How Strong Stakeholder Bonds Can Help Firms Avoid a Crisis

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Wharton's Witold Henisz and NYU's Sinziana Dorobantu discuss their research on crisis management and stakeholder relationships.

One negative news article or community protest can be enough to derail a company’s reputation, even its bottom line. In the digital age, the potential damage is accelerated through the power of instant, nonstop communication and social media. Crisis management has become so important in the corporate world that businesses hire teams of people just to handle it. But there is a better way. Witold Henisz, a management professor at Wharton, and Sinziana Dorobantu, a management professor at New York University, say the best way to handle a crisis is to avoid it. To do that, companies must invest the time in building relationships with stakeholders.

Henisz and Dorobantu visited with Knowledge@Wharton to discuss their paper, “Not All Sparks Light a Fire: Stakeholder and Shareholder Reactions to Critical Events in Contested Markets,” which was co-authored with Lite Nartey of the University of South Carolina. The paper is forthcoming in the journal Administrative Quarterly. An edited transcript of the conversation follows.

Knowledge@Wharton: Can you summarize your research?

Sinziana Dorobantu: We’re asking a fairly straightforward question: What happens to companies when they’re faced with a critical event, such as an unfavorable court decision or a negative news report from an environmental organization? How do their shareholders and stakeholders respond?  You see this in the news all the time. You see it with Uber. I would probably use Uber as an example of a company that’s trying to expand internationally very quickly. Because of the pace of its international expansion, it doesn’t have the time and the resources to engage with every community that it affects and with every government and every regulator in every country. Every single time there is a news story about Uber, it’s usually surrounded by a lot of negative reactions from other stakeholders who have something negative to say about, as well as reactions from stakeholders who have something positive to say and from consumers who are very happy with a new product. Companies that do this well, you don’t see in the news as much. Airbnb in the shared economy space is a good example. In the 1990s, Ikea faced a number of allegations of child labor being used by one of its employers in India. It took its time to work with nongovernmental organizations and with UNICEF to understand the problem, then put in place long-term solutions to make sure that whatever they do is in the best interest of the children.

Knowledge@Wharton: We’re talking about a situation where a company was doing things to make it right, as opposed to just taking a public relations approach?

Witold Henisz: Yeah. It’s very much about what it takes to build up the relationship with stakeholders. It’s not enough just to put out a glossy press release, to have a pretty sustainability report. You have to really engage the stakeholders. In fact, there is some other research that really gets into the nuts and bolts of how you build up that relationship. But it’s a lot more than a press release. It’s a lot more than a check. It’s some deep, long-held interactions.

Knowledge@Wharton: Could you give a summary of what that other research looked for and what it found?

Henisz: I’ll give you the nutshell version, which is that it’s worth investing in relationships. Once you have a strong, positive relationship, once you have a friend from a stakeholder, that friend is going to stick up for you. When you’re attacked, when you’re facing a down day, when someone’s coming after you, you’re not going to be first in front of the microphone. In Ikea’s case, it was Save the Children defending them against the allegations of a human rights abuse. The community members are talking about how, “It’s our mine, it’s our factory, we don’t want it shut down.” We’re getting someone else in front of the microphone to be what one could call an upstander, or an advocate, for the company.

Knowledge@Wharton: The lesson is that you want to do this spade work ahead of time. But do you talk about how to do that spade work?

Dorobantu: In this particular paper, we take those relationships as given. We’re comparing firms that have good relationships with their stakeholders with firms that don’t. And we’re doing this at the individual stakeholder level, so we’re looking at every single stakeholder. The stakeholder can be a local community. The stakeholder can be an NGO or an activist group. It can be a mayor, a governor, a regulatory agency.  We found a way to measure their perceptions of the company using newspaper reports. We essentially coded 22,000 articles about 26 mines in 20 countries around the world. For each of these mines, we have a very detailed timeline of which stakeholders spoke about the firm or took action against the mining firm, and what exactly they did. Is it an act of cooperation or conflict? Using this timeline, we showed that the stakeholders with whom the firm has built good relationships in the past are the stakeholders that, when something bad happens or a negative core decision comes about, are going to stand up and speak to defend the firm because they see this as a good firm. Whereas the stakeholders with whom the firm has a really bad relationship are going to use this as an opportunity to reiterate their opposition. Before you know it, for firms that have really bad relationships with their stakeholders, you have a chorus of voices. Uncoordinated voices, but what the public hears in the media is this sort of chorus of voices speaking negatively about the firm. And that’s the making of a crisis in today’s world.

Henisz: In the second part of the paper, we showed that it’s those choruses of negative opinion that contribute to a collapse in shareholder value. We can look at a similar set of critical events, about 160 in total, and the ones in which you see this negative chorus of opinion are the cases in which shareholder value collapses. The cases where you have the upstanders, where you have the stakeholders speaking on your behalf, the same degree of negative opinion at the onset doesn’t translate into a collapse in shareholder value. It’s not just this good thing to have, it actually contributes to the protection of shareholder value.

“It’s not enough just to put out a glossy press release. You have to really engage the stakeholders.”–Witold Henisz

Knowledge@Wharton: Are there other key takeaways from the paper?

Dorobantu: To me, it’s really the benefits of stakeholder engagement and doing this in a strategic and systematic way. The same process that the firm would apply to managing its relationships with suppliers and employees and customers needs to be applied to managing a much broader set of stakeholders, including the local communities, the activists, the NGOs and the government. That’s one big takeaway. If you manage to put in place these good stakeholder relationships, you prevent the crisis. The best way of managing the crisis is to not have one at all. I think another one that was very interesting to me is how in today’s era of increased transparency or information availability, you don’t need to have explicit coordination among stakeholders to end up with a social movement against the firm. Things get litigated and there is a decision. If there is a negative decision against the firm, then you might have a protest in the community. You might have the mayor or government speak out against the firm. You may have broader mobilization by activists. These different stakeholders never coordinated. They never got on a conference call or used an email distribution list. They were using information available in the public space, in the media.

Henisz: And social media.

Dorobantu: Yes. And these independent reactions all started to sound like a concerted voice against the company.

Knowledge@Wharton: I imagine social media can also be that early warning system, the canary in the coal mine. If companies are monitoring it and see problems that might be brewing, it gives them a chance to fix them.

Henisz: Exactly. I think one of the managerial takeaways is the need to invest not just in the relationships but understanding your stakeholders up front. You need to gather that data. In other work, we argue about the importance of meeting and talking and building these relationships with in-person contact, and monitoring them on social media and in print media. Being aware of what they’re saying and what drives their behavior is obviously very important. Again, invest in these relationships. The same way you invest in physical capital, the same way you invest in human capital, invest in relationship capital.

Knowledge@Wharton: You talk in the paper about the value of information signals. Is there something specific to say about information signals that you haven’t already covered here?

Dorobantu: Research from other scholars has shown that information signals coming from the media and stakeholder reactions are important to managers because they can foresee a crisis. They’re important to investors because they can foresee some problems through the future cash flow of the firm. We show in this paper that they’re important to stakeholders to synchronize their reaction in a way that doesn’t require explicit coordination among them. But I think if I were to push that to a managerial implication, I would say to managers and their teams, it’s really important not to wait until they see something already coming together and forming a social movement. They should really understand that in today’s world, almost any event, any statement, any action, can easily escalate into something much bigger and to a broader crisis because of these dynamics that we observed in our research.

“Before you know it, for firms that have really bad relationships with their stakeholders, you have a chorus of voices.”–Sinziana Dorobantu

Henisz: There are two different ways these critical events can escalate, and both of them catch managers by surprise. When you have the allies, it’s not just that your allies discount the negative information. They can actually rally to your defense. So, it’s really worthwhile having them. It’s not just that they say, “Oh, this doesn’t matter. I don’t believe this. Who are these people making these accusations?” They’ll stand up and defend you. It’s more than discounting the information signal, it’s reacting to it. On the other side, negative information can really set off this cascade. It can be a lot worse than the initial news story. It can blow up and spiral out of control, when you don’t have the relationships.

Knowledge@Wharton: Can you think of a good example where it went really south but could have been avoided?

Dorobantu: I would use two examples. I brought up Uber as something that I’m studying in current research. I think Uber will defend the speed of its international expansion based on the business model. They need a lot of drivers on the road in order to make the riders happy. They need a lot of riders to keep the drivers happy. It’s that need for a critical mass on both sides that explains the speed of their expansion. Because they are doing things so quickly, they don’t have the time to build these relationships between people as well as between companies and their stakeholders. Uber is an example of a company that’s been banned in hundreds of cities around the world because they didn’t put themselves in a situation to be defended by those who have a lot to gain, including the drivers who joined Uber and the riders who were happy to use Uber.

Henisz: As a result, their potential market capitalization has really plummeted. This has had a real impact. If you look at what the estimates were, Uber was going to be worth more than all of the automobile companies, worth more than all the airlines. That was based on Uber being successful in China, India, Germany, France and England. It’s not happening, so they can no longer justify that market cap. It’s really material to current owners, potential future shareholders and the future of this company that it’s had these missteps upfront.

Knowledge@Wharton: Developing relationships takes time. But if they had invested that time, would competitors have gotten a jump on them? What can you do? You’re going to take a hit in some way.

Dorobantu: If you talk to someone from Uber, they will always say that this was the only way because they needed to be the biggest player in the market and didn’t have the time to build these relationships. Is it going to backfire? I think very much so. Is it likely that some of the competitors who maybe took things a little slower and built these relationships were second in the market, but they were understood. They observed the problems that Uber was having and tried to address them by lobbying the regulators a little bit more and talking to the taxi drivers who are affected and seeing how they can actually find a solution that works for everybody. I don’t know. With Uber, it’s really too soon to tell.

“The best way of managing the crisis is to not have one at all.”–Sinziana Dorobantu

Henisz: Moving onto the new economy, let’s talk about energy companies. There is this boom in the fracking industry that Sinzi is also studying in some ongoing research. These are companies that made the play to go quickly, to expand gas supplies here in Pennsylvania and elsewhere around the world. There are all these estimates; this is going to revolutionize the industry. But you drive through these towns and see these protests. You see “no fracking here,” “stop fracking,” “don’t build this pipeline.” You see concerns and reservations. Well, who went slowly? It is some of the alternative energy suppliers — wind, solar and others — who are moving more incrementally, building relationships with government officials, building up support for wind farms, for solar arrays. I think you’re starting to see the future of the energy industry change a little bit in terms of what role is fracking going to play versus alternative energy? Fracking has worked in a few states in the United States. It hasn’t worked elsewhere. It’s not working in too many other countries in the world. Alternative energy continues to be the tortoise that’s moving steadily ahead. We’ll see which way it plays out over the next five or 10 years.

Knowledge@Wharton: Were there some legitimate environmental concerns about that industry that maybe went ignored?

Henisz: I think they could have addressed them through, “Let’s talk to the governments about what a reasonable standard is for water disposal and what has to happen to the water that gets pumped out of the ground? What are the standards of treatment that are going to be required?” They chose to take a little bit more of a cowboy mentality. “That’s the city’s problem. It’s not our problem. We’re following the law. We’re not giving up any information on what’s in the water.” That raised people’s concerns and skepticism.

It would have taken more time to decide what a reasonable water treatment standard would be, to build up state-level and national-level regulation. It would have created more transparency, more oversight. I think the industry would be a lot healthier today.

Knowledge@Wharton: What misperceptions did this study dispel?

Dorobantu: I think one of the biggest ones, at least something that I see a lot in the industry, is people think that building these relationships with the local community or with NGOs are just symbolic actions with very limited effects on the company’s operations or on the stock price. I think we’re providing evidence for the fact that it’s the other way around. These things are incredibly valuable, both in terms of allowing the operations to go ahead on schedule and on budget. As a result of that, they’re also incredible valuable for the stock price.

Knowledge@Wharton: It reminds me of something you said about the term “greenwashing.” You have a company that really is not taking care of the environment the way it should or the way the community thinks it should. But they’ll have a sustainability officer, plant a few trees and do a couple of symbolic things. You’re saying that’s not going to cut it.

Henisz: Yeah, I think it’s really important. We’re not measuring something that’s in the annual report. We think what’s important is what stakeholders think about the firm, and we’re measuring that. The key is not, do you have a report? Do you meet a standard? Do you get five stars? It’s whether there are people willing to stand in front of the microphone for you when you’re criticized. Do you have that network of relationships with community leaders, NGOs, government officials? That’s what matters. That’s what we’re trying to draw attention to. It’s not greenwash. It’s substantive, real relationships. Do the right thing for the right people.

“We’d encourage people to try to learn from their mistakes instead of repeating them.”–Witold Henisz

Dorobantu: To build off that, this is in the mining industry around the world. There are a lot of examples, particularly in parts of Africa, where mining firms, which are in the business of building things, have built a lot of schools and health clinics. They tend to be empty because they don’t think sufficiently far to staff them, and these become targets of community protest. On a few occasions, they’ve been bombed. The school that you see in a report has been bombed a few years later because the community really rejected that particular initiative because it was put in place without their input. Nobody asked them whether they wanted a school, whether this was a priority for the community. Nobody asked whether the health clinic would make the biggest difference. They were never consulted. One way of having a relationship is to have a meaningful conversation, listen to each other, try to address each other’s concerns. Very few companies do that in a very serious way.

Knowledge@Wharton: What makes your research different from other research in this area?

Henisz: There have been a lot of assertions that building relationships with stakeholders and being a responsible company can pay in a time of crisis. People have talked about the insurance value of reputation. This is the first research that we’ve seen that really gets down and shows that’s true, that the reason there’s a payoff when you’re under attack, the reason your share price doesn’t collapse is because individual stakeholders rally to your defense. We actually show that in our media reports. The day after a mine is attacked by the minister or the day after it’s attacked by Greenpeace, those neutral or slightly positive stakeholders like the mine more in terms of what they say to the press. The reason is they themselves feel threatened. And when you feel threatened, you respond. It’s not just that the people discount the bad news, they’re actually rallying in favor of the mine. I think showing that effect at the level of the individual stakeholder is really novel and buttresses this idea that there is an insurance value. We’re getting under the hood and seeing why it happens and how important those individual relationships are.

Knowledge@Wharton: Tell us what you may look at next? What are some of the more interesting things that this opens up for new research?

Dorobantu: We’re continuing this line of research with new research that looks at the importance of the timing of stakeholder engagements. We’ve had a couple of pieces where we’ve looked at the financial impact and impact on stakeholders’ reactions. Now, we’re trying to see how can you build better relationships with your stakeholders? We’re doing this in a couple of ways. In one, we’re looking at the benefits of doing this proactively. I think one of the biggest differences in terms of leaders and laggers in today’s world in many industries is this timing issue. Some firms have become better in terms of thinking about their stakeholders as they strategize about their operations. They’re trying to understand who the stakeholders are, where they are, how they are affected, what they care about, what they might say and go to the stakeholders. If it’s a local community, go to the local community and initiate a dialogue to try to address these issues from day one.

If you do that and do that well, then you’re likely to be in a much better situation down the road. This is where you address the crisis a year before it happens. You’re not going to be in the news. And if something happens, you’re going to be given a chance, either the benefit of the doubt or you’ll be defended by your stakeholders. You’ll be given a chance to address every single issue in a way that allows you to have a meaningful solution, which is probably also a collaborative solution.

Knowledge@Wharton: What haven’t I asked you about your study that would be important to know?

Henisz: People are often surprised that we study the mining industry and draw insights on what constitutes good stakeholder engagement and good corporate social responsibility practices from the mining industry. But there’s a reason for that. The mining industry made some massive mistakes. These firms that we’re studying wrote off a billion dollars in capital. Most of the firms we’re studying didn’t adapt better practices or better processes until a disaster occurred, and they learned from their mistakes. I think the reason we’re studying this industry is that they have learned. I guess we’d encourage people to try to learn from their mistakes instead of repeating them.

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