Reputational Risks and Takeaways for Investors

April 01, 2016

This week’s Chart of the Week examines the aftermath of three recent corporate scandals.

On August 15, 2015, The New York Times released an expose of the work environment at internet retail giant Amazon, describing a cut-throat work environment where employees were pushed to their limits. The company’s stock price sharply dropped in the weeks following the article, but has since recovered and continued to rise. Amazon’s buoyancy can be attributed to its established presence among consumers, lack of direct competitors, and the absence of legal/financial ramifications following the article.

On September 18, 2015, the Environmental Protection Agency (EPA) issued a Notice of Violation of the Clean Air Act to Volkswagen (VW) alleging that the automaker used software to deliberately evade clean air standards in certain diesel cars. The Department of Justice (DOJ) is suing VW for up to $46 billion, and the automaker must provide a solution for the nearly 600,000 cars affected by April 21, 2016. VW stock fell 65% immediately following the EPA announcement and has seen a feeble recovery since.

On September 28, 2015, legislators called for a subpoena of Wall Street favorite Valeant Pharmaceuticals in response to concerns about inflated drug prices. Shares immediately fell 16%, a trend that continued as investigators uncovered that Valeant’s serial acquisition strategy was buoyed by questionable accounting practices and unfounded price hikes. In the six months following, Valeant stock fell nearly 90% – from a high of $262 on August 5, 2015, to a low of $27 by March 18, 2016.

Investor Takeaway: Some companies are more resilient against reputational damage than others. Investors often do not have access to all the information, and seemingly profitable companies may stand on shaky foundations. It is important to distribute assets across many stocks to ensure that the reputational risk of any one firm cannot cause dramatic effects. In other words, holding diversified portfolios of securities can help insulate investors from the effects of single stock volatility emanating from corporate scandals.