Managing Reputational Risk through Environmental Management and Reporting: An Options Theory Approach

Reputation is a complex and multidimensional concept that may be organized in downside and upside reputational risk. In this article, we present a formal modelling for the management capabilities of environmental management and reporting over reputational risk, considering that reputational risk is becoming increasingly important for organizations and it directly depends on the information available about companies’ environmental performances. As long as the effectiveness of communication and disclosure plays a key role in the process, the usefulness of environmental management and reporting as a hedging instrument for reputational risk is addressed through different levels of information transparency. When considering a scenario of voluntary reporting, we show that environmentally concerned companies can reduce the cost of environmental management as a reputational risk strategy, as well as reducing the potential loss of reputational value from reputational threats and increasing the potential profit from reputational opportunities. In the context of mandatory reporting, we highlight the role of assurance companies as bearers of the risk of bad reputations for non-concerned companies. As a result, this novel approach applies theoretical oriented research from options theory to reputational risk management literature, so that it benefits from the option’s well known theory, robustness, and conclusions.