Reputation and the OFR

Seamus Gillen discusses the publication of the Reporting Standard on the Operating and Financial Review (RS1), which has put the finishing touches to a framework which will change the nature of corporate reporting for a significant number of companies

The Reporting Standard on the Operating and Financial Review (RS1), which applies to all GB-quoted companies and to “any other entities that purport to prepare an OFR”, is a principles-based standard which, in particular, makes clear that the OFR should reflect the directors’ view of the business. The objective is to assist shareholders to assess the strategies adopted by a company, and the potential for those strategies to succeed. The information in the OFR will also, it is claimed, be useful to a wide range of other users.

Some companies have been preparing OFRs since the time of the original guidance issued by the Accounting Standards Board in 1993, but probably most will find this a new and challenging task. We will wait and see how companies respond to the expectations set out in the guidance, how they deal with the emphasis on Key Performance Indicators (KPIs), and what form, if any, best practice will eventually take.

Reputational risk

One of the most notable features of the OFR is the increased importance and profile attributed to reputational risk. In the original 1993 guidance, reputational risk didn’t even occupy a footnote. In RS1, in contrast, paragraph 54 at the heart of the document states that directors “shall include a description of the principal risks and uncertainties facing the entity, together with a commentary on the directors’ approach to them”. “The principal risks and uncertainties facing entities will vary according to the nature of the business, although it is expected that some risks, such as reputational risk, will be common to all” (paragraph 56).

The document is peppered throughout with references to reputation, confirming how significant and business-critical the issue has become, due in no small part to the spreading influence of US business thinking in this country. The CEO of any leading US company will often see it as his or her main priority to guard their corporate and personal reputation. Witness the recent fall-out from the Spitzer interventions in US corporate life, and the reputation-recovery strategies being pursued by the fund management, investment banking and insurance industries, and one begins to understand the importance attached, State-side, to the task of managing reputational risk. One might also mention the speedy collapse of Arthur Andersen as evidence not simply of the effect of corporate reputation failure, but as evidence of the exposure auditors face when allegations that they have failed to do their job properly arise.

Meeting the challenge of the OFR

What does this mean for companies in this country who now have the formal task, under the OFR, of reporting how they deal with this challenge? Indeed, is reputation really an issue of any significance at all? The answer is undoubtedly yes.

Reputational issues are playing an increasingly important role in terms of a company’s branding, its differentiation strategy and its market positioning. Building the reputation of a company is one of the main challenges for a CEO and the senior management team - reputation has become one of a company’s most important intangible assets. It is all the more paradoxical, then, that such an important driver of corporate behaviour is one which is still elusive in terms of its measurement.

To respond to the OFR challenge, a company’s management needs to understand how “reputational equity” is built up within the company, how long term value might be generated by a top-class reputation, and at what point the financial community becomes sensitive to an improving or deteriorating situation. After all, from a business perspective, the main reason for managing reputation must ultimately be to strengthen investor sentiment and boost the share price. If the many cases of corporate fraud have taught us anything, it is investors’ sensitivity to finding out sufficiently quickly that a management team is beginning to lose control of its business - companies need to explore, and understand, the interdependence between damaged reputation, investor sentiment and any subsequent share price shock.

Not that there is always agreement on how to go about this. Champions of Corporate Responsibility within a company, for example, will often consider themselves at the vanguard of building and protecting reputation, but they will not always have the ear of those whose view of “value”, and of what needs protecting, is sometimes quite different. Both sides end up frustrated and non-aligned, producing the kind of outcome and behaviour which is unhelpful from everyone’s perspective. ACCA, through its sustainability reporting awards, has gone a long way to encouraging the debate on how to tackle this issue.

Another challenge lies in ensuring that values attributed in the corporate risk register as “reputational risk” represent a serious attempt to quantify the degree of reputational exposure of the company. Maybe the authors of RS1 were being more astute than they realised when making specific reference to reputational risk, because the outcome of the process - in terms of the resulting learning, both internal and external - could be particularly valuable and revealing.

It is clear that the challenge posed by the OFR means that companies must now get on with the task of measuring reputation as the means of managing it, and ACCA members will want to be able to engage with colleagues in their companies on means by which this task can be approached in a way which makes business sense, reduces to the minimum the compliance burden, and maximises the possible value to the company.

Measuring and managing reputational risk

In response to these challenges, we have been working to devise a reputational risk methodology which focuses on the ability of the senior management team to manage the key business relationships critical to delivery of the business plan, and the reputational factors which underpin, or undermine, the process. The methodology enables companies to chart their reputational profile, and track, measure and manage their reputational risk. It analyses reputational equity as a source of value creation, and uses KPI outputs to measure progress. Ultimately, the objective is to create value for the company - to understand the risk in order to move to the reward side of the equation.

We believe the work is ground-breaking in the way it brings us closer to devising a system to assess the extra financial and intangible issues which are playing an increasing role in corporate valuations. We want companies to be able to use the approach to improve the visibility of their reputational universe - a form of early warning system for issues potentially capable of satisfying or upsetting investors. Already, some insurers have expressed a view that the coverage and cost of D&O liability insurance will need to reflect the greater levels of disclosure anticipated from OFR reporting. And commentators have wondered whether credit ratings and the cost of capital might be influenced by “deficient” OFR reports. Using the outcomes of the reputational risk analysis as the basis for engagement with investors and corporate governance bodies, with a focus - in parallel - on improving corporate performance, produces business benefits out of an exercise which might otherwise be considered a compliance obligation.

ACCA has used our methodology to help them assess their own reputational risk profile in their quest to pursue thought leadership across their activities. And we recently co-hosted a breakfast seminar, chaired by John Plender of the FT, to consider these issues from a wider perspective. As a result, ACCA has produced a Technical Paper which pulls together some of the key points raised by addressing reputational risk in the context of the OFR. The outcome of that process is a further seminar on 15 November, when the debate will be taken forward.

As Richard Martin, ACCA’s head of financial reporting, has pointed out, disclosure changes behaviour. On that basis there are some interesting times ahead for companies. How quickly will it be before reputational risk becomes a feature of best practice reporting, with improved performance - and reputation - the outcome?

Seamus Gillen is a partner in Glenfern Consulting Ltd.