Operational and reputational risk in the European banking industry: The market reaction to operational risk events

In this paper I study the stock market reaction to the announcement of operational losses in European financial companies. Accounting for the effect of the nominal loss amount allows for an examination of the reputational damage caused by operational loss events. The analysis is based on a sample of 136 operational losses stemming from a database of the Association of German Public Sector Banks (Bundesverband öffentlicher Banken, VÖB). All operational loss events affect European financial institutions with settlements reported by the press between January 2000 and December 2009. In line with previous literature, I find a significant negative stock price reaction to the first press announcement of operational losses. Results show that the stock market also reacts negatively to the settlement announcement as losses are confirmed and the loss amount is known. Even after accounting for the nominal loss amount, cumulative abnormal returns are negative following the date of the initial news article and the settlement date indicating damages to the reputation of the firm suffering the operational loss. Multivariate regression results suggest that reputational damages are rather influenced by firm characteristics than characteristics of the operational loss event: companies with a high ratio of liabilities to total assets suffer more severe damages to reputation from operational losses than companies with more equity.