The Impact of Reputation on Stock Market Value
Corporate reputations rank amongst
the most familiar but least understood of a firm’s assets. No survey research
based metrics offer any real insight into how valuable they actually are or
indeed, what can be done to secure and build the value they represent. Black
and Carnes (2000) argued that corporate reputations contribute to a firm’s
value but they did not identify “a method for evaluating and measuring, in
dollar terms, an individual firm’s reputation”. This paper addresses that shortcoming
and offers a guide for investors and corporations.
The need to measure the impact of
reputation on market value has become increasingly urgent. By the start of 2012
the tangible book or net asset value of companies in the S&P500 accounted
for only around 49% of market capitalisation; 55% in the FTSE100. Earnings
expectations and other financials helped account for some of the shortfall but the
bulk is a function of intangibles, identifiable and unidentifiable. This creates
a variety of problems. First, it reduces the veracity of investors’ valuation
calculations. Second, it limits their ability to take a suitably measured
account of reputation events – actions that may materially affect a company’s
value. Third, it inhibits reputation owners (i.e. the companies themselves), from
managing their reputation assets in a truly objective and ultimately strategic
manner.
Valuation methods have advanced over
the last two decades but they invariably fall short when assessing corporate
brands i.e. those that relate to the business as an operating entity rather
than its products or services. Brand valuation techniques based on consumer
transactions assess ,for example, operating brands like Diageo’s Guinness,
Johnny Walker, Captain Morgan, Jose Cuervo and so on. But because none of them
are branded ‘Diageo’ the corporate brand does not have any material impact on
customer choice. As a result no economic earnings can be attributed and its economic
value is defaulted to zero.
Clearly, this is not the case. Diageo
like a host corporate brands is a global blue chip listed on a number of stock
markets around the world and there are widely used survey research studies that
testify to the fact that it commands a suitably well rated corporate reputation.
The issue is not that corporate brands do not have any value but that
traditional techniques aren’t geared up to identify it.
Corporate brands influence a variety
of different stakeholders to create value in a number of different ways. The
most important group however is investors. Investors buy or hold a company’s
stock on the basis of the economic returns they expect to generate from either
capital growth or future dividends and will sell it if they believe they can achieve
better returns elsewhere. New information, intelligence and insight is filtered
through the stock of extant impressions that add up to the company’s reputation
and any changes may add to or detract from it. As a result reputation informed investor
confidence flows through the market to influence the stock price.
The emerging hypothesis i.e. that a
company’s market capitalisation can be explained by a combination of financial
and reputational variables, was tested in a four part process: investigation,
data collection, modelling and measurement.
Investigation
First, eighteen qualitative interviews
were conducted with a selected group of buy and sell side investment analysts
working with major investment banks, fund managers and agency and client side
investor relations professionals. This identified the ‘wide’ set of influential
or potential ‘explanatory’ variables to be assessed in the main body of the
analysis.
Data Collection
Second, data were collected from a
variety of sources to represent each variable. Reputation data were derived
from the ‘Most Admired Companies’ reports published by Management
Today in the UK and Fortune in the US. These are based on survey
research studies conducted (entirely separately) amongst samples of ‘professional’
observers i.e. people who have a view of the brand as a business overall not
just its products or services. The sample included c-suite individuals (senior
and board level executives including ‘chief executive officers’, ‘chief
communications officers’, ‘chief financial officers’ etc’) from many of the
largest public companies in each market along with selected investment analysts
and business journalists.
The Most Admired studies
report perceptions of a comprehensive set of factors judged to be among the
principal components of corporate reputation. These constitute the basic make
up of each company’s reputation and are presented in the form of quantitative
measures of the ‘strength’ of perceptions of the following dimensions:
·
Quality of management
·
Innovation
·
Quality of
goods/products and services
·
Community &
environmental responsibility (UK) / Social responsibility (US)
·
Financial
soundness
·
Long term
investment value
·
Use of corporate
assets
·
Ability to
attract talent (UK)
·
People management
(US)
·
Quality of
marketing (UK)
·
Global
competitiveness (US)
Measures of the overall ‘strength’ of
a company’s reputation are derived from a simple average of the ratings of the individual
dimensions. Prior to any statistical analysis the data was cleaned and
consolidated into a basic data set of close to 180 companies in the UK and 320
in the US.
Financial data were sourced from
Factset and Bloomberg. The data comprised reported and consensus forecasts from
relevant industry analysts of a number of relevant variables such as income and
balance sheet data, financial ratios, EBITDA, dividend yields, betas etc.
Modelling
Third, ‘general’ investor behaviour
was modelled using econometric analysis to determine if reputation operates as a
primary driver of market capitalisation and to quantify the extent of any
influence. Reputation was introduced into the analysis as a singular ‘whole’
and at the level of its component parts. This helped determine which of the
nine factors were most influential along with their relative impact.
This modelling took the analysis well
beyond the empirical work described by Schwaiger (2004) that had explored the
idea that the investment community does not see and value reputation in a
one-dimensional temporal sense but rather, a two-dimensional one in which
reputation is divided into affective (sympathy) and cognitive (competence)
components. Extending this work into nine dimensions s allowed for richer
models that demonstrate the possible negative trade-offs that exist between
measures aimed at enhancing a firm’s reputation in terms of corporate
responsibility at the expense of short-term performance.
Initial modelling was carried out
using UK company data relating to the end of 2007. Once completed the process
was repeated annually until the most recent iteration relating to the end of
2012. The analysis was also repeated for US listed companies on the assumption that
the underlying hypothesis was not country specific and therefore should hold in
any developed equity market given that equity investors behave in a broadly
similar fashion. The analysis was completed for five separate years using US
listed companies and reputation data from Fortune’s ‘World’s Most
Admired Companies’. The results regarding the model form were entirely
consistent, thereby providing further evidence as to its general veracity.
Measurement
The fourth and final stage of the
analysis involved using the model to calculate a combination of reputation metrics
for each of the companies in the data base. Predicted values of the market
capitalizations of each company were calculated and from that a series of
leading indicator outputs were produced. They included:
· Reputation
Contribution – the
proportion of a company’s market value attributable to its reputation. The
primary measure of reputation value.
·
Reputation
Leverage – the extent
of the return that can be expected from a specific increase in overall reputation
strength (expressed in terms of increased market value).
·
Reputation
Risk Profile – On
the basis that extant reputation value is by definition value at risk – it can
disappear without appropriate support – the Reputation Risk Profile spells out
how it is distributed between its individual components. In short, it details
the scale of reputation value resident in each individual component of the
company’s reputation.
Corporate reputation is a powerful
driver of shareholder return
The implications of the analysis are
clear. Company reputations are real, present and often very substantial assets.
Their economic impact is considerable in both the UK and the US where they rank
amongst the most important repositories of value of listed companies in each
jurisdiction. As of January 1st 2012 they accounted for close to 26%
of the total market capitalization of the S&P500, or US$3,190bn of
shareholder value. At the same time they were delivering US$770bn of value
across the FTSE100 and US$67bn across the FTSE250.
Reputation returns vary from company
to company
The value of individual corporate
reputations varies considerably. There are winners and there are losers. Across
the 410 leading US and UK companies tracked at the start of 2012 they ranged
from a height of close to 58% (Apple) to a low of -39% (Sears Holdings). In
most cases, 91% of companies, reputation is a force for good and is creating
shareholder value. However, in the remaining 9% it is negative and destroying
value. The top 25 leaders and bottom 25 losers aggregated across both markets
with the impact of reputation (positive or negative) valued in US$ as at
January 2 2012 are shown in Tables 1 and 2.
As a group, the 25 companies with the
highest Reputation Contributions across both countries at the start of 2012 had
aggregate benefits valued at US$1,707bn.
Conversely, shareholders of the 25
companies with the lowest Reputation Contributions were losing US$16bn as a
result of those companies’ reputation weaknesses.

Reputation Value is driven by much
more than strength alone
The potency and thus contribution of
a reputation is dependent on much more than just strength. This is clear when
the two are compared directly as in Chart 1 below where each point represents a
different company.
Companies with a reputation strength of, for example, 6.5
(measured on a scale of 0 to 10) are showing corresponding Reputation Contributions
ranging from around 20% to 43%, a spread of 23 % points. Similarly, companies
with a Reputation Contribution of around 45% have reputation strengths ranging
from around 6.67 (out of 10) to over 8.

Equally, Reputation Contributions
have changed over time without any significant movement in the strength
of the underlying reputations. While the average Reputation Contribution in the
FTSE100 doubled in the four years to 2011 and increased by half in the
S&P500, the average strength of the underlying reputations was only marginally
changed. Reputations have become more valuable but more because of what they
‘provided’ investors with than simply how well they stood out.
Reputation strength has a part to
play but there are other factors at work. These relate to the make-up of
individual corporate reputations. Clearly, it’s not just how well a company is
known, it’s what it’s known for that counts and investors need to look
beyond the simple measures of strength if they want to understand the impact of
corporate reputation properly.
Reputation management is a means to grow shareholder returns
Reputation is not just a repository
of shareholder value, it is also a means to grow it. This analysis suggests
that a notional 5% improvement of the strength of an extant reputation would
yield a market capitalization growth of 2.5% for the average S&P500 company
and 2.2% in the FTSE100. While there are differences from index to index this
equates to a return on investment of around US$600m for an average sized
S&P500 (market cap cUS$24bn) and US$500m for a correspondingly average
sized FTSE100.
Incremental value growth depends on
the individual reputation that’s being built up. Reputations of different
companies are structured in different ways and they offer different potential
for ‘leverage’ – the increase in market capitalization that can be expected for
any improvement in general reputation strength. As a rule, less valuable
reputations will provide less opportunity for value growth however, there is
substantial variation and thus room for individual reputation managers to
manoeuvre within that.
Reputation management depends on individual reputations
Reputation growth is determined by
changes in the individual reputation components. Companies will achieve
disproportionately greater returns on their reputation management investment by
ensuring that their communications activity is aligned to promote the messages
that matter most to investors at the time. While the general requirements of
corporate messaging may, in the broadest sense, remain consistent, it’s clear
that the ‘needs’ of the investment community are a movable feast.
This study uncovered important evidence
of changes in the priorities allocated to different components of reputation.
The data revealed that in 2012 the investment community had started to look
beyond companies focussed on the more defensive characteristics of ‘quality
of leadership’ and ‘quality of products/services’ and is responding
more favourably to those companies it sees as ‘innovating’, ‘attracting
talent’ and ‘investing in marketing’. They were increasingly
eschewing shorter term defensive qualities and rewarding companies they perceive
to be geared up to capitalise on the changing economic cycle and preparing for
the upturn.

Reputation value analytics represents an important step forward in the
strategic management of corporate reputation. Moreover, it has important implications
for both the owners and managers of corporate brands and for the investors who
target them. First and foremost because it reveals the scale and location of
shareholder value residing in a company’s reputation and second because it
provides an objective basis for securing and growing value further.
This analysis presents reputation
owners with an objective basis to organise communications and broader based operational
or strategic activities to manipulate and ultimately optimise the reputation
component of a firm’s market value. It answers important questions: where the
messaging opportunities are?; can the company sustain a stronger reputation
i.e. is it being unfairly under-rated in any way?; and, is the return on the
investment required reasonable? Answers to all of these questions can have a
critical impact on investors’ decisions as to whether or not to support any
individual company.
The work of Reputation Dividend is
not a panacea for a company’s reputational shortcomings, but it can reveal the
most pressing value generating or destroying components. Moreover, by
disentangling the individual drivers of reputation value it can shed light on
whether issues are truly messaging problems, operational problems, strategic
problems or some combination of the three. Finally, in providing hard numbers
that reflect the magnitude of the reputation drivers in a language that is
simple and relevant to corporate leaders it will command a high degree of
credibility and utility for publicly owned companies and their investors.
Black, E.L. and Carnes T.A, (2000)
The Market Value of Corporate Reputation, Corporate Reputation Review,
Vol. 3, No. 1, 31-42
Schwaiger, M, (2004), Components and
Parameters of Corporate Reputation – An Empirical Study, Schmalenbach
Business Review, Vol. 56, January, 46-71
While the
individual measures are broadly consistent across the two studies there are
some differences (as indicated).