Analysts are influenced to some extent by the “stories” issuers tell, and stakeholders take for granted that at least some receive the benefits of doubt from raters. Subjectivity is a feature that should be embraced and exploited by the storyteller — usually treasurers — to the benefit of the entities they represent — whether those are for profit corporations, nonprofit institutions issuing municipal debt, or divisions of government.
More than a year ago,
And now, we are seeing more and more reports of stakeholders’ skepticism of what they believe are overly generous ratings. Certainly, credit rating firms do focus on the numbers, but their proprietary methodologies have always had a subjective edge to them — influenced by clients’ stories and by the reputations of the storytellers.
Why is the story-telling aspect of bond ratings so important? Data developed by Steel City Re, focused on companies dealing with reputational issues, show that, all other things being equal, the variance between great and poor reputations can alter the cost of capital by as much as 80 basis points. And while our research focused primarily on large corporations, it doesn’t require a leap of logic to assume the same is true of municipal issuers.
When successful issuers make their case for debt ratings, they know that their reputations have influence. If their reputations are based on confidence in their governance and operations, they have tangible value. When the narrative they present is compelling, it affects the decision-making process of stakeholders — in this case rating agencies.
When we talk about storytelling and narratives, we’re not talking about simple spin. Having demonstrably strong risk governance protocols — validated by third parties, underwritten and insured — is a story that credit analysts will be able to understand and appreciate.
Issuers are at an implicit disadvantage if they are not well positioned to offer this type of positive narrative – likely having misunderstood the fundamental nature of reputation, defined it incorrectly and employed inadequate mitigation measures to deter and defend against attacks.
They often recognize that they have exposure, name board committees to oversee it, but then turn it over to marketing to manage with marketing solutions rather than risk managers with risk mitigation strategies.
Reputational value is not measured by media coverage — or ESG scores and CSR campaigns or by the warm and fuzzy images they market to the public. It is measured by the degree to which actual performance is aligned with stakeholder expectations. A hospital may get short-term points with some stakeholders for opening clinics in underserved communities or by offering scholarships for promising disadvantaged medical students. But if a newly constructed orthopedic surgery building — built through a new bond issue — fails to meet revenue projections because of faulty assumptions by executive leadership and inadequate oversight by the board, that hospital’s reputation for good governance, sound management and financial stability — along with its cash flow — is going to decline materially. Their efforts to be good corporate citizens are not going to protect them, because when an entity fails to meet expectations, reputational crises ensue. Subsequent media coverage will amplify the damage. Cash flows are the first casualty — and that’s what bond raters are interested in.
Fortunately, given our capacity at the present time to perform data analytics around large volumes of data and apply various parametric criteria to measure stakeholder disappointment, reputational risk is measurable, manageable and insurable. We’ve seen the results proven out in reputational indexes we’ve created of S&P 500 companies and the same type of data analysis is possible with respect to both corporate and municipal credit ratings.
Issuers need to be able to tell a clear and persuasive story, backed up by third party analysis and warranties. They need to be able to say, “Our reputation risk management is better than our peers, and, if our reputation is better protected, our future cash flows are more secure.” Those attributes, relative to comparable rivals, should be — and often are — factored into the rating model.
In addition to credit ratings, effective management of reputational risk carries additional benefits — protecting against damage from politicians and regulators as political winds shift. Organizations with the best story to tell about their governance and operations are the least likely targets.
Political risk management benefits notwithstanding, if bond ratings were purely objective, algorithms would make short work of their determination. The data would go in and the ratings would come out. But they’re not. They’re done by human beings, whose interpretation of the facts being presented to them is influenced by their perceptions. Reputational protection and resilience — and its underlying metrics — is an important part of that story.
