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European Management Journal Vol. 21, No. 2, pp. 201–212, 2003  2003 Elsevier Science Ltd. All rights reserved. Printed in Great Britain doi:10.1016/S0263-2373(03)00015-X 0263-2373/03 $30.00 + 0.00

The Reputation Index: Measuring and Managing Corporate Reputation KAREN CRAVENS, The University of Tulsa ELIZABETH GOAD OLIVER, Washington and Lee University SRIDHAR RAMAMOORTI∗, Ernst & Young LLP, Chicago Perhaps the most critical, strategic, and enduring asset that a corporation possesses is its reputation. Although corporate reputation is undoubtedly a significant and relevant corporate asset, formidable measurement challenges have effectively kept this major intangible asset out of the financial statements. We propose the creation of a ‘reputation index’ that would be of broad scope and attempt to capture key dimensions and evaluate diverse organizational components including corporate strategy, financial strength and viability, organizational culture, ethics and integrity, governance processes and leadership, products/services, strategic alliances and business partnering, and innovation along with information already contained in the corporation’s annual report.  2003 Elsevier Science Ltd. All rights reserved. Keywords: Corporate reputation, Intangible assets, Measurement, Reputation index, Financial reporting Traditional financial statements reflect a reliability – relevance trade-off: they are historically focused (thus ensuring reliability) but omit key intangible assets that are frequently seen to be amongst the most significant value drivers (thus underemphasizing relevance). Consequently, they do not provide adequate, relevant information about the market value of companies. The resulting divergence between book value and market value became most apparent as the pace of globalization and the Internet revolution caused the prevailing business paradigm to experience a tectonic shift during the last decades of the 20th century. Overly optimistic markets caught up in the changes in technology and in the shape of the emerging, complex global economy drove up the value of companies to unimaginable levels. Then in 2001, everything changed: venture capital money European Management Journal Vol. 21, No. 2, pp. 201–212, April 2003

began to dry up, and what was previously labeled ‘irrational exuberance’ was abruptly replaced by a sort of ‘irrational pessimism.’ Seemingly stable firms, almost overnight, began to lose significant amounts of market value. This roller-coaster ride that the capital markets have given us over the past 20 years, if nothing else, has persuasively demonstrated the gap that can exist between a company’s market valuation and the information provided by current financial statements. Federal Reserve Board Chairman Alan Greenspan comments on the importance of this gap in terms of corporate reputation: As the recent events surrounding Enron have highlighted, a firm is inherently fragile if its value added emanates more from conceptual than from physical assets. A physical asset, whether an office building or an automotive assembly plant, has the capability of producing goods even if the reputation of its managers falls under a cloud. The rapidity of Enron’s decline is an effective illustration of the vulnerability of a firm whose market value rests largely on a capitalized reputation. The physical assets of such a firm compose a small proportion of its asset base. Trust and reputation can vanish overnight. A factory in such a context cannot. (Greenspan, 2002, emphasis added).

To date, questions about this gap and how to quantify it have been raised, but not even the appropriate questions are clear. More importantly, in the wake of increased attention to corporate reform measures, this gap becomes even more of a critical issue. This paper proposes the creation of and lays the framework for a new measure, a corporate reputation index, which would be used in the context of additional recommended disclosures in the financial statements. The reputation index could accompany the financial statements much like a bond rating summarizes the overall risk associated with investing in a company. Before discussing the preliminary components of the 201


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corporate reputation index, we review some of the major studies and metrics that have been produced thus far. These studies have helped to identify the need for information, while a set of potential metrics has begun to address those needs. The next section highlights the importance of corporate reputation; then we describe how such an index would be developed. After illustrating the various components of the index, a methodology is provided as to the mechanics used to arrive at a summary evaluation metric. The final sections denote these issues in the context of a corporate reputation audit, with a concluding section providing questions for future research.

Previous Studies: Business Reporting, the 21st Century Global Economy and Intangibles A variety of reports and initiatives have served to focus attention on the objective of business reporting in general, and more specifically on the need to address the recognition, measurement and disclosure of intangible assets. While most academics acknowledge the array of problems associated with the valuation of intangible assets, these difficulties have not prevented an almost universal recognition that we must address this issue. The business world has changed dramatically, creating an urgent need to assess the efficacy of business reporting in providing a faithful representation of business performance. In 1994, the American Institute of Certified Public Accountants (AICPA) released Improving Business Reporting – A Customer Focus. In the report, the AICPA’s special committee argues that the focus on business reporting should be more forward-looking, be more centered on ‘factors that create longer term value,’ and better align externally reported information with that used for internal business purposes. The report specifically cites the need to focus on nonfinancial measures (p. 5). While the AICPA report (1994) does not deal directly with issues in the new economy, the Canadian Institute of Chartered Accountants’ (CICA) Performance Measures in the New Economy (McLean, 1995), which came out in the following year, does. This report recognizes the need for a radical shift from the current accounting model and finds Canadian companies experimenting with new measures of performance. If the report is correct, the profession is currently undergoing a paradigm shift that will continue for another 10–15 years, a shift that will enable accountants to better report the economic reality behind knowledge-intensive businesses, intangible asset values, along with green accounting issues. Non-financial performance measures collected by the 202

Danish Agency for Development of Trade and Industry with the co-operation of 10 companies were published in 1998. That memorandum, Intellectual Capital: Reporting and Managing Intellectual Capital, summarizes the companies’ reasons for developing intellectual capital accounts. While these accounts help the company develop and grow, they also can provide information to other interested parties. In The Netherlands, the Ministry of Economic Affairs approached accounting for knowledge capital from another angle in its 1999 pilot project, Balancing Accounts with Knowledge. Instead of case studies using companies, this project depends on the reports of four accounting firms, KPMG, Ernst & Young, PricewaterhouseCoopers, and Walgemoed, which had been asked ‘to carry out a practice-oriented study of the intangible assets of a number of their clients, and to produce a trial appendix to the external financial annual report’ (p. 5). Another study published by the Institute of Chartered Accountants in England and Wales (ICAEW) in 2000 looked at New Measures for the New Economy, suggesting three alternative approaches to dealing with intangible assets. These approaches range from the incremental, the radical, to the hybrid. In April 2001, the FASB published its special report. This report summarizes and analyzes previous studies. The report also evaluates the merits of considering an intangible element as an asset and the various trade-offs available for measurement and reporting. The SEC also established a taskforce to report on the relative merits of alternative disclosures. These reports point to the current lack of consensus concerning the definition of corporate assets. Yet researchers have begun to develop ways to quantify assets that previously have been treated as intangibles. As Baruch Lev notes, ‘measurement and valuation difficulties concerning intangibles should not provide an excuse for nondisclosure of relevant information about intangibles’ (Lev, 2001, p. 102). Lev is in the process of applying for a patent for his Value Chain Scoreboard which proposes nine areas of measures that encompass indicators that are quantitative, standardized, and empirically linked to value (Lev, 2001, pp. 111–115). Harvey and Lusch (1999) look at the other side of the intangibles, describing a classification and assessment index for intangible liabilities. Their classification schemata develops four categories of potential liabilities related to process, human, informational, and configuration issues. They also describe a six-step framework created to assess the magnitude of these liabilities. Harvey and Lusch note the importance of an awareness of the potential liabilities that may be created outside the boundaries of traditional financial statements (off balance sheet risks), arguing that if intangible assets make their European Management Journal Vol. 21, No. 2, pp. 201–212, April 2003


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way to the financial statements, preparers, management, and regulators must examine the other side of the journal entry. These liabilities, that may contain the potential to destroy value, are necessary to ‘balance the books’ as an offset to the equities generated from intangible assets. Harvey and Lusch assert that the end result of this assessment be a ‘reserve for off-balance sheet liabilities’ (1999, p. 91) included as supplementary information to the financial statements. We build on their work by focusing on a more comprehensive assessment of corporate reputation as a supplementary disclosure to the financial statements. This reputation index would focus on disclosure of the positive as well as negative aspects of corporate reputation and would provide an additional degree of standardization. With standardization of measures, the index would thus be more comparable across firms and industries.

The Importance of Reputation in the New Economy Arguing that ‘good reputations create wealth,’ Fombrun indicates that high reserves of reputational capital give an organization distinct advantages: ❖ Their products and stock offerings entice more customers and investors – and command higher prices. ❖ Their jobs lure more applicants – and generate more loyalty and productivity from their employees. ❖ Their clout with suppliers is greater – and they pay lower prices for purchases and have more stable revenues. ❖ Their risks of crisis are fewer – and when crises do occur, they survive with less financial loss (Fombrun, 1995). Thomas Mosser of Burson-Marsteller, then the world’s largest public relations firm, expands on the idea of reputational capital in defining the interdependence of corporate brands and branded products this way: Every institution or corporation has two assets on which success and survival are based – its Brand (upper case ‘B’– representing the image, reputation of the corporation or institution, including its financial assets, performance and people) and its ‘brand’ (lowercase ‘b’– the products or services it sells or provides). The interrelationship between these two assets…efforts against either of them must (not) be reduced, with one taking precedence over the other. (Harris, 1998, p. 22)

Both Mosser’s and Fombrun’s comments highlight how truly important the intangible asset of corporate reputation is to the entire strategic mission of the European Management Journal Vol. 21, No. 2, pp. 201–212, April 2003

organization. Perhaps the most dramatic illustration of the power of intangible assets, such as corporate reputation, is the market phenomenon associated with various dot-com start-up companies. Without substantial tangible assets, a working infrastructure, or a functioning business operation, many dot-coms were able to attract substantial venture capital funding and generate tremendous market values over a relatively brief amount of time. This shows the power of the Brand (upper-case B) as concentrated on a very few intangible assets comprising corporate reputation. The fact that many of these firms are no longer in business or are suffering low market values shows the capricious nature and critical importance of corporate reputation. Why would the market attribute such high values to companies that as yet had no established reputation? The answer is two-fold: first, the product/service being sold was in vogue and the market was good, and second, the new firm’s corporate reputation was derived from the firms associated with it during the start-up period. With various strategic alliances and business partners, venture capitalists, underwriters, or banks connected to a dot-com start-up company, the reputation of these associated companies acted as a proxy for the reputation of the fledgling company. This illustrates Mosser’s ‘Brand’ rather than ‘brand association’ (Harris, 1998). The asset of corporate reputation, suggesting an ability to attract funding and talented personnel to launch a business, was indeed an intangible or hidden asset in this case. The market was recognizing and responding to an underlying asset – the corporate reputation – of the affiliated companies. The relationship among corporate reputation, market value and financial performance highlights the function of financial statements for both internal and external users. Financial statements have traditionally existed in somewhat of an intermediary role between the public-oriented needs of regulators and creditors, and the more private concerns of investors and management. However, recent research indicates that there is increasing evidence of the deteriorating usefulness of financial reports as a valuation measure (Lev, 2001, pp. 99–100). Over time there is less of a relationship between key financial variables and stock prices. In terms of corporate reputation, the financial statements are not designed to function as the primary means for reputation management. After all, it is well understood that it is the fundamentals of value creation – business performance – that drive the accounting. Hence, the ultimate effect of decisions regarding corporate reputation will flow through to the financial statements of the firm and eventually translate to market value. Empirical evidence regarding the diminished usefulness of financial reporting information (Lev and Zarowin, 1999) also lends support to the idea that additional disclosures supplementing financial information are necessary. Fin203


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ancial statements are woefully inadequate in terms of assessing and managing corporate reputation.

Developing a Corporate Reputation Index In response to the need to evaluate intangibles associated with corporate value, several methodologies have been developed that incorporate market values and book values to provide a residual measurement of intangibles. Baruch Lev and Marc Bothwell formulated a Knowledge Capital Scoreboard based upon subtracting the book value of corporate assets from market value (Mintz, 1999). Their approach utilizes historical and expected rates of return that differ for tangible and intangible assets. The resulting Scoreboard is based only on public information and provides a ratio that is an assessment of the degree to which the company is knowledge-based. Baruch Lev is also in the process of obtaining a patent for The Value Chain Scoreboard (Lev, 2001, p. 110) which is similar to Kaplan and Norton’s Balanced Scorecard (1996) in that it is a comprehensive attempt to quantify non-financial measures as indicators of performance. Lev intends that the Scoreboard functions as both a tool for internal decision-making and as a means for external disclosures. The Scoreboard measures such value-creating activities as internal renewal, customers, intellectual property, and growth prospects. Lev notes that the Scoreboard must be customized to an individual company and recommends a total of 10–12 indicators. Forbes magazine showcases a value creation index (Baum et al., 2000) that resulted from a joint research initiative begun in 1999. The team developing the index incorporated their own wisdom, outside surveys, and empirical research to create eight major drivers of corporate value. Once the drivers were identified, they weighted the driver categories according to the explanatory power of the driver in terms of market value. The Canadian Institute of Chartered Accountants has developed Total Value Creation to provide a means to assess the value creation potential of organizations (Upton, 2001). This method is the result of collaboration with global partners to address the need for better performance tools to report value in the new economy. The method is designed to supplement financial reporting and function primarily for use by senior management and the board. Future plans include making the information available to those external to the firm. The European Foundation for Quality Management employs a model to encompass non-financial performance measures and is used by companies such 204

as British Telecom (Leadbetter, 2000). The components of the model are based on the elements used for the determination of the Malcolm Baldridge Award for Quality. Although not as aggregate a measure as knowledge capital or value creation, the value of a key corporate brand can be the primary intangible asset for many companies. In 2001, Business Week magazine partnered with the leading international brand consulting firm, Interbrand, to provide the first list of the best 100 global brands (Khermouch et al., 2001). Interbrand uses their own methodology for quantifying the value of a brand much in the same way as these other indices. These indices look at either individual elements that will affect corporate reputation or try to measure the intangible assets or liabilities, but none isolate all of the comprehensive elements of corporate reputation. Much like knowledge capital, corporate reputation is an aggregate intangible asset that must be evaluated using both internal and external information. Harvey and Lusch (1999) suggest the most relevant foundation in their methodology to assess off-balance sheet liabilities deriving from intangibles. However, this methodology must be expanded and standardized to create a type of disclosure comparable across companies and industries.

Case Studies of Similar Aggregate Indices Given the difficulties in assigning a value to numerous intangible assets, we propose developing a composite index that relies on various scale weights that would allow standardization in the measures rather than on absolute quantitative values. We envision developing the index using a series of categories and relative weights to derive an overall classification value based on both internal and external information. The index would thus parallel other indices that develop an aggregate classificatory weighting such as the US News & World Report College Rankings or the Moody’s Bond Ratings (cf. Cornelissen and Thorpe, 2002). The college rankings are based on up to sixteen indicators of academic excellence that vary according to the mission of the university. Each indicator is incorporated in creating an overall score by a weighting factor determined by US News & World Report staff. The weighting factors may change from year-to-year and are completely subjective and judgmental. In creating the rankings, US News & World Report employs surveys to solicit such intangible components as faculty dedication to teaching in evaluating academic reputation. Over successive years of reporting these college rankings, the scores and weightings do start achieving a longitudinal sort of self-consistency. European Management Journal Vol. 21, No. 2, pp. 201–212, April 2003


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Components of the Corporate Reputation Index There has been aggregate information gathered that will help shape the index. A survey of 650 CEOs listed ‘has high quality products and services’ (72 per cent) and ‘is a company you can trust’ (72 per cent) as the two most important components of corporate reputation (Winkleman, 1999). Other components include: ‘has high-caliber management’ (43 per cent), ‘adds value to all customer transactions’ (39 per cent), ‘conducts business in a human and caring way’ (28 per cent), and ‘is an innovator in the industry’ (23 per cent). These comments capture the most essential components of corporate reputation: leadership, strategy, culture, and innovation. We expand on these categories to suggest a corporate reputation index based on specific measures relating to: products, employees, external relationships, innovation and value creation, financial strength and viability, strategy, culture, and intangible liabilities. Our goal is to provide a comprehensive set of components for the index and an initial set of illustrative measures from which to begin empirical research. Thus, while we believe that the components of corporate reputation are comprehensive, the specific component measures featured in the index will develop over time as research progresses. We envision the reputation index as a standardized set of common as well as unique component measures that would be consistent across companies and industries. Table 1 illustrates the components of the corporate reputation index and includes illustrative measures for each of the components. In contrast to other measures of intangible assets, the corporate reputation index is based primarily on internal assessment of non-quantitative factors and does not rely on market values or asset values. Instead, the components of corporate reputation are evaluated on the basis of internal and external information. The basic index includes (common) factors that should be relevant in assessing corporate reputation in general. If an element is not relevant, then that item is neither a reputation-enhancing nor a reputation-destroying component and hence would not factor into the overall score. That is why the nature of the index is such that a classification ranking is created rather than an absolute value. One of the most important activities in developing a reputation index will be to query key groups who interface with the organization to assess their opinions of corporate reputation. The most important key group is obviously the customer (e.g., customer satisfaction, customer loyalty, customer prospects, churn rate, etc.). Similarly, reputation should be assessed from the perspective of suppliers, employees, partners in alliances or partnerships, and even from competitors. This assessment would differ from typical surveys developed by a corporation in that the survey should be much more comprehensive than an assessment of satisfaction. The following secEuropean Management Journal Vol. 21, No. 2, pp. 201–212, April 2003

tions list the elements that would be measured in the index. Products The product (good or service) offering of the organization represents one of the key means for value creation and for building a brand image through product/service reputation. With the value and image, however, comes a major area of risk exposure in terms of corporate reputation. The product provides the essential interface with the customer and a major driver of corporate reputation. If the product does not offer value to the customer or has a negative quality association, then it is almost impossible to create a strong corporate reputation. The reputation index needs to consider whether the corporate name and reputation (in their relationship to company brands) can be separated. For example, the store name Gap is linked with the clothing and accessories sold under the same brand name. However, all customers may not be aware of the fact that Gap, Old Navy, and Banana Republic are owned by the same company. The index must assess the extent to which the reputation of one store name affects the overall corporate reputation. It is also important to assess awareness of the corporate name and any brand names across a wide group of constituents (e.g. the notions of cross-branding or co-branding products and services). In addition to consumer awareness, the index must measure the strength of the corporate reputation in terms of the attributes of the products or services offered, including quality. Similarly, the extent of external quality failures as evidenced by warranty and liability claims is also a part of reputation. Employees The employees are the means by which a corporate reputation is created. Through the actions of all employees, at the senior management and lower levels, the public derives an image of the corporation. For most industries, if the employees are not loyal to a company, then it is unlikely that customers and other stakeholders will be loyal1. A similar situation applies with respect to trust. That is why it is essential to assess the employee’s opinions of corporate reputation and overall satisfaction with the company. The index could evaluate the length of time that employees remain at the company and the extent to which new applicants seek jobs at the company. Training and development reflects an investment in both the employees (by the firm) and in the company (by the employees). Management makes the decisions regarding strategy and products or services and creates the company culture in which choices that affect corporate reputation are made. Since upper management is the most visible group of employees, the level of trust inspired by upper management is also an important measure. This trust will also be reflected in the degree to which 205


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Table 1

Components of the Reputation Index

Index components

Illustrative measures

Anchor scale values: 1= least desirable; 9 = optimal (ideal)

Products/services

Quality associations Public awareness of corporate name and products/services Extent of brands and umbrella brands Warranty claims Liability claims

Almost none (poor) Almost none (poor)

Highest (perfect) Highest (perfect)

Single brand item Often, numerous Often, numerous

Numerous brand lines Never Never

Almost none (poor) Common, extensive None conducted None, unfilled positions None or rare None or rare

Highest (perfect) Almost none (perfect) Formal, informative Excessive, high interest Extensive Highest (perfect)

None, isolated, lack of information flow Almost none (poor) Poor Common, extensive Incongruent, at odds with long-term objectives

Extensive and regular

Employees: All levels

Employee satisfaction with employer Turnover Exit interviews Number of applicants for open positions Training and development efforts Employee feedback relative to meeting employee needs Coordination and communication efforts across functional and business areas Upper management CEO personal reputation only Competency Turnover Compensation and evaluation packages and goal congruence with strategic objectives Information collection from subordinates External relationships (non customer): Suppliers Payment terms Major supplier quality Relationship quality of major suppliers Relationship duration for major suppliers Quality of suppliers for suppliers Partners Existence of alliance relationships Longevity of alliance relationships Recognition of key strategic partners Reputation of key strategic partners Joint venture contractual agreements Competitors Industry participation Competitor response to key corporate initiatives Investors Market premium Market stability Environment Environmental policy Dedicated employee positions Liability claims Regulatory intervention Society Charitable endeavors Employee quality of life initiatives Innovation Formalized program to generate and evaluate innovation Growth relative to customer needs New product/service development Value creation Identification and responsiveness to customer needs Customer retention Financial strength Information content of annual report Additional disclosures

206

None, isolated

Almost none (poor) Poor, no level of trust Beginning Almost none (poor) None None or beginning Unknown Poor None Isolated Ignores

Highest (perfect) Highest (perfect) Almost none (perfect) Congruent and contributes to achieving long-term objectives Regular, participative

None None, unstable None None Often, numerous Often None None None

Highest (perfect) Highest level of trust Enduring, long-term Highest (perfect) Numerous Enduring, long-term Well-known High Numerous Active, exchange of info Immediately matches or responds to actions Highest Long-term stability Formal, well-developed Dept. and sr. manager Never Never Extensive and varied Extensive and varied Mature, successful

Stagnant (poor) None Unaware of customer needs Frequent loss Almost none (poor) None

Steady and consistent Extensive at all stages Anticipates and meets all needs No customer defection Highest (perfect) Numerous and extensive

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Table 1

(Continued)

Index components

Illustrative measures

Anchor scale values: 1= least desirable; 9 = optimal (ideal)

Strategy

Strategic priorities relative to reputation Integration of strategy across business units Management control system fostering consistency Ethics policy Reporting procedure for ethics violations Upper management attitudes Ethics committee on the board Inadequate research and development process Lack of adequate information infrastructure Organizational structure – lack of flexibility Bad word-of-mouth among customers Inadequate distribution channels

Ignores reputation None

Culture

Intangible liabilities

communication and coordination exists across functional areas and the level of information exchange between managers and subordinates. Although the actions of all employees are reflected in corporate reputation, upper management and the CEO in particular can have a significant individual effect on corporate reputation. The personal reputation of the CEO should be evaluated. Consider how central the reputation of key CEOs such as Jack Welch, Rupert Murdoch, Bill Gates, and Michael Eisner are to their respective companies (GE, News Corporation, Microsoft, and Disney). Similarly, the competency and turnover of all upper management should be assessed as well. Management must be competent to make decisions and their motives should also be examined. Thus, the evaluation plans and incentives should be examined in relationship to both strategic objectives and to the motives for decision-making. For example, the recent rush by a number of corporations to restate earnings may reflect an awareness of how performance plans are tied to corporate reputation. Executives may have received substantial compensation through the exercise of short-term options without a corresponding increase in company value. This lack of goal congruency between the goals of the shareholders and the goals of managers could thus have a negative effect on corporate reputation. External Relationships External relationships, in addition to the relationship with customers, are important components of corporate reputation. Key relationships with suppliers, partners, investors and even competitors may be overlooked in traditional accounting measurement and evaluations. The quality and nature of these relationships will also contribute to corporate reputation. To some extent, an association with an external firm acts as a form of product guarantee (Klein and European Management Journal Vol. 21, No. 2, pp. 201–212, April 2003

Highest priority Complete formal and operational integration No formal system in place Formal system with perfect consistency None in Place Highly effective None in Place Highly effective Unethical or ignores Corporate priority No Yes No formal process Highly developed and successful process No infrastructure Well-developed Totally inflexible Highly flexible Numerous and common Non existent Numerous and common Non existent

Leffler, 1981) or as a replacement for corporate reputation when none exists (Larson and Starr, 1993). This is commonly reflected by the choice of an underwriter for firms undergoing an initial public offering (Beatty and Ritter, 1986). Once firms are established, the choice of a partner may still be used as a means to enhance reputation (Kotha et al., 2001). In a study of the effect of reputation on corporate performance, Kotha et al. (2001) showed that reputation borrowing did enhance firm performance in a sample of pure internet firms. Internet firms without a history of performance were able to benefit by an association with venture capitalists who did possess a favorable and stable reputation. The reputation index should measure the quality of the suppliers and even the suppliers’ suppliers. Similarly, the corporate reputation of any strategic alliance or joint venture partner can have an impact on reputation. One study showed that although prevailing business opinion rated alliances fairly low in generating corporate value, alliances are one of the primary drivers in value creation (Baum et al., 2000). Results documented that companies with more joint ventures and alliances enjoyed higher market values. The extent to which investors have confidence in the corporation is an informative measure that can be determined through analyst activity, share volume, and surveys. It is also necessary to examine corporate reputation from the perspective of competitors. Is the company respected in the industry and how do competitors respond to actions by the company? Well respected companies can expect a rapid response from competitors to any key corporate initiatives while those with less reputation may be ignored. External relationships encompass the interaction between the company and society and the environment. To the extent that the company contributes to 207


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charity and is concerned with societal and environmental issues, this will be reflected favorably in corporate reputation. Consider the motivations of Philip Morris in creating television commercials that describe the charitable activities of its Kraft subsidiary. Some companies may emphasize the importance of societal or charitable concerns by creating internal performance measures related to these issues (e.g., Skandia’s Annual Report supplements from 1996 to 1999). Innovation and Value Creation Both innovation and value creation are essential corporate attributes in the new economy. Boulton et al. (2000) detail various means of value creation determined from a three year study of 10,000 firms. They assert that value creation starts with the investment and management of a portfolio of key assets. These assets vary by firm yet range from the more traditional physical or financial assets to customer, employee and supplier, and organization assets. Supporting research from a survey of 113 US and European firms documents the positive financial rewards from customer value initiatives (Troy, 1996). Measures to assess corporate reputation in terms of innovation and value creation should be centered on customer-focused attributes. For example, growth relative to customer needs, new product/service development and customer retention are useful measures. A joint research project involving Forbes magazine, Wharton and Ernst & Young found that innovation was the single most important driver in corporate value for durable manufacturing (Baum et al., 2000). They also found that customer satisfaction was tied to innovation rather than to market value. Additional quantitative measures of innovation and value creation are suggested by Lusch (2000) in terms of creating long-term marketing value. Lusch (2000) proposes metrics such as: (1) per cent of sales from products introduced in the last three years; (2) per cent growth projected over the next three years in size of target markets; and (3) per cent of sales over the last three years from new-wave marketing channels. Quantitative measures such as these could be incorporated into the corporate reputation index to evaluate innovation and value creation. Financial Strengths and Viability It has been suggested that financial reporting is a ‘reputation-management tool’ in that it enables companies to release private information to the public domain, preferably in the most favorable light. Ultimately the extent to which users of financial statement information can trust the information affects its value. The rash of recent restatements undoubtedly affects the firm’s reputation. The same is true for additional disclosures. Consumers of additional corporate disclosures may question the motives for such disclosures, yet the disclosures will still influence corporate reputation. 208

Strategy The strategy of the company should be at the focal point of decision-making. Thus, the extent to which strategic priorities address corporate reputation issues will emphasize the importance of reputation. Similarly, the degree of risk involved with various strategic choices will have an impact on corporate reputation. The degree of risk amplifies both the success and failure of strategic initiatives. The reputation index should assess strategic priorities and consider how these priorities are integrated across business units. The lack of a coordinated strategy or lack of coordinated strategic implementation could lead to a loss in value of intangible assets and a decline in corporate reputation. The management control system of the organization implements the strategy and fosters consistency in application across the business units. This consistency is accomplished by gathering information and providing incentives that align the goals of managers with the goals of the company. A review of the management control system as part of the reputation audit identifies if mechanisms are in place to support maintenance of reputation in terms of strategy and incentives. Culture Aside from creating a culture that is receptive to an internal evaluation and external disclosure of reputation, the evaluative process should involve specific attention to the ethical climate of the organization. Ethical violations have the potential to create significant negative reactions from all stakeholder groups. Bausch and Lomb suffered from negative publicity after exposure of unethical sales practices in a Business Week cover article (Maremont, 1995). Subsequent regulatory attention included an investigation by the US Securities and Exchange Commission. Thus, the index should take into account the existence and extent of a corporate ethics policy. Is the policy actively reviewed and are the employees made aware of the policy? More importantly, are there channels for the employees (and those external to the firm) to report ethical violations or questionable practices? The attitudes of key management are particularly critical with respect to ethical concerns. Even if a strong policy exists, if upper management does not enforce the policy it is not effective. Establishing an ethics committee on the board of directors can indicate the level of priority attached to ethics issues in the organization. The ethics committee can also provide a hierarchy for reporting ethics violations at high levels in the organization. Intangible Liabilities The final component of the index should consider separately the intangible liabilities that may be generated by corporate action or reputation. Although liabilities may be implicit in the other components of corporate reputation, considering areas of exposure together will increase the likelihood that potential liabilities are not overlooked. The same sort of actions European Management Journal Vol. 21, No. 2, pp. 201–212, April 2003


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that generate positive intangible assets in terms of corporate reputation can also yield liabilities. Harvey and Lusch (1999) developed a classification schemata to categorize and assess intangible liabilities. The nature of these liabilities are such that there is a future claim on the firm’s assets that is unrecognized on the balance sheet at present. The liabilities result from actions in the past that could retard future growth or earnings. It is perhaps more difficult to estimate an intangible liability because the liability can relate to an asset but may be the result of an error or lack of judgment. Because of this complexity, Harvey and Lusch (1999) create separate categories for internal and external liabilities that fall into four main areas: (1) process issues; (2) human issues; (3) informational issues; and (4) configuration issues. Harvey and Lusch (1999) suggest liabilities in the internal process issues category ranging from weak strategic planning and inadequate research and development to antiquated manufacturing and poor new product development processes. External liabilities can result from poor product quality and lack of regulatory compliance. For example, Citigroup’s negotiations for a settlement with the Federal Trade Commission regarding predatory lending practices were motivated by a desire to settle the issue and avoid further damage to corporate reputation for lack of regulatory compliance (Beckett, 2002). Human issues consider employee turnover, training and competency along with negative word-of-mouth among customers and customer liability suits. Internal information issues liabilities may be the most difficult to estimate, but could potentially be the most critical. Harvey and Lusch identify lack of adequate information infrastructure and inability to turn data into information, or lack of analysis as the prime internal liabilities. Externally, they identify decreasing corporate reputation, negative brand or product information in a recall, successful litigation against the company or unfavorable analyst reports as liabilities. Potential liabilities in the configuration issues category bring together elements from the other components in the framework from Table 1 as well. Harvey and Lusch describe potential internal liabilities resulting from organizational structures with a lack of flexibility, lack of patents and copyrights, or inadequate geographic locations. External liabilities could result from inadequate distribution channels or lack of strategic alliances.

Assigning Values to the Index to Develop an Aggregate Measure of Corporate Reputation To transform the qualitative measures in Table 1 into a form more suited to computing a reputation index, European Management Journal Vol. 21, No. 2, pp. 201–212, April 2003

we suggest a nine-point scale to assess the magnitude of the measure. The scale values for the measures in Table 1 are anchored with 9 as an ideal or benchmark and 1 as the lowest, or least desirable measure on the scale. The responses to the scales for the individual measures should be averaged for each separate component of corporate reputation. Once there is an aggregate measure (value of 1–9) for each component, an overall measure can be created by applying weights to each of the components and summing the values. We suggest a range for the weights of the components in the index in Table 2. The analytic hierarchy process would be an ideal technique to validate suggested weights for the various indicators2. As this is an exploratory framework for considering corporate reputation, we suggest a range of weights but advocate that a more refined range of weights should be determined for each of the components. In suggesting weights to apply to the various components of corporate reputation, we consider the effect of the product or service offered to be of primary importance. The range for the weight of this component might range from 30 to 60 per cent. Employees, external relationships, innovation, and value creation can each reach a maximum of 20 per cent as noted in Table 2. All of these components are important, yet the relative impact on corporate reputation depends upon the strategic mission and operational efforts of the company at a given point in the corporate life cycle. Thus, these components may vary significantly in importance according to specific company characteristics and priorities. Although the minimum value for these components ranges from zero to one, value creation has a minimum weight value of 5 per cent. This component is so critical in terms of the reputation of the company that there is a higher minimum value. The annual report, strategy, culture, and intangible liabilities components have a maximum weight of 10 per cent as some of the elements of these components are implicitly considered in other areas. The final step in creating a corporate reputation index is to translate the overall single scale measure (range of 1–9) to a classification ranking. We employ Table 2 Relative Weights for Index Components in Developing an Aggregate Measure of Corporate Reputation Index Component

Range of weights (sum to 100%)

Products or services Employees/suppliers External relationships/alliances Innovation Value creation Financial strength and viability Strategy Culture Intangible liabilities

30–60% 1–20% 1–0% 0–20% 5–20% 0–10% 1–10% 1–0% 0–0%

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nine classification categories for the index that are associated with descriptions of various standards of corporate reputation. This ranking is similar to ratings for bonds as developed by Moody’s. Table 3 lists the classification rankings and suggests general descriptions for the range of overall scale measures. Since the descriptions noted with the scale value of 9 for measures in Table 1 are ideal, we do not anticipate that many companies would achieve a score of 9 for many of the measures of corporate reputation. Thus, it is unlikely that many companies would be classified according to the highest rating of A1 on the scale in Table 3. Few companies should also fall into the lowest range of the scale, C1–C3, as companies with very poor corporate reputation must correct this or perhaps would cease to operate. In this scale, the majority of companies should fall within the B categories or in the A2 or A3 categories.

The Reputation Index as an Output of Auditing Corporate Reputation The process of creating a reputation index would be most effective if conducted by an entity viewed as independent from the organization. Having the index developed by an independent consulting firm or as part of the traditional or reputational audit would increase the reliability of the information and would reduce any inherent bias. A formal reputation audit is one way to evaluate how the elements of corporate reputation relate individually and collectively to the overall value of the firm and to its stakeholders. We suggest that the reputation index may be created as the output of a formal audit process. Fombrun (1995) advocates the performance of a periodic reputational audit in light of the corporate entity’s culture and competitive strategy. The reputation audit will encompass all areas and levels of the organization transcending traditional boundaries. Much like brand valuation or market orientation initiatives, a reputation audit provides a unifying element for separate areas of the business. Similarly Petrick et al. (1999) suggest that executives be involved in assessing global corporate reputation through an annual global

Table 3

reputation audit including global awards and rankings and organizational quality indices. Costa (1998) recommends that a regular ‘ethical orientation audit’ will create long-term trust in a step-by-step process. By instigating a formal reputation ‘audit’ rather than a reputation ‘assessment,’ the process is associated with a greater degree of credibility and importance. With a reputation audit, management can address potential concerns from the public regarding the motives for disclosure and completeness of information supplemental to the financial statements. Including the reputation index in the context of a reputation audit allows for the index to have validity in an external disclosure environment.

Research Questions for Future Empirical Investigation Our objective is to provide a platform from which to begin an investigation into the assessment and measurement of corporate reputation. Although various initiatives around the world have begun to value the collection of key intangible assets of a corporation, corporate reputation warrants a singular focus. This is particularly true given the litigious nature of the current business environment: Quite often, in matters of litigation, a company’s reputation becomes the main focus (offensively or defensively) of its case. In this regard, reputation management has emerged as an important factor in positioning a company or product at every stage of its development, evolution, and maintenance – and validating the strength of its position with research. (Marconi, 2001, p.10).

We envision future research considering corporate reputation to refine the specific measures suggested for the components of corporate reputation. This process will help to highlight the critical importance of this key intangible asset and to encourage corporations to actively manage the components of corporate reputation. Empirical work is necessary to validate the components of corporate reputation and to completely develop the constructs used to measure cor-

Classification Rankings and Descriptions for a Corporate Reputation Index

Index Value

Overall Scale Range

Description

A1 A2 A3 B1 B2 B3 C1 C2 C3

9 8–8.9 7–7.9 6–6.9 5–5.9 4–4.9 3–3.9 2–2.9 1–1.9

An ideal level of corporate reputation – rarely achievable A more practical goal for corporate reputation A high level of corporate reputation

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Corporate reputation has minimal value Corporate reputation has marginal value Corporate reputation has little or negative value

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THE REPUTATION INDEX

porate reputation. Similarly, it is necessary to refine the weighting scales for the components by means of primary research including survey data and application of prioritization techniques such as the analytic hierarchy process. Research in general on intangibles has begun to suggest that these assets are so central to most organizations that the valuation issues cannot be ignored. The creation of a corporate reputation index is the first step in standardizing measurement and management of the most central intangible asset of all – corporate reputation.

Declaration ∗ The views expressed in this manuscript are Dr Sridhar Ramamoorti’s personal views and should not, in any way, be construed as reflecting the views of, or endorsement by, Ernst & Young LLP.

Notes 1. An exception may exist in industries such as fast food retailing. McDonald’s or Wendy’s may experience a high staff turnover, yet in reality it is the quality of the service experience that matters in terms of customer loyalty. 2. The analytic hierarchy process uses a series of pairwise comparisons so that an individual decision-maker can evaluate the relative importance of a multitude of items without simultaneously considering more than one combination. The analytic hierarchy process provides a way to aggregate the opinions of numerous decision-makers and reconcile inconsistencies to arrive at a relative set of weights for the items being evaluated.

References American Institute of Certified Public Accountants (AICPA) (1994) Improving Business Reporting – A Customer Focus. Baum, G., Ittner, C., Larcker, D., Low, J., Siesfeld, T. and Malone, M.S. (2000) Introducing the new value creation index. Forbes ASAP April 3, 140–143. Beatty, R.P. and Ritter, J.R. (1986) Investment banking, reputation, and underpricing of initial public offerings. Journal of Financial Economics, 213–232. Beckett, P. (2002) Citigroup may pay $200 million in FTC ‘predatory lending’ case. The Wall Street Journal Online 6 September 6, pp. 1–4. Boulton, R.E.S., Libert, B.D. and Samek, S.M. (2000) Cracking the Value Code. HarperBusiness, New York. Cornelissen, J. and Thorpe, R. (2002) Measuring a business school’s reputation: perspectives, problems and prospects. European Management Journal 20(2), 172–178.

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Costa, J.D. (1998) The Ethical Imperative: Why Moral Leadership is Good Business. Addison-Wesley, Reading, MA. Danish Trade and Industry Development Council (1997) Intellectual Capital Accounts – Reporting and Managing Intellectual Capital. Danish Trade and Industry Development Council, Copenhagen. Fombrun, C.J. (1995) Reputation: Realizing Value from the Corporate Image. Harvard Business School Press, Boston. Greenspan, A. (2002) Remarks given on April 22 to the Institute of International Finance. New York. Harris, T.L. (1998) Value-Added Public Relations: The Secret Weapon of Integrated Marketing. McGraw Hill, Chicago, IL. Harvey, M.G. and Lusch, R.F. (1999) Balancing the intellectual capital books: intangible liabilities. European Management Journal 17(1), 85–92. Kaplan, R.S. and Norton, D.P. (1996) The balanced scorecard: translating strategy into action. Harvard Business School Press, Boston. Khermouch, G., Holmes, S. and Ihlwan, M. (2001) The best global brands. Business Week 6 August, pp. 50–64. Klein, B. and Leffler, K. (1981) The role of market forces in assuring contractual performance. Journal of Political Economy 89, 615–641. Kotha, S., Rajgopal, S. and Rindova, V. (2001) Reputation building and performance: an empirical analysis of the top-50 pure internet firms. European Management Journal 19, 571–586. Larson, P. and Starr, J. (1993) A network model of organizational formation. Entrepreneurship: Theory and Practice 17(2), 5. Leadbetter, C. (2000) New Measures for the New Economy. Institute of Chartered Accountants in England and Wales, London. Lev, B. (2001) Intangibles: Management. Measurement and Reporting, Brookings Institution Press, Washington, DC. Lev, B. and Zarowin, P. (1999) The boundaries of financial reporting and how to extend them. Journal of Accounting Research 37(Suppl), 353–385. Lusch, R.F. (2000) Creating long-term marketing health. Marketing Management Spring, 17–22. Marconi, J. (2001) Reputation Marketing: Building and Sustaining Your Organization’s Greatest Asset. McGraw Hill, Chicago, IL. Maremont, M. (1995) Judgment day at Bausch & Lomb. Business Week 25 December, p. 39. McLean, R.I.G. (1995) Performance Measures in the New Economy. CICA, Toronto. Mintz, S.L. (1999) Seeing is believing: a better approach to knowledge capital. CFO.com. Netherlands Ministry of Economic Affairs (1999) Balancing Accounts with Knowledge. Netherlands Ministry of Economic Affairs, The Hague. Petrick, J.A., Scherer, R.F., Brodzinski, J.D., Quinn, J.F. and Ainina, M.F. (1999) Global leadership skills and reputational capital: intangible resources for sustainable competitive advantage. Academy of Management Executive 13(1), 58–69. Skandia. Supplement to 1996-1999 Annual Reports. Troy, K. (1996) Change Management: Striving for Customer Value. The Conference Board, New York. US News & World Report (2002) America’s Best Colleges. US News & World Report, Washington DC. Upton, W.S. Jr. (2001) Business and Financial Reporting, Challenges from the New Economy. FASB Financial Accounting Series Special Report. Financial Accounting Standards Board, Norwalk, CT. Winkleman, M. (1999) The fickle finger of reputation. The Chief Executive April, 79–81.

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KAREN S. CRAVENS, The University of Tulsa, 600 S. College Avenue, Tulsa, OK 74104-3189, USA. Email: karen-cravens@ utulsa.edu Karen Cravens is Arthur Andersen Faculty Fellow and Professor of Accounting at the University of Tulsa. She is a licensed certified public accountant, and has published widely in academic and professional journals.

ELIZABETH GOAD OLIVER, Williams School of Commerce, Economics and Politics, Washington and Lee University, Lexington, VA, USA. E-mail: oliver@wlu.edu Elizabeth Goad Oliver is Associate Professor and Associate Dean of the Williams School of Commerce, Economics and Politics, Washington and Lee University. Much of her research has investigated the influence of culture on pensions and welfare benefits.

SRIDHAR RAMAMOORTI, Ernst and Young LLP, 111 N. Canal Street, Chicago, IL 60606, USA. E-mail: sri.ramamoorti@ey.com Sridhar Ramamoorti is Assistant Director of Thought Leadership in the Litigation Advisory Services practice of Ernst and Young LLP, Chicago.

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