Our last blog talked about leading indicators and the need to include them in commercial risk management processes. We also detailed 2 of the top 5 leading indicators that financiers need to constantly monitor if they want to detect risk early. These were customer reviews and negative news media. If you didn’t get the chance to catch that, you can read it here. In part 2 of this series, we take a deeper look at the remaining three.
Leading indicator #3: Public perception and reputation
In 2011, reporters from News of the World, a bestselling weekend newspaper in the UK, were caught hacking hundreds of phones. The public outcry against these revelations was so huge that the paper shut shop in just 3 days. More recently, Silicon Valley Bank collapsed after a Twitter-induced crisis of confidence saw customers withdrawing over $40 billion in 48 hours making it one of the largest bank runs and quickest bank collapses in US history.
While these may be extreme examples, they do demonstrate the power of public perception and reputation. An Accenture study of over 7000 companies found that reputational damage cost the affected companies around $180 billion in revenue and slowed growth by over 20%. So, it's not only about the optics, it's about the bottom line too.
The fact that we live in an age of social activism also makes monitoring a company’s public perception a very timely and necessary activity. This can be done by scanning social media sites such as Twitter and Reddit where popular and unpopular opinions are discussed and dissected with great alacrity amongst its millions of users – meaning that reputational harm is just one viral post away.
Social media scanning can also reveal opinions that highlight potential risks well before they materialize. For example, veteran short-seller William Martin predicted Silicon Valley Bank’s collapse 2 months before it happened in a now-viral thread that laid bare the bank’s liquidity issues in great detail. Of course, scanning millions of posts every day for additional insights is not an easy manual task but more on that later.
Leading indicator #4: Unusual business activity
All businesses have their ebbs and flows – there’s nothing unusual about that. However, exaggerated business highs and lows should raise red flags. And while the existence of a red flag does not necessarily mean that something is amiss, it should prompt financiers to take a closer look under the hood.
For example, Silicon Valley Bank’s assets grew by over 190% from 2019 to 2021. During the same period, most other peer banks’ assets grew at an average of around 30%. A closer examination would have revealed that SVB’s unusual astronomical growth was fuelled by an overreliance on uninsured deposits, a volatile funding source made even riskier by the increasing interest-rate environment. And as we mentioned before, all of this was laid bare on Twitter months before the bank collapsed.
Another example of Twitter latching onto deviant behavior before the corporate world is Luckin Coffee, a Chinese startup with an aggressive growth strategy. The company found itself in hot water after its stellar financials were called into question by a tweet. The tweet was put out by investment research firm Muddy Waters and contained a document detailing the coffee company’s fraudulent behavior. Tellingly, Luckin Coffee filed for bankruptcy a year later.
Other examples of unusual business activity that warrant a closer look include:
High employee turnover – This could be a sign of poor company culture and management. Mass layoffs can also signal dwindling profits. E.g.: Weeks before it collapsed, Pink Energy (a.k.a. Powerhome Solar) laid off more than half its workforce.
Major investors jumping ship – Stakeholders usually jump ship to avoid potential losses. E.g.: Two years before it collapsed, several investors pulled out of Greensill Capital, a financial services company, after learning about the company’s concentration risks.
Trouble retaining auditors or insurers – Insurers generally withdraw coverage if they see potential risks in a company’s future and auditors resigning could be a sign that fraudulent activity is afoot. E.g.: Greensill Capital’s insurers refused to extend their coverage of the company about 6 months before it collapsed.
Behavior of corporate staff – Corporate staff that engages in unethical practices or unstable online behavior can damage a company’s reputation beyond repair. E.g.: The erratic behavior of Adam Neumann, CEO of WeWork brought negative publicity and increased scrutiny on the company and played a role in its devaluation.
Financiers can glean such information by screening various contemporary and traditional online sources.
Leading indicator #5: Legal, tax, and compliance issues
Lawsuits and fines are a drain on a company financially and reputationally. And if the underlying issues aren’t resolved swiftly, they act as precursors of future risk. This is especially true in the case of federal investigations as they attract a lot of negative exposure. For solar energy provider Pink Energy, this certainly proved to be the case. The announcement of an official investigation by the Missouri Attorney General was a tough blow for the company, one they were unable to recover from despite several rebranding attempts.
Greensill Capital also had plenty of similar red flags. The company was involved in several conflict-of-interest cases that tarnished its reputation in the years preceding its collapse. In addition, one of the final nails in its coffin was an investigation into one of its subsidiaries by the German regulatory body BaFin.
How to monitor leading indicators
As you can see, monitoring digital media for leading indicators of risk can help lenders and investors detect portfolio risks early. It also complements historical data analysis by providing financiers with an up-to-date picture of a company’s business health. Combining both these processes strengthens a financial institution’s overall resilience and provides an extra set of risk guardrails. However, manually scanning thousands of news stories and social media posts is a time-consuming, costly, and ultimately impossible task, especially if you have a portfolio with thousands of public and private companies.
Unstructured data is also difficult to quantify and view objectively, making it all the more important to use automated tools that can process vast quantities of data such as TRaiCE. The TRaiCE platform’s AI-led processes can track and analyze unstructured data on all the companies in your portfolio. Crucially, it condenses this into a proprietary risk index that showcases the business impact of all this information in an easy-to-understand format. This way, if there is hidden information out there, you will know about it without having to spend your (and your team’s) every waking minute on data analysis.
For a deeper dive into how TRaiCE can help with early risk detection, read our case study on the subject or get in touch with us today to see how you can supplement your existing risk monitoring processes and make them more foolproof.
