The corporate risk landscape has shifted significantly in recent years. Larger and more varied risks than ever previously thought have been seen in companies and countries who had believed they were immune from those risks. Rapidly increasing globalization poses a common challenge—how to integrate the social and political risks of government instability, political corruption, business corruption, child labor practices, anti-corporate sentiment, terrorism, environmental pollution, and others, into management decisions. To date, no adequate methodology for integrating these issues into risk management has been found.
Developing and implementing an appropriate model for decision-making and measurement of social and political risks is critical for improving organizational performance by more effectively (a) anticipating, evaluating, preparing for, and mitigating risks, and (b) managing alternatives. To effectively manage risk and improve the resource allocation process, risks must be measured and integrated into ROI calculations
These calculations can be applied to day-to-day operational decisions and capital investment planning, such as choices about plant location. Robust decisions under both circumstances are predicated on sound identification of risks, their assessment, and their mitigation and avoidance. We know, for example, that a wide array of political and social issues in both the developed and developing world can often cause a major impact on profits in an organization’s home country. These risks affect all types of organizations, including for-profit, non-profit, global, domestic, and large and small enterprises.
Generally, risk can be described as any event or action that will adversely affect an organization’s ability to achieve its business objectives and successfully execute its strategies. Risk relates to the probability that exposure to a hazard will have negative consequences. Social risk relates to the potential impact of, for example, disease, damage to the environment, infringement of the rights of indigenous peoples, and challenges by stakeholders due to negative perceptions of business practices—all of which can jeopardize a company’s value. Political risk can generally be understood as execution of political power that threatens a company’s value. The distinction between social and political risk is, however, often blurred, and different sectors in varied locations can be affected differently by either kind of risk.
Societal perceptions of the connections between a company and particular social and political risks can cause enormous costs to companies, regardless of the company’s direct involvement in the issue. Whether society is reacting to a real or perceived risk, it may take action, including consumer boycotts, leading to loss of sales or increased regulation that negatively affect a company, whether by (a) increasing its costs, or (b) prejudicing its achievement of business objectives or its ability to carry out its strategies. Thus, managing these types of risks is critical, whether they are real or perceived.
Public perception of companies has proven to be an important component of risk. Research following anti-World Trade Organization protests in Seattle showed that investors drove down the market capitalization of companies without a reputation for corporate responsibility on average by $378 million per company, but did not penalize firms reputed to be socially responsible. (Schneitz and Epstein, 2004). This demonstrates the significant positive financial impact of a reputation for managing social and political risks well.
Companies must more clearly recognize the importance of (a) integrating a broader set of risks into management decisions, and (b) developing expertise in measuring the impact of social and political issues on financial performance. This clearer recognition requires managers to include measurement of social and political risks in ROI calculations. Currently, companies that do consider these issues often relegate them to a footnote in the reporting of investment decision and do not include them in calculating ROI. That effectively gives a zero valuation to risks that can negatively affect corporate earnings, shareholder value, and brand value.
Some businesses are prone to social and political risk because of the location of their facilities, their product and customer characteristics, the nature of their employment relationships, or industry characteristics, etc. Well-known examples include Nike, Wal-Mart, and Shell, as well as the notorious social risks associated with industries like mining, footwear, apparel, toys, and chemicals. Also, varying social and political risks, and degrees of risk, affect companies located in specific countries or regions of the world. More globally, devastating terrorism attacks such as September 11, 2001 have dramatically increased risk, resulting not only in a terrible impact on individuals and government, but also an overwhelming impact on businesses. Corporations hoping to properly manage risk require more analysis, evaluation, preparation, mitigation, and response planning.
This Guideline, aimed at CEOs, CFOs, and other top managers, provides a model for identifying and measuring social and political risk, and including these risks in ROI calculations, to create a more robust enterprise risk management (ERM) system. This modeling forms one small part of ERM, simply by including previously ignored risks.
Schneitz, Karen and Marc J. Epstein. “Exploring the Financial Value of a Reputation for Corporate Social Responsibility During a Crisis.” Corporate Reputation Review, Dec. 2004.
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