We defined reputational risk as the risk resulting from customers’ and investors’ perceptions of a company’s action or inaction on climate change. There are also reputational risks from employees, suppliers, the general public, and the media, though we did not consider them specifically in this report (Ernst & Young 2010).
To assess the reputational risk of an industry, we used a method for evaluating the brand value risk to climate change based on a methodology outlined in a 2004 report by the Carbon Trust. The method consists of three parts:
1) Estimating the brand value to the industry. Does brand matter? Reputational risk is most applicable for those companies in which there is strong competition within the industry and their brand is important in differentiating themselves from their competitors, such as in retail, whereas it’s not as important for commercial fishing.
2) Estimating the proportion of the brand value that would be sensitive to the climate-related actions of a company. Does climate change matter for the brand? For those companies in which the brand is important, does addressing climate change specifically help or hurt the brand? Climate-related actions that may affect the brand include:
- Company statements and policy positions on climate change;
- Perception of how a company manages its emissions;
- Perception of the industry that the company is a part of;
- Publically available data of GHG emissions, which is now available through SEC filings, voluntary reporting through the Carbon Disclosure Project, and accessible via Google Finance and Bloomberg
3) Based on our understanding of the industry via our industry reports and consumer sentiment on climate change, estimating the risk of climate change to the company overall. An important component of this risk is the sensitivity of the consumer to climate change. The 2004 Carbon Trust report explains that there is a progression of consumer awareness that needs to happen for reputational risk to become important:
1) Consumers need to be concerned about climate change;
2) Consumers need to make the link between the environmental issue and their daily actions; and
3) Consumers need to modify their purchase behavior to reflect their concerns about how companies are addressing the issue. The report acknowledges that this is not yet happening widely but cautions companies to consider the risk of being a laggard should consumer behavior shift quickly (Carbon Trust 2004).
Bottom Line: Industries for which brand value is important should consider reputational risk from climate change and take immediate steps to develop a plan for mitigating that risk.
Disclosure and Reputational Risk
Our definition of reputational risk also includes the risk from investors’ perceptions. Investors are increasingly paying attention to the climate risk that is embedded in their investment portfolios by considering existing and potential future investments in industries that will be most affected by climate change and associated energy issues. A 2010 Ernst & Young report summarizing the findings of its survey of company executives found that more than 40% of respondents believe equity analysts are already accounting for a company’s climate-related actions in its valuations of the company. Equity analysts rely on disclosure reports for such information. The Ernst &Young survey found that 64% of respondents are already communicating GHG or carbon emissions via a corporate social responsibility or sustainability report but that nearly a third have not made any such communication. A reason for this may be that risk managers are not prioritizing reputational risk to climate change. A recent survey of risk managers by Ceres, an NGO that does a lot of work in the investor/climate change nexus, found that “reputational risk” ranked as the least important risk for industries economy-wide (that is, after physical exposure risk, policy/regulatory risk, litigious risk, etc.)—only 16.7% of respondents thought it was “very” likely that their company is exposed to reputational risk. Almost half of respondents indicated that it is “not at all likely” to be a risk for the company (Ceres 2010). However, given the growing trend for disclosure in the policy arena and now in the investor arena, companies that are currently not reporting are falling behind, and are at risk of having analysts and investors turn to third-party sources for information that may be inaccurate (Ernst & Young 2010). It is not yet a widely established practice for investors to consider climate change impacts, but there are many efforts being taken to change this:
- Efforts to pass shareholder resolutions on climate change (usually, acknowledgement of climate change as a problem and commitment to do something about it);
- Pressure for mandatory and better information disclosure on climate risks;
- Pressure for investors to make investment decisions based climate risk;
- Investors can also raise the cost of investment capital to compensate for increased risk from climate change (Ceres 2011).
Bottom Line: Investors increasingly want disclosure reports that fully address the risks posed by climate change.