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Rogue employees and company misconduct spook markets most

  • Freshfields crisis management study shows covenant breaches and litigation crises fastest to be resolved  
  • System failures and hacking have little effect  
  • 15% of executives at crisis hit companies that can’t regain pre-crisis share value leave within a year but just 4% among companies that do 

‘Behavioural’ crises triggered by companies acting illegally or questionably or by rogue employee activity spook investors the most and can cause shares to crash by 50% or more on the day they become public. In contrast, ‘operational’ crises impairing a company’s ability to function, such as significant product recalls or environmental disasters, have a modest impact in the first 48 hours of a crisis breaking but typically cause the greatest long-term effect on shares.

Shares hit by ‘corporate’ crises affecting the corporate and financial wellbeing of a company, including financing covenant breaches or material litigation, are the fastest to recover. ‘Informational’ crises, often impairing a company’s IT, such as system failures or hacking, have only a moderate effect on shares. The findings are part of a new study* by international law firm Freshfields Bruckhaus Deringer on the effects of major reputational crises on large, internationally listed businesses.

Additionally, a review of 899 directors serving on the boards of the companies analysed which suffered a share price hit revealed a departure rate among senior executives of almost 10% within a year of the crisis breaking. This increased to 15% among executives unable to steer their company’s share price back to pre-crisis levels within six months but dropped to just 4% among those who did. It contrasts with the market’s average boardroom attrition rate of just 8%, recorded among crisis-hit companies’ direct competitors, listed on the same exchange, but unaffected by a crisis of their own.

The study’s main findings include:

  • Companies typically benefit from a window of 24 to 48 hours, during which financial market reaction to a crisis is limited. Of the 78 global reputational crises analysed, less than half (48%) of affected companies saw share prices fall on day one. It rose to 54% after two days. A month on, the findings show a peak in negative sentiment, with six out of 10 companies affected. A year later more than half (53%) had not seen share prices regain pre-crisis levels.
  • ‘Behavioural’ crises such as money laundering or anti-competitive conduct have the greatest short-term impact on shares. However, they are the only type of crises where companies come close to regaining pre-crisis valuations after six months (down just 2%).
  • ‘Operational’ crises such as accidents or asset seizures have the greatest long-term effect on share price – down almost 15% after six months. A quarter of companies were still down on pre-crisis levels after a year.
  • ‘Corporate’ crises such as those affecting companies suffering a liquidity issue or material litigation made up more than one quarter of companies experiencing a share drop on day one. Typically shares recovered swiftly with only one in seven affected after six months.
  • ‘Informational crises’, such as those stemming from customer data losses or theft of commercial secrets, were of moderate concern to markets. Affected companies’ shares did not fall more than 3% on day one. None saw shares fall more than 30% within a year of the crisis breaking.
  • Unpredictable crises, less core to a businesses’ daily activities, have the greatest up-front shock value. Problems that go to the heart of a company’s operations deliver a longer-term negative impact. One year later, three-quarters of companies experiencing share price falls of more than 70 per cent tended to be those suffering a crisis that struck at businesses’ heart.

Chris Pugh, global head of disputes at Freshfields, commented: ‘No reputational crisis is ever the same but common threads exist in terms of how emergency responses should be prepared and rolled out and how the markets tend to react’.

‘Our research shows that directors typically benefit from a window of 24 to 48 hours, during which financial market reaction to news of a major reputational crisis will be relatively restrained. It’s often their last chance to take quick and decisive action before financial news bulletins take centre stage’, he continued.

‘The speed at which a company’s executives are dragged to face the ‘court of public, and financial markets, opinion’ largely depends on the type of crisis they are tackling. Executives at firms affected by a behavioural issue should typically prepare for an up-front hit on their share prices whereas those dealing with an operational matter are probably going to be in repair mode for the long term’.

‘Crises that strike at a business’ core have a greater long-term impact on share price as markets are more likely to lose faith in a management team that cannot resolve a crisis that is intrinsic to its operations.’

‘There is a double incentive for directors at crisis-hit companies: the attrition rate among companies that achieve a recovery in their share prices within six months is even lower than at unaffected companies. Those directors that can withstand the storm and guide their organisations to calmer waters are much more secure in their roles,’ he concluded.

ENDS

* The Freshfields study, completed in September 2012, is compiled from an analysis of 78 major reputational crises, taking place since August 2007 (the start of the credit crunch), affecting large, internationally listed business. Share price data was sourced from Bloomberg. Information relating to changes in senior management was sourced from the companies' own websites and annual reports, as well as from press archives.

The companies included in the study are listed across 16 stock markets including the London Stock Exchange, The New York Stock Exchange, NASDAQ, Swiss Stock Exchange, Deutsche Borse, Euronext NV, Paris Bourse, Milan Stock Exchange, Madrid Stock Exchange, the Luxembourg Stock Exchange, the Hong Kong Stock Exchange, Shanghai Stock Exchange, Johannesburg Stock Exchange, Australian Stock Exchange, Bombay Stock Exchange and Tokyo Stock Exchange.

The study is based on crises stemming, roughly equally, from four categories: Behavioural crises involving allegations of illegal or questionable conduct by the company or specific employees. These may include claims of bribery and corruption; senior employee misconduct or human rights violations. Operational crises that seriously impair the company’s ability to function, such as significant product recalls or environmental incidents. Corporate crises that affect corporate or financial wellbeing, including liquidity issues or material litigation; and informational crises that seriously affect a company’s IT infrastructure or electronic data systems, including system failures; hacking and loss of customer data. 

The Freshfields team was led by: