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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