comprehensive approach offers clients the advantage of superior risk management advice and risk management services, delivered more economically. www.hanoverstonepartners.com

Notes 1 https://www.google.com/trends/explore?date=2010-01-01%202016-11-25&geo=US&q=twitter%20anger2 Kossovsky, N. Reputation, Stock Price and You. Why the market rewards some companies and punishes others. (Apress, 2012.) 3 Tow Center for Digital Journalism at Columbia University: http://www.emergent.info/about4 Brooking, E.T.; Singer, P.W.: War goes viral. How social media is being weaponized across the world. The Atlantic, November 2016.5 http://www.telegraph.co.uk/news/uknews/crime/11925950/Social-media-is-driving-the-rise-of-hate-crime-but-it-can-also-stop-it.html6 After “Monthly active users of selected social networks and messaging services,” StatistaCharts, https://www.statista.com/chart/5358/twitters-user-growth-in-perspective/.7 https://www.theguardian.com/media/2016/jul/12/how-technology-disrupted-the-truth?CMP=share_btn_tw8 Carvalho, C.; Klagge, N.; and Moench, E. "The Persistent Effects of a False News Shock," Journal of Empirical Finance 18, no. 4 (September 2011): 597-615. 9 https://www.bloomberg.com/news/articles/2015-03-03/company-cash-bathes-stocks-as-monthly-buybacks-set-record10 http://www.businessinsider.com/goldman-forecasts-record-rate-of-buybacks-in-2017-buybacks-forecast-2016-1111 Prior, M., Sood, G. and Khanna, K., 2015. You cannot be serious: The impact of accuracy incentives on partisan bias in reports of economic perceptions. Quarterly Journal of Political Science, 10(4), pp.489-518. 12 Huang, C.W., 2015. Takeover vulnerability and the credibility of signaling: The case of open-market share repurchases. Journal of Banking & Finance, 58, pp.405-417.13 https://blog.nacdonline.org/2016/10/competing-stakeholder-expectations-raise-personal-risks-for-directors/

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