July 29, 2006
Corporate Reputation as an Intangible Asset
Posted by Brayden

One of the intangible assets that a company has is its reputation.  Corporate reputation is a perception of high esteem or respect for a firm's activities, strategies, etc.  The quality of a firm's choices and outcomes are one driver of reputation, but reputation also has a life of its own.  Once a firm establishes strong visibility in the media and among investors and analysts, improvements in quality tend to lead to stronger gains in reputation.  Reputation is also related to non-financial performance criteria, such as the ability of a firm to deal well with its stakeholders.  When a firm is viewed as being fair to employees and the larger global community, its reputation is enhanced.

I bring up corporate reputation because it is one way that firms that are attentive to nonshareholder constituencies may improve their total market value.  As I mentioned in my earlier posts, attending to all stakeholder demands may be important to maximizing the total market value of the firm.  Corporate reputation is the mechanism linking stakeholder management with market value maximization.  A lot of good organizational research indicates that improved corporate reputation leads to improved financial performance (e.g. Fombrun and Shanley 1990; Landon and Smith 1997).   Roberts and Dowling  (2002) demonstrate that reputation actually enhances long-term financial performance, which assuages critics who argue that reputation offers only temporary financial gains.  They argue that reputation is important to market value creation because it is so difficult to replicate.  If it were easy to create a good reputation, any firm would do it and it would immediately lose its value.  Thus, reputation is a source of persistent competitive advantage.

One of the most well known researchers of corporate reputation is Charles Fombrun of the Reputation Institute.  For anyone looking for a straightforward and comprehensive treatment of the subject, I recommend Fombrun's (coauthored with Cees Van Riel) Fame and Fortune: How Successful Companies Build Winning Reputations.  In the book, Fombrun and Van Riel outline the pathways from reputation to financial performance. One path is by improving the operating performance of a company.   

In general terms, a good reputation can improve a company's efficiency and effectiveness by stimulating employee productivity.  It also creates a reservoir of goodwill toward the company that derives from partners, suppliers, dealers, creditors, and regulators whose support often manifests itself in the form of lower input prices, including a lower cost of capital, and translates into higher margins.  The company's lower input costs are supported by its ability to charge better prices for its offerings, a factor that enhances the company's margins, encourages financial analysts to give favorable ratings to the company and fuels demand for its shares (pg. 27).

The logic is similar to that offered by Joel Podolny in his book Status Signals.  He argues that status (which is similar but not sociologically synonymous with reputation) exhibits the Matthew Effect.  Firms that have high status typically attract better employees who are willing to work for the firm at a lower wage, simply because of the status benefits it provides to their ego.  Suppliers want to do business with high status firms, so they are willing to take some profit hits in order to do so.  The result is that high status (or high reputation) firms can offer the same quality product for a lower price than their competitors.  The result of this feedback process is that high status firms become firmly embedded in a status hierarchy.  Status and reputation, thus, tend to reproduce themselves.

Of course, the whole point of Fombrun's project is to encourage managers to do things that will enhance their reputation, so he believes that there is at least some mobility in reputational assessments.  How do firms improve their reputations?  One of the most crucial things that they can do is improve their standing among stakeholders that are often ignored by profit-seeking companies.  In chapter 3, Fombrun and Van Riel demonstrate empirically that the best way to enhance reputation is to "improve its emotional appeal to consumers" (pg. 59).  To improve these perceptions by 7 percent, a firm could improve perceptions of its social responsibility by 26 percent.  Thus, doing good things for the environment, for communities, and for activist-related stakeholders inevitably feeds back on consumer perceptions, which in turn leads to improve reputation and enhanced market value.

The link between corporate reputation and market value shouldn't be forgotten when discussing directors' or managers' dealings with nonshareholder constituencies.  Secondary stakeholders are, in this sense, important to the total market value of the firm.  In extremely competitive industries, the firm that comes out on top may be the firm that is best able to handle its stakeholders and consequently enhance its reputation.

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Comments (4)

1. Posted by Jeff Lipshaw on July 29, 2006 @ 11:57 | Permalink

"In extremely competitive industries, the firm that comes out on top may be the firm that is best able to handle its stakeholders and consequently enhance its reputation."

Without diminishing for a minute the well-deserved regard that should be accorded corporations with "good reputation," and without having seen the studies, I would suggest the following slightly different spins on this:

1. What does "coming out on top" mean? It seems to me the studies should define the dependent variable as having achieved a superior ROI or ROE over a significant period of time (with cash flow matching earnings in the long run). The problem with market value as the dependent variable it that it means trying to discern the reasons why investors are investing. Is Google trading at whatever ungodly amount it's trading at because investors expect a short or long term return on investment, or because they think it is a "nice" corporation with good values? Does BP trade at a higher multiple than ExxonMobil because Lord Browne comes across as a good guy and its slogan is "Beyond Petroleum, and Lee Raymond is/was a pugnacious SOB, and the Valdez spilled oil all over Alaska? Better example: does Toyota trade higher because investors are happy it invented hybrids, or does it trade higher because it was first to understand that "green" sells, and hence achieved a higher endogendous return? If one really wants to prove that doing good is a significant cause of making good, the making good dependent variable should be pure making good. If purely doing good without a making good return is attractive to investors ("I buy X shares and receive an annual return of 1000 clear conscience utils), then Greenpeace and charities should be going public.

2. It seems intuitively implausible that a "nice" corporation without product or cost differentiation would outperform a "not nice" corporation with significant technology or cost differentiators. If the studies factor that out, then it is nice to know that niceness, all things being equal, makes a difference. Or as I understand statistics, it's nice to know niceness is correlated to success (r) but how much of the success is explained by niceness versus the other factors (r-squared)?

2. Again, my intuition is that a nice corporation with a flawed business model is a nice but flawed corporation. I would be willing to believe there are management characteristics tending to support both (a) the tendency toward niceness, and (b) operational excellence, and (c) strategic excellence. That is, there is a more fundamental variable to success than "niceness" and it is not fully independent of the other factors.


2. Posted by Vic on July 30, 2006 @ 18:07 | Permalink

It won't surprise anyone here that I agree with Brayden.

Jeff -- I think the best way, and perhaps the only way, to make sense of corporate reputation is to see how it translates into revenue (on the consumer side) or morale (on the employee side). It's not that shareholders of Google or Whole Foods are pushing the stock price higher because they like the CEOs. Rather, it's that people are willing (for example) to pay higher prices to shop at Whole Foods, and employees are willing to work non-union jobs there, because they feel an emotional attachment to the brand. The shareholders, in turn, just react to the profits.


3. Posted by brayden on July 30, 2006 @ 18:39 | Permalink

Jeff - Fombrun and Van Riel emphasize that the mechanism that links reputation and market value is a reduction in operating costs. Firms with lower operating costs tend to be more profitable, of course.

Ceteris paribus, suppliers and clients express a preference to do business with a prestigious firm. Thus, in highly competitive industries the more respectable companies tend to have a competitive advantage. This advantage leads to measurable differences in profitability.

In fact, many of the studies do not make stock market value the dependent variable. The Roberts and Dowling paper I mentioned uses ROA as the dependent variable.

I wouldn't completely disagree with your point about a flawed company being a flawed company, regardless of reputation. However, having a good reputation allows managers to hide flaws easier and gives them some leeway when dealing with stakeholders in times of crisis or difficulty. People may be more willing to forgive the flaws of a reputable company.


4. Posted by Jeff Lipshaw on July 30, 2006 @ 19:15 | Permalink

Vic and Brayden:

The points are fair. As I said, I suspect it's the case that reputation correlates with performance in absolute terms. (I spent many years trying to recruit people to work in Detroit in the auto industry - tell me about it.) It's the relative impact of reputation to other success factors that I wonder about.

Brayden, do you know what competitive industries they studied? (I was going to look, but it meant logging into the libary website to access the journals.) My own intuitions come from many years in heavy industry. So talking about Whole Foods and Google makes the problem too easy! I'd be curious about a "good reputation" plastic additive company versus one with that is not so nice but has differentiating process technologies, or a "good reputation" conventional auto parts maker versus one that has systems integration capability.

And, as I said, I wonder if those variables are really independent of each other. As environmentalism is a luxury of the developed world, is the focus on reputation the luxury of companies that already have a differentiating business model? Or is there some aspect of leadership that is a common ingredient of both product performance and reputation?

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