![]() ![]() The market reaction after a fine can shave an additional 5.5 percent off shareholder value-though there can be some recovery after three months. Imminent fines for various forms of malpractice can generate losses even before they take effect. Most of them subsequently recovered their losses, however. The companies involved in such events lost 3.5 percent of their market value in the month following a settlement. Settlements are negotiated in suits brought against companies for price-fixing in, for example, commodity, credit card, or equities markets. Recovery, if it occurs at all, is short-lived, and companies can lose as much as 5.5 percent of their TRS over the next 120 working days. The market reacts negatively to penalties-such as those resulting from misleading equity research or from miscalculated pension annuities-handed down by regulatory bodies or civil courts. Deceptive sales practices and concealment.The market value of companies reporting losses from borrowers that fraudulently obtained credit and later defaulted declined by 3.5 percent of TRS. This type of internal fraud appears to have a contradictory effect on corporate market valuations: a net gain around the date when the event is first revealed but an eventual 3.5 percent loss in market value. more than 12 times the total actual loss of $23 billion (Exhibit 1). The combined market value of the institutions was $15 trillion. Yet over the next 120 working days, the total returns to shareholders (TRS) of our sample declined by a whopping $278 billion, 2 2. at financial institutions in Europe and North America and found that as news of a crisis reached the market, the initial declines were limited to levels in line with the actual fines, settlements, and monetary losses. Fitch Risk Management’s OpVar Loss database provided our sample of events for this study. We analyzed more than 350 operational-risk incidents 1 1. At present, few banks factor potential market losses into their operational-risk-management plans or capital allocations, for example. In general, these companies base their risk calculations and allocate their capital on the probability that a particular incident will occur and the size of the resulting financial loss-the sum pocketed by an embezzler, for instance, or the fine for breaking a rule. Moreover, they typically have a wealth of data to call on as well as strict reporting standards. Financial institutions are particularly vulnerable to events that make them appear risky in the eyes of their customers. The experience of the financial-services industry yields useful insights into the long-term effects of operational risk. Operational crises in financial institutions Certain organizational changes and processes will promote a more rapid and candid response and reinforce measures to prevent similar events from recurring. And it’s not necessarily the biggest missteps that deliver the biggest blows share prices can plummet as a result of even the smallest events.Ĭorporations can take a better-informed and more systematic approach to preventing operational-risk crises-and to protecting shareholder value when they do occur. ![]() Indeed, recent McKinsey research shows that a company’s loss from such a crisis pales beside the eventual loss to shareholders. ![]() Many companies underestimate the long-term effect of these events on their market value. They approach operational-risk measures not as exemplary management practice but as regulatory requirements that should be dispatched with a minimum of fuss. ![]() In our experience, executives typically view paying a fine, for example, or reaching a settlement in a court case as merely the cost of staying in the game. Yet few companies think strategically about operational controls. Avoiding operational risks-either dramatic (embezzlement and loan fraud, for example) or mundane (such as regulatory compliance)-can prevent sizable losses from damages, fines, and sullied reputations. Many companies regard the funds they allocate to meet the regulatory requirements concerning operational controls as money well spent. ![]()
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