DealMakers - Q1 2019 

The cost of not saying sorry

Max Gebhardt

 

In this age of round-the-clock company scrutiny, we see almost as much focus given to how a company handles a crisis as the crisis itself.

 

South African companies have faced their fair share of bad press and reputational body blows over the past few years. Whether in the form of health scares and product recalls for consumer goods companies; charges of bribery and corruption for consulting and auditing firms; fines issued in operating markets of communication companies; or accidents and fatalities for construction groups, different crises can have serious consequences for a company’s existence, job security and share price.

Max Gebhardt

With turbulence in our world growing, and the always-on nature of news, the potential for crisis has become an almost daily consideration for business. Globalisation, investor activism, regulatory change, political and cyber risk are all contributing to increasing business vulnerability and the need for Boards to carefully consider their ability to respond effectively.

With this in mind, FTI Consulting researched around 100 recent incidents that have made the headlines. The crises reviewed span the last 20 years, and include oil spills, cyber hacks, plane crashes, cases of fraud, product recalls and many more. We were interested to see what patterns emerge from these events – patterns which might be instructive for Boards and communicators when facing their own crisis scenario.

 

As we all know, the effects of a crisis can be significant and long-lasting. Findings revealed that in 14 of the 100 cases, the crisis event had been so catastrophic that they had resulted in companies ceasing to exist. Additionally, in almost a third of the 100 cases, a senior executive of that company ended up losing their job. This idea of a sacrificial lamb is nothing new, but such a high number suggests that Boards’ tolerance for missteps is low.

 

The typical pattern of share prices in the aftermath of a crisis is to see a big drop in share price at the end of day 1. This continues through the first week and only starts to plateau after a month or so. But we saw huge discrepancies in the way that share prices behave following different types of crisis. For example, a month after a crisis event had become known, the average share price decline across cases of systemic financial mismanagement was 70%, whereas individual corruption cases showed a decline of just 5%.

 

In terms of recovery after a crisis, those same cases of mismanagement were still on average 63% below their origin after three months, whereas individual corruption cases had recovered most of their value, on average sitting at just 1.9% below their origin.  And what about media coverage? Instinctively, we know that a crisis will dramatically increase the media’s interest in a company, but even we were surprised to discover by how much. Our study found that in the month after a crisis, a company can expect to receive almost 35 times the amount of coverage than the month beforehand. In terms of social media impact, the post-crisis month saw on average 280 times more mentions than a month before a crisis.

 

These are significant numbers. Indeed, the magnitude of traditional and social media interest around these events begins to shed light on another central learning from our study, namely the intangible impact of a crisis beyond clear and well understood value proxies such as market capitalisation. This goes to the heart of the unseen element of crisis preparedness and management that all boards need to consider.

 

As we began to see variations in the way that different crises behaved (when we cut our media analysis by crisis type we discovered that it showed a similar pattern to share price impact), we began to wonder whether companies are hit harder when external audiences perceive a culture of mismanagement.

 

In other words, were investors hitting the share price more heavily, or do the media apply more scrutiny in events where management is perceived to be to blame? Clearly the degree of culpability in crisis situations contains a heavy degree of subjectivity from the outside looking in but our analysis did show that in crises where the management is deemed to be at fault, those instances are punished more heavily.

 

We finally turned to the all-important issue of ‘the apology’. Many CEOs instinctively feel that it is right to apologise but some are advised that they should not. The argument against apology is that it is tantamount to an acceptance of guilt and that then opens the door to potential litigation.

 

Reputationally, however, the lack of apology can have significant impact on the credibility of management and the reputation of the wider firm. So, do apologies work? Interestingly, apologies were found to be relatively few and far between in our study. Indeed, we found evidence of a public apology in only 37 of our 100 crises. We also found that most of those apologies arrived slowly - only 16 of the 37 apologies were issued within two weeks of the crisis incident becoming known to the public.

 

The main charge against the apology is that it can be bad for business – that it can lead to protracted and expensive legal liabilities. We wanted to see whether there was some way of comparing the financial impact of an apology with the impact of not apologising.

 

The most effective way to do this was to compare the total cost of litigation and compensation for as many crises as we could, against the relative value destruction in terms of market capitalisation for those companies. We considered the damage to the value of the owners’ shareholdings to be the best proxy for reputational impact under these circumstances (although it is fair to note that the cost of litigation will impact share price itself).

 

We discovered 37 crises where the cost of litigation was publicly reported. The total cost of the litigation and compensation relating to those crises was $66.73bn. This compares to a total destruction in market capitalisation for the same businesses of $138.36bn. By this measure, it could be argued that if you don’t apologise, you will double your litigation costs in terms of value lost.

Boards need to consider the impact of not apologising in a crisis situation. The effect of reputational damage in terms of share price destruction easily outweighs the cost of litigation. The crises which hit hardest are those where management is clearly culpable or endemic cultural decay is evident. For example, the report suggests that culture and effective employee engagement are even more important than planning for cyber risks.

 

Companies need to be prepared for the explosion in traditional and social media interest which will come their way in a crisis situation. Preparing for their ‘nightmare scenario’ events could mean the difference between keeping their doors open and going out of business.

 

 Gebhardt is Head of FTI Consulting South Africa.