Character, culture, emotions and biases are factors in most business decisions but are inadequately reflected in economic or risk models, according to Anthony Fitzsimmons and Professor Derek Atkins of Cass Business School, who argue a new approach to reputational risk is needed.
People and the way they behave can be the seeds of greatness: but one of the insights from Airmic’s flagship report Roads to Ruin (2014, Cass Business School) was that people are usually the underlying causes of disaster too. Individual and organisational behaviour, most of it normal and predictable, not only lies at the root cause of most crises, but also tips potentially manageable crises in to unmanageable reputational calamities.
Unfortunately, this family of risks is not yet systematically captured and dealt with by mainstream risk management. Some areas are captured by “process safety”, but this leaves huge gaps as to individual and organisational behaviour. Taken with a view of reputational risk that is often too narrow, leaders and risk professionals have a blind spot that leaves them and their organisations vulnerable to severe reputational damage. This is the gap through which unexpected crises regularly emerge to derail respected organisations.
At the heart of the problem is the fact that classical, widely-taught economic models assume rational and benefit-maximising decision making. They do not take account of the integral role played by human factors such as character, culture, feelings and incentives in decision-making by all normal people in all contexts, including the most intelligent and respected leaders. Yet many treat them as reflecting reality.
Nor do these models take account of heuristics and biases that healthy people sub-consciously use to simplify decision-making, such as:
- The recognition heuristic: better known as “better the devil you know”. However, the less-familiar option may be the better choice.
- Optimistic bias: this leads people to delude themselves that bad events are less likely to happen than good ones.
- Self-serving bias: the tendency to attribute positive events to “our skill” and adverse ones to outsiders or bad luck.
Some of these can be effective when life is simple but all become sources of serious error when applied to the complexities of modern life. It is therefore important that we rethink reputation and reputational risk so that they absorb insights from fields such as behavioural economics, psychology and anthropology. We have concluded that the most useful definition of reputation is “the sum total of how your stakeholders perceive you.” This leads to a deceptively simple definition of reputational risk, as “the risk of failure to fulfil the expectations of your stakeholders in terms of performance and behaviour”.
“Performance and behaviour” is about what you do and how you do it. Traditional enterprise risk management techniques capture many kinds of performance failure but, crucially, miss large areas of risks from behaviour and organisation. The result is that systemic risks, which both cause crises and destroy organisations, their reputations and their leaders’ careers, remain unrecognised and therefore unmanaged.
Worse, our research shows these behavioural and organisational risks often take years, sometimes decades, to emerge. In the meantime, leaders believe all is well, so do nothing. Helped by the self-serving bias, they are fooled into complacency by what is, in truth, a run of good luck. Meanwhile they miss the opportunity to fix problems before they cause harm.
Overcoming this complacency is the first challenge for risk professional and leaders alike. As Richard Feynman, the Nobel laureate who unravelled the behavioural and organisational risks that caused NASA’s Challenger disaster, perceptively put it to a Caltech audience: “The first principle is that you must not fool yourself; and you are the easiest person to fool.”
By Anthony Fitzsimmons and Professor Derek Atkins, two of the four authors of Roads to Ruin, and the authors of a new book, ‘Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You’.
More info at www.reputability.co.uk. Their book can be purchased at www.koganpage.com/reputational-risk. For a 20% discount, use code ABLRRR20