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You'd Better Give a Damn 'Bout Your Bad Reputation, and Here's Why

No, most corporate CEOs aren't Joan Jett. But somehow many of them keep acting as though they'd like to be.

Executives at Transocean (RIG), forever associated with the death of eleven employees and the biggest oil spill in American history from its Deepwater Horizon facility, continued to cement their reputation for poor judgment and overall cluelessness. After awarding themselves bonuses for the "best year in safety performance in our company's history," the executives belatedly announced that they were "voluntarily" donating the safety bonuses to the Deepwater Horizons Memorial Fund "because we believe it is the right thing to do." (All that criticism had nothing to do with it, of course.)

Berkshire Hathaway did much better when it had to answer some pointed questions after the abrupt departure of the likely successor for the legendary Warren Buffett. Target (TGT) customers must walk past protesters who object to the company's contributions to an anti-gay politician. Johnson & Johnson (JNJ), once the gold standard for reputation protection following the Tylenol poisoning of 1982, found a story about its "quality catastrophe" on the cover of Business Week earlier this month.

Your reputation is your biggest asset -- and also your most fragile
Every week there's another example of a company scrambling to prevent a catastrophic loss of its most important asset -- its reputation -- whether the problem is financial, strategic, operational, or ethical. Maureen Errity, co-chair of the Deloitte Center for Corporate Governance at Deloitte Services, says, "Managing reputational risk does not fit into any category; it is ingrained in each of them."

I recently had the opportunity to chat with Jonathan Low of Predictiv Consulting to learn more about managing this kind of reputational risk. Here's an edited transcript of our discussion.

How should boards of directors evaluate reputational risk?
Boards must address reputational risk as they would any other threat to shareholder value that could result in loss of the institution's license to operate. When one looks at the loss of shareholder value suffered by major global public companies such as Toyota (TY), BP, Goldman Sachs (GS) and AIG in the past year, all largely due to loss of confidence based on management performance, it becomes apparent that reputational risk is significant.

It is so closely intertwined with enterprise risk that for boards to ignore it or worse, to dismiss it as a public relations matter, will simply cause additional pain as hedge funds, journalists and others probe for additional weaknesses.

Paying CEOs to guard the company's rep»

Paying for a good rep
How can incentive compensation be designed to minimize reputational risk?
The litany of "pay for performance" based problems, most recently with the financial and mortgage crises, ought to instruct us as to the difficulties of using compensation to minimize any sort of risky managerial behavior. Any compensation system will be gamed the minute it is announced as those affected try to manage to influence the outcome in their favor.

Tying compensation to longer term (years, not quarters) objectives is the best solution, but reputational metrics should be part of a comprehensive set of measures that cover multiple, intertwined goals aligned with corporate strategy.

What's the difference between reputational risk and branding?
Brand is a promise to the consumer. Inherent in that promise are fundamental notions of quality, safety, ethical behavior, fair pricing and management credibility. Reputation is tied more specifically to familiarity and favorability. Reputational failures impact brand value and can reduce brand equity.

Given the investment in major brands and the impact of those brands on market value, diminution of brand value through an increase in reputational risk represents a potentially significant financial cost. Conversely, brand problems can have an impact on reputation; Coca-Cola's problems with a small batch of CO2 a decade ago are a good example of that because they implied that management was not paying attention to details.

Similarly, Toyota's recent brake problems conveyed the same message. One might also argue that Goldman Sachs' designing and selling investment products that hurt some clients but not others were a type of 'brand' problem since the GS brand AND reputation were damaged.

Examples to follow... and to avoid»

What to do, what not to do
Can you give good and bad examples of the way corporate mangers have responded to reputational hits?
Good -- Southwest Airlines' response to the roof of a plane in flight tearing open. SWA was open with the press and public, cancelled dozens of flights at great expense and called in outside experts. When it became apparent the problem was Boeing's, that was a relief, but even if it had been a maintenance issues, SWA showed that they would spare no expense to identify the problem and fix it.

Bad -- BP's handling of the Gulf oil spill is the poster child for poor response to a crisis. They tried from the outset to minimize the seriousness of the issue which affected their credibility. As the problems became more and more complex, their initial craftiness diminished their effectiveness as communicators and they were never able to get ahead of the story again. Their ability to remain independent is now being questioned.

Beware major issues of trust and integrity»

Guard your integrity
Which is more difficult to respond to, a reputational hit regarding a product (recall, contamination, safety issue) or an investor issue (accounting fraud, CEO dismissal for cause)?
Investor issues are harder. Products can be recalled, reformulated or withdrawn. Most people recognize that there are technical issues involved, so if the company is transparent about its methods, consumers and analysts will give generally them another chance.

Issues of trust and integrity can not be "recalled and reformulated." When an organizations' most fundamental values are called into question, the impact is more dramatic, less tangible and harder to contain. The public will rightly demand evidence of a change over time before granting such companies another chance.

The on-going problems at HP (HPQ) are an example; the company under Carly Fiorina contravened much of what the founders stood for. The ongoing leadership problems suggest that the board has not figured out how to catch up with competitors strategically and keeps betting on quick leadership fixes to make it right.

CEOs: Purer than Caesar's wife -- ideally, at least»

It's good to be the king... but not easy
How do you set the tone at the top?
Recognize that the CEO lives in a fishbowl. He/she has no privacy, will be given no mercy -â€" and based on the compensation at stake, should expect neither. If you can not live the values the company espouses, don't take the job. If you are not willing to part with subordinates who violate company rules, now matter how impressive a salesperson or manager, you should not take the job.

In sum, if done properly the job is difficult because the tone at the top must be austere and ethically faultless. That has to be wearying and is clearly not for everyone. If the company's reputation is as important to the board as it should be, then truly exceptional people must be sought to lead and no compromises can be brooked.

The ultimate demonstration of concern about reputation requires that the CEO and other top executives must have tough but achievable long and short term reputational metrics built into their compensation packages -- and if they fail to meet those goals, the board can not bail them out.

Illustration by David Apatoff