Reputation risk for the pharmaceutical industry — the peril of economic damage from angry or disappointed stakeholders — is particularly complex because of the myriad expectations placed on the industry by a diverse range of stakeholders. Patients and public advocates expect a stream of innovative, inexpensive and effective medicinal solutions. Investors expect a stream of innovative, valuable new products with low development costs and significant revenues. Regulators expect absolute safety, irrespective of effort or cost. Politicians, regulators, litigators and bloggers exploit the inevitable disappointments for their personal benefit.
As reported in the late July edition of Agenda (the Financial Times service for corporate boards), the reputation of the industry as a whole is soaring, led by those companies that are racing to develop COVID-19 vaccines and treatments. Patients, investors, regulators, and politicians are united in their expectations for rapid, safe, effective, and world-saving solutions. The research and development process and the capabilities of pharma firms to create new medicines is on vivid display as an administration in Washington continues to use drug prices as a campaign issue, while now also paying companies billions of dollars to create a life-saving vaccine.
The response to the COVID-19 crisis is casting a bright reputational halo over the entire industry. But as Icarus of Greek mythology learned, if you’re going to fly close to the sun, you’d better be sure your wings can withstand the heat. At some point in the future, the dust will settle, a vaccine will become available, and we will then see the reputational peril of those heightened expectations. Fred Hassan, a board member of Amgen, told Agenda that the halo should last for at least two years.
What's at stake
Whenever that halo vanishes, some stakeholders will inevitably be disappointed and angry – and those sentiments will ultimately translate into reduced sales, margins and market cap; diminished employee morale and difficulty attracting and retaining talent; higher cost of capital, regulatory actions and more.
Two years is probably optimistic. Certainly, any company that received federal funds and failed to produce an effective vaccine is going to fall under heightened scrutiny. Faced with increasing budgetary challenges and a deep recession, Congress is going to start looking for villains – for any example of spending it can call wasteful – and it’s easy to find fault when looking in the rearview mirror.
The scrutiny has already begun. The White House recently announced new executive orders linking Medicare reimbursement for some drugs to lower prices paid for the medications overseas, eliminate Anti-Kickback Statute immunity for drug maker rebates, expand drug imports and obligate certain clinics to pass along so-called 340B discounts to patients. We are also now starting to see stories in the media about corporate executives and board members profiting personally as companies receiving government money or recognition have been experiencing significant increases in their stock prices.
Between late February and early July 2020, the average market capitalization of 18 pharmaceutical companies of the S&P500 increased by 7.1 percent while the average market capitalization of the balance of the S&P500 decreased by 15.3 percent. Insiders in some of the smaller, higher-flying companies extracted nearly $1B from the sale of appreciated equity. When Kodak announced it was receiving research funding, its three-day equity returns outperformed the S&P500’s returns by 1,300 percent. How long before investigations commence, hearings are scheduled, and shareholders’ derivative lawsuits are filed?
The luster of saving us from a pandemic will fade quickly and stakeholders, from activist investors and plaintiffs’ lawyers to politicians and regulatory agencies, are going to focus on every aspect of companies’ operations. Individual companies will be bigger targets than ever for negative media and social media commentary and issues that otherwise would have had negligible business impacts — issues like downsizings of staff, complaints of discrimination or harassment, the ups and downs of R&D and market cap — suddenly will be headline-making news.
Board members of these companies should be particularly concerned. The Caremark International litigation that set the legal standard for board liability made it clear that boards have a duty to protect mission-critical operations. With reputation now widely recognized as central to corporate value, plaintiffs’ lawyers are seeing opportunities.
Dozens of cases over the past two years now note damage to companies’ reputations as an issue, and board members are increasingly being targeted. Courts are viewing directors’ duty of loyalty more expansively and are sustaining pleadings: for example, In Re Clovis Oncology, Inc., the court ruled that the board failed to protect the firm’s reputation for pharmacologic innovation. This recent change in stance appears to be the beginning of what could be a long-term trend in future court holdings and opinions. Consider that Hassan opined that only a very few of the 160 programs currently in development for COVID-19 treatments will be successful.
Protecting reputational risk
Pharma companies have a limited window of opportunity to mitigate these reputational risks — these perils of disappointed stakeholders. They must transform their existing enterprise risk management apparatus into a strategic intelligence gathering and analysis operation, spread across corporate silos and touching every corner of the organization. They need an Integrated Reputation Group (IRG) to build a thorough understanding of what stakeholders expect. The IRG would gather customer intelligence from sales, investor intelligence from investor relations, bond market intelligence from treasury, compliance intelligence from legal – and would gather the corresponding operational intelligence from the respective line operations.
In addition to gathering intelligence from every corporate silo, the IRG would determine the costs of missed expectations, flag material risks and, with the support of executive leadership, coordinate the deployment of resources from other departments to both meet and manage expectations, or finance the costs of loss with captives and insurance.
The Integrated Reputation Group would focus on areas of major concern to stakeholders: ethics, innovation, safety, security, sustainability, and quality. It would uncover threats to reputation that had not previously been recognized, mitigated or elevated to the Board level. And even if a crisis occurs that had not been predicted, the existence of a trained Integrated Reputation Group would give companies and their boards their strongest possible defense.
Through its ability to identify and mitigate potential threats, an Integrated Reputation Group creates a good story of reputational resilience and value. When a company employs a team that goes above and beyond the traditional ERM model to anticipate and address 21st century risk, stakeholders will reward that company in the form of benefits such as preferential equity investment allocations, bond ratings, and liability insurance costs. And with Reputation Insurance as the executive summary of superior ERM — simple, easy to understand, completely credible, and prepositioned — the enhanced reputations will help preserve value and accelerate recovery when external crises inevitably occur.
The time will come when plaintiffs’ lawyers, activist investors, regulators and government officials come knocking. Board members in that position will want to be able to say that their Integrated Reputation Group has been implementing today’s most robust reputation risk management strategies. How pharmaceutical companies and their boards fare when we emerge from the global pandemic hinges on their ability to anticipate and mitigate 21st century risks; they need a modern ERM model that, in and of itself, is a reputational asset.
Top image courtesy of Ross Parmly via Unsplash.com.