The Place of Reputation in the Due Diligence Make Up: An Introduction

 

It takes 20 years to build a reputation, and five minutes to ruin it – Warren Buffet.

The concepts of Due Diligence and corporate governance have become one of the foremost buzzwords in the corporate world within the last few decades. The concepts continue to expand in meaning and scope as new business formations are being developed. They have come to form a major part of companies’ economic strategies, while also used to steer a company away from corporate scandals. They have, in short, become indispensable to the success of corporations today. An understanding and respect for due diligence and corporate governance make absolute business sense.

Conventional due diligence is usually robust and cuts across; legal, finance, accounts, structure, compliance and many other aspects.^[1] It extends also to areas of business activity that go well beyond the transaction itself, with which it is usually associated, for example, cultural and reputational. This article focuses on reputational due diligence, but before then, what is corporate due diligence generally?

There is not a fixed definition for due diligence, as it means different things to different people, and sometimes, it varies per industry or sector. Traditionally, due diligence has involved a process of discovery that is relevant in key business transactions, as well as operational activities. It has become the norm in decision-making such as; partnerships/JVAs, mergers & acquisition, choosing the right jurisdiction, buying and selling assets, and generally entering into business with another entity. There is an endless variety of related words in the dictionary that can be used to understand due diligence. For the purpose of this ‘expose’, it is not suitable to lay out all the terms that make up due diligence. We, however, find the following contextualization apposite:

Due.com – ‘…mainly a legal and financial course of action, first designed to avoid litigation and risk, second to determine the value, price and risk of a transaction, and third to confirm various facts, data and representations’.

The same company alternatively defines it as – to ‘assist management to justify the price of a merger, acquisition, alliance or joint venture by verifying, validating and analysing available date’.

Due diligence activities regarding a possible transaction has no precise starting point. If for example, there are speculations about a merger, each party to the transaction must be willing to commence due diligence activities. This, however, is where the definition becomes obscure. Before any merger speculation, there would have been a significant amount of due diligence, before any talks begin, either formally, or informally. Therefore, there is no precise starting point to due diligence, as there must have been some data gathering and organisation prior; it is a continuous operation^[2].

Charles Bacon^[3] proposes a third definition – to ‘provide a framework within which organisations can continuously confirm that their actions and transactions are supported by the policies, procedures and management decision-making methodologies’.

All companies are either directly or indirectly involved in due diligence. Larger companies require a more formal approach, so as to structure the information and turn it into reliable data. Smaller organisations would find it easier to do an informal due diligence without much in terms of structural approach. They can make notes and reach ad-hoc decisions per time. What is paramount is, each company understands the role of due diligence and how it works for the company’s common good.

THE PLACE OF REPUTATION IN COMPANIES

Reputational due diligence cuts across; reputation management, crisis management, brand management, intellectual property management, corporate governance management, and stakeholder management, underpinning again, the continuous nature of due diligence. Risks like stakeholder pressure, either from the industry analysts complaining about product quality, the financial community complaining about the remuneration of the executives, or NGOs bemoaning the absence of published policies or environmental damage, can and does impact the intangible asset of a company. The market value of a company is generally made up of: Tangible assets (less debt), Intangible value and Goodwill. The intangible value is sometimes interchanged with goodwill and on the balance sheet, it is often labelled as intellectual capital. Product and brand reputations are a huge part of this intellectual capital. While they are complex to break down and measure, the UKFSTE100 estimates it to be about 71 per cent of a company’s market value. According to Interband, 2000, 96 per cent of Coca-Cola and 97 per cent of Kellogg’s are intangible.^[4]

There is a plethora of evidence suggesting that the public reputation of a quoted company correlates with its future share price valuation. A company’s reputation, therefore, is key in improving or rescinding its intangible value, and that goes for companies that aren’t listed too. It is also not the reputation in isolation that’s critical, it is how the reputation aligns with and whether it meets the expectations of stakeholders.

Price Waterhouse Coopers had this to say in 1999 –

‘The management of reputation integrity is one of the greatest corporate challenges of the new millennium. As forces of globalisation continue to gain momentum, society increasingly demands that large multinational corporations improve their performance in the areas of human rights, the environment, worker health, and other governance issues. Failure to address these demands has proved damaging to a company’s most important asset – its reputation’^[5]

Reputation, is gaining increased focus, as it is the one thing that crumbles a company quicker than others. The Yale School Management has published that over 400 companies have left Russia since its occupation of Ukraine^[6]. This is a current example of reputational-risk aversion. It does not matter whether they support the occupation or not, they’ve realised that their withdrawal achieves two major things – it gains them empathy from the global market, and saves them from having a tainted reputation. Respected reputation is built over a long time, as it combines reliability, credibility, responsibility and trustworthiness, all of which are hard-won.

Some of the major causes of reputation loss as seen from real-life experience, found in a lot of corporate literature include:

• Weak corporate governance as seen in Enron and WorldCom;
• Compliance with regulations and reporting requirements; e.g failure to comply with the Financial Reporting Council Act
• Risk management practices such as; environmental, health and safety, socio-economic risk management and so on;
• Stakeholder engagement procedures.^[7]

REPUTATION DUE DILIGENCE

The risk-reward asymmetrical relationship has gained acceptance in the corporate world; most businesses agree that there is no reward without risk, and the higher the risk, the higher the potential reward. The best companies strike a fine balance between their risk and reward appetites. Many organisations are assessed mainly based on their risk appetite and how much risk-averse they are. To build and maintain a good reputation, untenable expectations by stakeholders in a company must be managed through transparency, inclusion and education.

The starting point for any company is to have a clear understanding of the implication of its risk and reward strategy in going into any transaction, and this includes answering questions like: How could its reputation be damaged? How, if well managed, could it enhance its reputation over that of its competitors?

The implication of a range of intangible risk factors influence share price, and this is vital. These risk factors include:

• Corporate reputation and individual brand values;
• Regulatory regime and government reaction to public pressure;
• Media and NGO interest;
• Employee morale; and
• Investor, lender and insurance confidence.

These factors are considered within the framework of the earlier mentioned issues that is – reputation management, brand management, intellectual property management, corporate governance management, and stakeholder management. We limit ourselves to reputation management.

REPUTATION MANAGEMENT

The media and NGOs, sometimes even shareholder activists, work together to create public awareness. If an issue is considered newsworthy, and a stakeholder launches a campaign around it, it leads to increased public awareness. Companies, thus, need to assess the current and/or potential damage or value the issue could have. Questions to be asked include the sustainability of the campaign, the depth of the coverage and the range of the awareness. A negative, one-off headline can be fairly damaging but a long drawn out campaign can severely undermine a company’s reputation, even if among locals.

It is the case that once a company is in the spotlight over a certain issue that goes its reputation, that company becomes vulnerable. One of the strategies employable in this regard would be diversion; that is to make it out to be a sectoral or industry problem, as opposed to an exclusive problem.^[8]

Some issues can be quickly addressed, if carefully managed, can even enhance a company’s reputation, for example, product recalls where the company initiates the recall, prior to media exposure of the risks. Others are stubborn and the company has to live with them, as part of their operation. Examples include:

• Oil companies that are active in parts of the world where their staff and operations are at risk from saboteurs and media exposure of environmental damage;
• Clubs like Manchester City and Paris Saint Germain, having to operate with human rights violation allegations against their ownership.

CONCLUSION

A good corporate reputation can influence; investors willingness to hold its shares, consumers’ willingness to buy from it, suppliers’ willingness to become its partner, competitors’ determination to enter its market, media coverage and pressure group activity, regulators’ attitude towards it, its cost of capital, potential recruits’ eagerness to join and the motivation of existing employees.

Corporate reputation is now defined in stakeholder terms. One of the definitions sees it as ‘the aggregate perceptions of multiple stakeholders about a company’s performance’.^[9] A good reputation is therefore achieved when the stakeholders’ expectations and experiences of the company are aligned. Stakeholder expectations represent the expectations of all conceivable parties interested, or in some way involved in the workings and development of a company. The major stakeholders include; customers, employees, and investors while others include, regulators, strategic partners, suppliers, the media and host/local communities. It is considered good business sense to do due diligence on the roles and impact of these stakeholders.

REFERENCE

1. Fombrun, C., Gardberg, N Sever, J., The Reputation quotient: A Multi-Stakeholder Measure of Corporate Reputation, Journal of Brand Management, Vol. 7, 241-255, 2000 ↑
2. Linda S Spedding, Due Diligence Handbook: Corporate Governance, Risk Management and Business Planning, CIMA publishing, 2009, Elsevier Limited ISBN: 978-0-7506-8621-1 ↑
3. CEO, Due.com ↑
4. Quoted in Business Case for Corporate Responsibility, by Arthur D. Little and Business in the Community, 2003. ↑
5. Price Waterhouse Coopers, Earning Your Reputation: What makes others respect your Company? 1999) ↑
6. https://som.yale.edu/story/2022/over-400-companies-have-withdrawn-russia-some-remain ↑
7. Deloitte and Touche. From Carrots to Sticks: A Survey of Narrative Reporting in Annual Reports, p. 1, 2003. ↑
8. See Shell’s reporting of their known retrievable oil and gas reserves under the US SEC guidelines. ↑
9. The Analyst: A Perspective on Business Risk, Number One, Corporate Governance, July 2003. ↑