Reputation, Stock Price &you

Table of Contents
Introduction (15 pages)

 <ol> <li>BP case study; intro to stakeholder perspectives. </li> </ol>
Part I: How stakeholders shape and are shaped by reputation
(In the first part, case studies and analysis will illustrate the bulleted points
listed for each chapter)
Chapter 1-Customers (25 pages)
 <ol> <li>How expectations customers hold about a company help
shape a companys reputation </li> <li>How actions taken by a company
in managing ethics, innovation, quality, safety, sustainability, and security shape
customer expectations </li> <li>How a companys reputation affects
customer behavior </li> <li>How corporate directors have the unique opportunity
to frame the entire reputation-forming process from the perspective of customers
</li> <li>Why professional marketing, and communications efforts play a
relatively minor role in reputation formation from the perspective of customers </li>
<li>How customer behavior collectively determine a companys stock price
or value. </li> <li>Case studies: Zales, Rolls Royce, Research in Motion, Kodak
</li> </ol> Chapter 2-Employees (25 pages)
<ol> <li>How expectations employees hold about a company help shape a
companys reputation </li> <li>How actions taken by a company in
managing ethics, innovation, quality, safety, sustainability, and security shape
employee expectations </li> <li>How a companys reputation affects
employee behavior </li> <li>How corporate directors have the unique opportunity
to frame the entire reputation-forming process from the perspective of employees
</li> <li>Why professional marketing, and communications efforts play a
relatively minor role in reputation formation from the perspective of employees </li>
<li>How employee behavior collectively determine a companys stock price
or value </li> <li>Case studies: Apple, Inc; Goldman Sachs/Blackrock </li> </ol>
Chapter 3-Vendors (20 pages)
 <ol> <li>How expectations vendors hold about a company help shape
a companys reputation </li> <li>How actions taken by a company in
managing ethics, innovation, quality, safety, sustainability, and security shape
vendor expectations </li> <li>How a companys reputation affects vendors
behavior </li> <li>How corporate directors have the unique opportunity to frame
the entire reputation-forming process from the perspective of vendors </li>
<li>Why professional marketing, and communications efforts play a relatively minor
CHAPTER
Avoiding
Hara-Kiri
This book was purchased by valeriu.tones@reputation-management.ro
A reputation for a thousand years may depend upon the conduct of a single
moment.
Ernest Bramah
In one of the final scenes in the 1993 murder mystery film, Rising Sun, a police
inspector stands in a Japanese corporate boardroom at the top floor of a
towering office building. In front of the entire board, he prepares to accuse one
member of criminal culpability. With tension rising, fellow board members
begin to distance themselves physically from the soon-to-be-accused. Taking
the cultural cue, the executive takes the honorable route and leaps out of a
window, mercifully ending the crisis for all.
In an example of real life imitating art, the scene was replayed on Tuesday, 15
June 2010, when five major oil company executives lined up at a witness table
for a House Energy and Commerce Committee hearing to investigate the
Deepwater Horizon oil rig disaster, which at the time was still pouring 50,000
barrels of oil a day into the Gulf of Mexico. Exxon Mobil CEO Rex Tillerson
said, We would not have drilled the well the way [BP] did. Chevron CEO
John Watson and Shell Oil Co. president Marvin Odum concurred. Rep. Joseph
Cao, who had emigrated from Vietnam, closed the scene: In samurai days, we
2 Chapter 1 | Avoiding Hara-Kiri
would just give[the Chairman of BP]a knife and ask [him]to commit
hara-kiri.1
But the simple solution of seppuku that might have sufficed in an earlier
Japanese culture is not available in our complex multifaceted world. BP did not
have the luxury of quickly and mercifully ending the fallout from the
corporative event that best exemplifies a modern reputational crisis: the
explosion of the Transocean Deepwater Horizon oil-drilling rig in the Gulf of
Mexico.
The explosion on 15 April 2010 of the Deepwater Horizon platform, situated 40
miles southeast of New Orleans on the Macondo Prospect oil field, killed 11
and critically injured 17 of the 126-member crew. Within hours, Deepwater
Horizon was completely destroyed. As it burned and sank, severance of the
connection between the well-head and the rig opened the spill of oil into the
Gulf of Mexico. On the day of the Energy and Commerce Committee hearing, a
government panel confirmed that this oil spill was the largest in U.S. history.
Anatomy of a Reputational Crisis

The Deepwater Horizon disaster was yet another mishapan industry
accident, as BP CEO Tony Hayward explained shortly before he stepped
down.2 Oil spills happen all around the world and, as Hayward implied, are an
inevitable part of doing business. According to the Oil Spill Intelligence Report,
spills in the size range of at least 10,000 gallons have occurred in the waters of
112 nations since 1960.3 The Deepwater Horizon spill was a very large one,
releasing 205.8 million gallons, but still ranks second to the deliberate release of
about 240 million gallons of crude oil into the Persian Gulf during the 1991
Gulf War.4
Accidents involving oil tankers, pipelines, and offshore platforms have caused a
number of very large oil spills. Platforms have several failsafe systems to
reduce accidental spills. The weight of the drilling fluid/drilling mud acts as the
first line of well control. If an influx of pressurized oil or gas breaks through the
mud, well-control is maintained through the rigs emergency-closure devices
(rams) that seal off the well and route the wellbore fluids to specialized pressure
controlling equipment.4 Both systems failed the Deepwater Horizon in April
2010.
Chapter 2 picks up the BP story and explains why the Deepwater Horizon spill
was more than an accident. But to provide context for this and the many other
Reputation, Stock Price, and You 3
case studies that follow, it is important first to introduce the variables that can
transform a business operational event into a reputational event:
The event affects a large number of stakeholders
comprising many different interests.
Reputation-impacting business processes are at the heart of
the event.
24/7 news coverage and incessant exposure through social
media promote awareness of the event.
The companys antecedent PR campaign(s) is dissonant
with the unfolding facts of the event.
The companys inept crisis communications exacerbate the
ill-will triggered by the event.
Because all these key variables were present, BPs accident was a modern
reputational perfect storm. Deepwater Horizon is the poster child for a
reputational event in which the market punishes a company.
Reputational Stakeholders
The stakeholders who impact directly the profit and loss statement are
customers, employees, vendors and suppliers, and creditors. Investors set the
earnings multiple. The special stakeholders, by virtue of their enterprise-wide as
well as industry-wide influence, include corporate directors, analysts, and
regulators.
Though the perspectives and values of stakeholders vary, each of them forms
expectations of how a corporation will behave. In chapters devoted to each of
the stakeholders, Parts 2 and 3 of this book show how expectations stakeholders
hold about a company help shape a companys reputation and its stock price.
Reputation-Impacting Corporate Behaviors

Behaviors in six key areas of business performance underpin reputation: ethics,
innovation, quality, safety, sustainability, and security (Table 1-1). Reputation
is the summation of stakeholder expectations in these six areas of behavior.
Table 1-1. The Six Key Business Processes Underpinning Reputation5
Business Definitions
Process
Ethics The moral principles by which a company operates; integrity is the act of
adhering to those moral principles. Ethics are an integral part of governance
that, along with integrity, affect the reputation value of all other intangible
assets. Ethics are also the keystone intangible asset because they form the basis
for trust and confidence.
Innovation The design, invention, development, and/or implementation of new or altered

products, services, processes, systems, organizational structures, or business
models for the purpose of creating new value for customers and financial
returns for the firm. Intellectual Property is part of this.
Quality The extent to which a product is free from defects or deficiencies.

The extent to which a service meets or exceeds the expectations of customers or
clients, especially in comparison to peers.
The extent to which products and services conform to measurable and verifiable
criteria.
Safety The state of being reasonably certain that a set of conditions will not
accidentally cause adverse effects on the well-being of employees, the public, or
the environment.
Sustainability The making, using, offering for sale, or selling of products and services that
meet the needs of the present without compromising the ability of future
generations to meet their own needs.
Security The degree of protection a company offers against events undertaken by actors
intentionally, criminally, or maliciously for purposes that adversely affect the
firm. Because fear is the great disruptor of life and commerce, it is useful to
think of security, the most ethereal of the intangible assets, as absence of fear.
The chapters that follow show how companies cultures lead to choices in
managing ethics, innovation, quality, safety, sustainability, and security that
shape stakeholders expectations. They show how companies reputations affect
stakeholders economic behaviors and, in turn, how those behaviors create
reputational value shaping companies profit and loss statements and stock
prices. The book builds the business case for reputation awareness by operating
executives, reputational management by senior executives, and reputation
oversight by the board of directors. We conclude that since measurements
facilitate management, reputational value metrics can help companies do the
right thing by their stakeholders.
Reputation, Marketing, and Crisis

Communications
Reputation is an expectation of behavior shaped by direct personal experience
and by information from diverse secondary sources.6,7 The cacophony of
secondary sources has increased in step with the growth in the democratic
capabilities of the Internet: every individual armed with a keyboard, camera,
and Web access or even just a smartphone can be an investigative journalist.
While it remains true that communications professionals can help disseminate
information and shape a story with authentic content, they have less impact on
reputation creation than in the past.
Many businesses are still somewhat uncertain about whether to perceive
reputation as the outcome of actual business practices or as an image created
through company-generated communications. This book shows that it is both. It
is a diversity of communications channels and third-party signals, reflecting
authentic corporate behavior, that can help shape the expectations of
stakeholders. It also shows that when image-making is not grounded in
substance, it can produce highly counterproductive results.
Reputation and Risk Management

Executives are seeking reputation management advice, even if theyre not sure
where to look for it.8 They intuit a link between reputation and intangible asset
value and recognize that intangible assets comprise more than 65% of the value
of the average traded firm. Many have heard that improving a firms reputation
can add on average 6% to its enterprise value,9 and that the average major crisis
will shave 7% of a firms market capitalization. Growing awareness of the
importance of reputation is also showing up in corporate annual reports. As of
June 2012, 355 of the annual reports of the S&P 500 constituent companies
were disclosing the significance of reputation risk, up from only 40 firms in
2009.
This book considers the subject of reputation from the perspective of a risk
underwriter of reputational value. Most case studies conclude with action
points, and each chapter provides an actionable summary. The content is geared
toward improving readers understanding of the links between corporate
culture, behaviors, reputation, and value. The single most important
management lesson is that managing reputation means managing the business
processes underpinning reputation. Consider this:
Reputation is a consequence of corporate behavior that motivates stakeholders to behave in

ways that either reward or punish the corporation.
Organization of the Book

Chapter 2 is an overture that fleshes out the BP reputation story and details the
failure of reputation-linked business processes. It describes how the reputation
of BP evolved within each stakeholder group, how that evolution changed each
stakeholders expectations of BP, and how those changes triggered economic
consequences.
Part 2 of this book, comprising Chapters 3 through 7, focuses successively on
the classes of stakeholders whose actions directly drive revenues and the costs
of operations thereby creating measurable reputational value. Customers will
reward companies with superior reputations by accepting higher prices,
consuming greater volumes, and compressing purchase cycle times. In the
setting of a superior reputation, employees generally will work for lower wages
and create less operating friction; vendors and suppliers will provide superior
service at lower cost; creditors will provide capital on better terms; and equity
investors will grant management greater freedom to operate.
Part 3 looks at the groups of stakeholders with outsized influence on corporate
reputational value: corporate boards in Chapter 8, analysts in Chapter 9, and
regulators in Chapter 10.
Part 4 offers perspectives. The book overall is objectivejust as risk is an
objective probabilistic expectation of frequency and severity. In the spirit of
American pragmatism, this book observes and explains without moralizing.10
For example, we make no judgment on what ethical behavior is. A vast

literature exists on that subject dating to ancient civilizations. We dont define
it. Rather, we measure the results of behaviors associated with it.
Andrew Carnegie once said, I used to listen to what people say; I now pay
attention to what people do. We too look at behaviors: specifically, how each
class of stakeholders behaves in response to the organizations reputation.
Those behaviors constitute observable, empirical evidencenot judgments and
not speculative opinions. Those stakeholder behavior response patterns are the
pillars of reputational value metrics calculated by Steel City Re, employer of
this books author.
But since the drivers of reputation are corporate behaviors, and behaviors are
subject to moral hazard, Chapter 11 focuses on reputation as a human construct
in the context of liberal and conservative politics. It suggests that reputation can
provide a mechanism for merging human values and the profit-making
imperative of corporations.
Chapter 12 returns to form and introduces algorithmically generated
reputational value metrics on seven of the companies presented in the preceding
studies. These mathematical formulations objectively link reputation to the
actual public record of expected stakeholder behaviors in the market. These
algorithms generate dependable metrics that can offer guidance to stakeholders
interested in recognizing, shaping, and valuing the behaviors that create
corporate reputation.
Chapter 13 reviews central lessons in the volume and restates the business case
for reputation management on the premise that executives at all levels of an
organization can manage best that which they measure. And thats the essence
of Reputation, Stock Price, and You.
1 Broder JM. Oil Executives break ranks in testimony. New York Times. 15 June 2010. Available
at: http://www.nytimes.com/2010/06/16/business/16oil.html. Accessed 14 June 2012.

2 Elkind P, Whitford D, Burke D. BP: 'An accident waiting to happen'. Fortune. 24 January 2011.
Available at: http://features.blogs.fortune.cnn.com/2011/01/24/bp-an-accident-waiting-to-happen/

Accessed 22 July 2012.
3Accidental discharges of oil. Global Marine Oil Pollution Information Gateway. Available at:
http://oils.gpa.unep.org/facts/oilspills.htm Accessed 21 July 2012.
4 Repanich J. The Deepwater Horizon spill by the numbers. Popular Mechanics. 10 August 2010.
Available at: http://www.popularmechanics.com/science/energy/coal-oil-gas/bp-oil-spill-

statistics. Accessed 21 July 2012.
5 Kossovsky N, Miller TA. Mission: Intangible. Managing risk and reputation to create
enterprise value. Pittsburgh/Vancouver: Intangible Asset Finance Society/Trafford, 2010.

6Abdul-Rahman A, Hailes S. Supporting trust in virtual communities. In: Proceedings of the
Hawaii International Conference on System Sciences, Maui, Hawaii, 47 January 2000.
7Sheehan NT, Stabell CB. Reputation as a driver in activity level analysis: reputation and
competitive advantage in knowledge intensive firms. Corp Reput Rev. 2010;13:198208.
8 Schumpeter. Whats in a name? Economist,. 21 April 2012.
http://www.economist.com/node/21553033. Accessed 22 July 2012.

9Greenberg MD. On breaking the log jam: The how and why of corporate reputation leadership.
Corp Finance Rev. 2012; 17(1):1117.
10 Pfeiffer R. An introduction to classic American pragmatism. Philosophy Now,
October/November 2003 (43). Available at:

http://philosophynow.org/issues/43/An_Introduction_to_Classic_American_Pragmatism.
CHAPTER
A $54 Billion
Reputation
BP plc delivered the worst of a poor set of quarterly results among top oil
companies on Tuesday, slashing $US5 billion off the value of US assets and
undershooting expectations with its operating result. The British oil company
is struggling under the weight of litigation over the 2010 US Gulf oil
spillbringing the total set aside for the disaster to $US38 billion or well
over two years worth of profits at current prices.1
Canberra Times (31 July 2012)
For more than a century, BP (NYSE: BP) has been one of the worlds giant oil
producers. The company was founded in 1901 when a lawyer-turned-mining-
and-mineral-tycoon named William Knox DArcy negotiated with the Persian
Shah for a 60-year concession to explore for oil on property covering 480,000
square miles. Nearly a century later, in a $50 billion deal, British Petroleum
acquired Amoco Corporation, the fifth largest oil company in the United States
and largest producer of natural gas in North America, forming BP Amoco plc.
The Amoco name soon disappeared and the company has been known since
as BP plc.
2 Chapter 2 | A $54 Billion Reputation
Headline Risk: Reputation vs. Reality

From the mid-1990s to the early part of the new century, BP deliberately turned
greenat least in its public persona. In a speech on climate change at Stanford
University in March 2002, Lord John Browne, the group chief executive of the
British oil giant, declared BP to be a different kind of company: I believe the
American people expect a company like BPto offer answers and not
excuses. Companies composed of highly skilled and trained people cant live
in denial of mounting evidence gathered by hundreds of the most reputable
scientists in the world. Stakeholders took Brown at his word. BP was the first
to say that climate change was a problem, the first to take responsibility, and the
first to have an internal target for reducing their emissions, said Eileen
Claussen, the president of the Pew Center on Global Climate Change. They
were pretty brave.2
BPs reputation as a green company was solidifying in the early 2000s.
Although Tony Hayward, Lord Brownes successor, dismissed the idea that the
group was working to save the world, many employees continued to take the
green commitment very seriously.3
Time magazine framed stakeholders expectations in 2006 this way:
Pull into a BP station this holiday weekend and you may notice a green and
yellow starburst over the pump, an image intended to remind you, as youre
emptying your wallet of $20 bills, that at least youre supporting a green
company. BP, after all, was the first oil giant to publicly acknowledge the
risks of global warming, back in 1997. The firm has cut its own carbon
emissions 10% below 1990 levels and last year established an alternative
energies division. Its investing big money$8 billion over the next decade
on renewable fuels, such as wind and solar power. Just last week, BP
announced a partnership with DuPont to develop and commercialize
advanced biofuels (superior to ethanol), starting next year. Even if youre
being gouged at the pump, as you might suspect, BP at least seems to be
putting its profits to good use.4
BPs observable actions affirming a commitment to sustainability were

reinforced with an effective media campaign. Beginning in 2000, and at a cost
of $200 million, Ogilvy & Mather Worldwide initiated a campaign that aspires
to a conversational, almost confidential voice that suggests, You know what oil
companies do to the environment, and we do, too, but honestly, were not like
that at all.2 Out went the old British Petroleum shield that had been in Britain
for more than 70 years, and in came the green, yellow, and white sunburst that
seemed to suggest warm and fuzzy feelings about Earth.
Five years after the companys successful repositioning as oil industry leader on
environmental issues, a string of adverse events began chipping away at the
firms reputation. In 2005, an explosion at BPs Texas refinery in the United
States resulted in 15 deaths and 170 injuries. The company was forced to settle
1,350 lawsuits related to the refinery disaster, and hundreds of civil suits are
still pending. In 2006, corroded pipelines caused two BP oil spills in Prudhoe
Bay, Alaska, and 267,000 gallons of thick crude oil spread over two acres on
the Tundra of Alaskas North Slope. In 2007, BP agreed to pay $373 million in
restitution and fines to settle illegal propane trading allegations, including
alleged environmental violations centering on the Alaskan pipeline leaks and
Texas refinery explosion.
BP welcomed some good news in 2007 when the company inked an agreement
with Libya providing for access to deepwater blocks for exploration. Even that
news, however, was tainted by allegations that the deal was conditioned on the
United Kingdoms release of the Libyan intelligence agent, Abdel Baset al
Megrahi, the man responsible for the destruction of Pan Am Flight 103 and the
loss of 270 lives over Lockerbie, Scotland.
The list of adverse events continued to lengthen. In early 2009, the State of
Alaska, the U.S. Department of Justice, and the U.S. Department of
Transportation all filed civil lawsuits against BPs exploration business relating
to the 2006 Prudhoe Bay spill.
Stakeholders expectations, and the reputation that BP had established for its
unique concern for Earth, initially helped minimize the adverse effects of these
events. BP had created some degree of reputational resilience, exemplified by
this observation from Time magazine: Its also worth putting BPs
transgressions, alleged or otherwise, in context. No other integrated oil
companycertainly none with $285 billion in saleshas made a bigger
commitment to alternative energy, cutting greenhouse gases and educating the
public about conservation.4 A January 2007 issue of Business Week reinforced
a positive perception of BP with the cover story, Beyond the Green
Corporation. Pondering whether socially responsible policy could also add to a
companys bottom line, the article contended that Innovest's better-than-Exxon
AA risk rating for BP was derived from its $8 billion commitment to alternative
energy.5
But BP was under financial pressure. When Tony Hayward assumed the helm
of BP in 2007, he received a mandate from the board: no more safety disasters.
He committed to increase the companys attentiveness to safety. Just a few

months later, Hayward made a second pledge to boost BPs dreadful bottom
line, promising to close an $8 billion profit gap with Shell. That, of course,
meant cutting budgets.6
Hayward was aware of the tension between the costs of safety processes and
profits. The U.S. Chemical Safety Boards 341-page report after the 2005 Texas
City refinery fire identified one major cause to be corporate cost-cutting.
Furthermore, the company was aware of the importance of key business
processes to its value and proudly disclosed its safety management processes to
its shareholders. The companys 2009 Annual Report disclosed that a key
enabler for safe, reliable, and compliant operations was the BP Operating
Management System, which provides a common framework for all BP
operations, designed to achieve consistency and continuous improvement in
safety and efficiency. BPs operating management system includes mandatory
practices, such as integrity management and incident investigation, which are
designed to address particular risks.
BP also asserted that these processes created value when deployed by the right
people with the right skills and capabilities. But given the relative
underperformance of equity, the company also acknowledged that it needed to
improve performance. They stated that incentives were in place to create value
for shareholders. Our people strategy has already resulted in refreshed group
leadership and senior management teams, recruitment focused on individuals
with strong operational and technical expertise, and appropriate reward for
performance at all levels (italics ours).
Notwithstanding those incentives, the federal Occupational Safety and Health
Administration (OSHA) proposed in 2009 a record fine against BP for failure
to abate previously cited hazards at Texas City.7 OSHA also cited BP for
hundreds of new willful safety violations, which, according to the Center for
Public Integrity, totaled 829 from June 2007 to February 201097% of the
violations for the entire industry.6 In short, as the chairman of the federal
Chemical Safety Board observed, BP had yet to achieve an effective safety
culture with regard to process safety management.8
The BP Regional Oil Spill Response PlanGulf of Mexico, dated June 30,
2009, covers all of the giant oil companys offshore operations in the Gulf and
is one more example of a work product developed in an environment that had
yet to develop an effective safety culture.9
BP mentioned sea lions, seals, sea otters, and walruses in its planArctic animals that had
not been seen in the Gulf for millions of years.
The BP plan offered a Japanese home shopping site as the link to one of its primary
equipment providers for BP in the Gulf of Mexico Region [for] rapid deployment of spill
response resources on a 24 hour, 7 days a week basis.
In due course, lawmakers and TV comics would find fodder for incredulity and
humor throughout.10 Three omissions were less laughable:
The plan included no information about tracking subsurface
oil plumes from deepwater blowouts, although more oil
might spread below the surface than at the top.
The plan included no oceanic or meteorologic data, despite
the ocean-floor site being in a hurricane-prone region.
The plan included no measures for preventing viral and
bacterial disease transmission to captured animals in rehab
facilities. This had been found to be a major risk after the
Exxon Valdez spill.
When metrics and control systems go awry and cost-cutting happens, morale
among employees tends to decline quickly. One indication of morale decline at
BP was an increase in complaints filed under BPs code of conduct. This code is
designed to ensure that all employees comply with legal requirements and
company standards in key areas such as safety, workplace behavior, bribery and
corruption, and financial integrity. A second indication of morale decline was
an uptick in employee complaints under Open Talk, a BP program that enables
employees and contractors to report confidentially safety concerns or any
suspected breach of compliance, ethics, or the code of conduct. When
complaints under the Open Talk program decreased from 1,064 in 2006 to 874
in 2009, BP inferred that the risk controls in their operating management system
were working. In fact, when normalized against a shrinking employee pool, the
reporting rate was actually increasing. On the other hand, dismissals for
violations fell off sharply. Slipping morale began to show elsewhere. In 2008,
for example, only 42% of employees even bothered to respond to the survey on
employee engagement.
Reputationally Linked Process Failure

Safety is a reputationally linked process. In the energy business, process safety
generally comes down to a single issue: keeping hydrocarbons contained inside
a steel pipe or tank.6 An early chapter of the official U.S. government report,
issued less than eight months after the explosion, explains that the disaster was
not fortuitous but institutional. The January 2011 report, Deepwater: The Gulf
Oil Disaster and the Future of Offshore Drilling, observed that most of the
mistakes and oversights at [the] Macondo [well] can be traced back to a single
overarching failurea failure of management.11,12 All stakeholders were
affected by the failure.
The 24/7 news cycle brought stories that outraged stakeholders of every variety.
Many vented through various social media channels. The media saw that
adverse BP news sold content and advertising and they produced more of the
same. The ink in the drink, as the disaster was soon called, generated
predictable reactions among every stakeholder group: customers, employees,
suppliers, creditors, equity investors, the board, analysts, and regulators.
Customers
Both customers and potential customers of BP were shocked. Initially most
customers seemed to withhold negative reactions.13 But three months into the
crisis, the average consumerand how many individuals of driving age are not
potential consumers of BP-branded fuel products?began to look at BP
differently. Many had seen the logos yellow sun and green leaves as evidence
that the company was beyond petroleum and different from other oil
companies and expected different behavior from the firm. They were
profoundly disappointed and felt deceived.
In 1998, Ernest Lowe and Robert Harris published a paper in Corporate
Environmental Strategy lauding BP for Taking Climate Change Seriously:
British Petroleums Business Strategy. Twelve years later, they added a red-
letter banner to their website:
BPs Deep Horizon Blowout demonstrates that the company culture reported
on in this [1998] paper has drowned in deeply polluted water. BPs own
employees are reporting pre-blow out decisions made on a least cost rather
than lowest risk basis, decisions leading to the deadly explosion of the oil
platform. This disaster is already at the scale of the Exxon Valdez oil spill,
with oil and toxic dispersants soaking Gulf wetlands, killing birds and
marine life, and threatening the livelihood of tens of thousands of fisherman,

processors, and tourist industry employees. Perhaps BP and the rest of the
petro-industry can learn from the golden era described here.14
In the aftermath of the spill, BP-branded gas stations reported sales declines of
10%40% from Florida to Illinois.15 But BP owned just a fraction of the more
than 11,000 stations across the United States that sold fuel under the BP banner.
In an unfortunate demonstration of unintended consequences, the boycotts hurt
mostly independent business owners who licensed the BP brand, and the net
effect on BPs revenue line was negligible because the drop in BPs branded-
fuel sales was offset by an almost equal jump in its unbranded-fuel sales.
Brand licenses eventually come up for renewal, and a BP-branded service
station can just as easily offer fuel and convenience products under alternative
brands. In 2011, BP reported 2.6% fewer BP, ARCO, and Aral retail brand
licensees and 7% lower branded-fuel sales globally than in 2009.29
Fuel is fungible. Notwithstanding a damaged brand, BP can just as easily
distribute fuel through resellers who will then bring white-label products to
market. In 2011, BP reported 5.9% higher unbranded-fuel sales globally than in
2009.
Employees
Employees, including the CEO, suffered in the usual way: loss of morale and
turnovers. Five weeks after the explosion, CEO Tony Hayward wrote an e-mail
to all BP employees apprising them of the particulars of the event and response.
He closed with a direct appeal: [My]request of you all remains the sameto
stay focused, and do all that you can to ensure we have safe, reliable and
efficient operations, wherever you are working.16 Meanwhile, the company
was shedding 800 more employees from its U.S. operationsa net of 3.5%,
mostly from the corporate unit.
Everybody is really angry, said an employee at the London headquarters in
St. Jamess Square to the Financial Times. There is some sympathy that this
may be down to bad luck. But [chief executive] Tony Hayward has made the
situation a million times worse. The reaction of staff mirrored that of the
outside world. The question they were asking is: Am I working for the company
I thought I was working for, with the right values?17
Internally, there were two major worries. The first was whether concerns about
BPs potential liabilities would hold back crucial investments in other parts of
the business. But the bigger internal worry was how both the widespread
disillusionment and potential cash crunch would impair the ability of BP to pay
enough to retain and recruit talent.
The stress of four months of relentless crisis management took its toll on the
CEO. When he closed an apology for the disruption to the lives of Gulf of
Mexico area residents, he added for emphasis, Theres no one who wants this
over more than I do. Id like my life back.3 Against memories of videos of
Hayward at polo matches and of Deepwater deaths, it was a gaffe heard round
the world. The company gave him his life back in July, replacing him with new
CEO Bob Dudley.
Suppliers
As one of many cost-cutting strategies in 2009, BP began to simplify supplier
relationships. Mr. Hayward spoke of his commitment to driving deflation into
the supply chain18 and reduced the number of IT suppliers from 40 to 5. 19 In
the Gulf of Mexico, the company was drilling in cooperation with suppliers
Halliburton and Transocean. Strategic partnerships with a few key suppliers is
clearly better than managing many, but to succeed in any strategic
multisourcing, governance becomes critical. With BP, merely shrinking the
number of suppliers was inadequate when both supply-chain visibility and
governance fell far short of the task.20 Transocean, Halliburton, and other
partners made small safety tradeoffs that combined to create a much higher
overall risk profile for the ultimate provider of goods to the end-customer, BP.
After the explosion, supplier-associated costs jumped as companies discovered
that doing business with BP was riskier than previously imagined. Credit risk
was an obvious consideration as BPs cash flows began being channeled in a
variety of unexpected directions (see Chapter 9). Vendors also discovered that
BP was attempting to spread some of the costs of the fallout. After adjusting for
declines in the wider stock market, BPs two minority partners, Anadarko and
Mitsui, and the rigs owner, Transocean, lost about $35 billion in combined
value.21 BP also sued its vendors: On April 21, BP sued Halliburton and
Cameron International over the Gulf disaster, aiming to hold Halliburton
accountable for improper conduct, errors and omissions, including fraud and
concealment. Halliburton said it would vigorously deny these claims. BP
also filed suit against Transocean Ltd., the Deepwater Horizons owner and
operator. According to BPs complaint, the former breached its contractual
duties, including failing to adequately maintain the rig and fix earlier engine
problems and failing to train its crew and properly coordinate efforts to fight
fires on the vessel. They also sued Cameron International over allegations that
the blowout-prevention equipment they had supplied was a cause in whole or
in part of the blowout and ensuing oil spill in the Gulf.22
The increased risk of doing business with BP ballooned production and
manufacturing expenses. From 2008 to 2009, BP had cut its expenses from $26
billion to $23 billion, and cut purchases from $266 billion to $163 billion. In
2010, among the consequences of the explosion were jumps in expenses by $41
billion to $64 billion and in purchases by $53 billion to $216 billion.10 Included
in these additional $94 billion in costs were $40 billion BP set aside for various
claims. As of April 2012, vendors conducting cleanup operations pocketed
around $14 billion of BP money.
Creditors
Though BP was asset-rich, its liquidity position was challenged before the spill.
After the spill, its credit costs rose dramatically as its credit-spread movements,
usually measured in hundredths of a percentage point, rose to six percentage
points over government rates. The Economist noted at the time that such
dramatic deterioration in perceived creditworthiness can create a vicious and
unpredictable spiral. There was a fear that counterparties to BPs giant and
poorly disclosed derivatives book might demand extra collateral from it, leading
to big cash calls.20 Or not lend at all.
Tony Hayward spoke of how capital markets were effectively closed to BP at
the height of the crisis. We were not able to borrow in the capital markets
either short or medium-term debt at all, he said.23 Bob Dudley called it a near-
death experience.
The regulatory arms of the executive branch and the oversight arms of the
legislative branch of the U.S. government, as described below, pummeled BP.
A meeting with U.S. President Barack Obama on 16 June 2010 gave BP what it
desperately needed to calm the credit markets, starting with a limit on its
damages outlay. Obama promised to end his market-rattling assault, telling
the world, BP is a strong and viable company, and it is in all of our interests
that it remain so. Said Hayward: We needed political calmness. We needed to
stop being attacked by the most powerful government in the world.6
The reputational benefits of this about-face by the United States were
desperately needed. BP was not so lucky enlisting help from its home
government. Much-needed relief from financial pressure through a parallel
strategy involving investment by a sovereign wealth fund was thwarted by
concurrent suggestions that BP had pressured the British government into

commercially beneficial but ethically questionable actions.
Nineteen days after the BP executives meeting with the U.S. president, on 5
July 2010, the chairman of Libyas national oil company disclosed that he was
encouraging Libyas sovereign wealth fund to take a strategic stake in BP. The
announcement came shortly after news that Libya had agreed to allow BP to
start drilling off shore in accordance with a 2007 agreement. While these two
pieces of news might have opened capital markets, they were instead met by
howls of outrage when the physician who had diagnosed former Libyan agent
Megrahis terminal prostate cancer and given him three months to livethe
grounds given for his compassionate release by the United Kingdom the year
beforestated that on further reflection he could survive for 10 years or
more.24 In fact, Megrahi succumbed to his cancer nearly 6 years later in May
2012.
Equity Investors
In 2009, BP profits fell by 45% as Tony Hayward received a 41% increase in
his remuneration package comprising about 4 million ($6 million) in salary,
bonus, and share awards. Four days before the Deepwater Horizon explosion,
BP appeared to have shrugged off fears of a shareholder revolt over its
executive pay policy after preliminary results showed that notwithstanding the
lobbying of PIRC, the investor body, 84% of shareholders voted in favor of its
remuneration plans.25
After adjusting for declines in the wider stock market, about $65 billion was
wiped off the value of BP in the first eight weeks following the crisis.
Shareholders reacted through both their votes and their lawyers.
At the 2010 annual general meeting, Sir William CastellBPs senior
independent director and chairman of the safety committeesaw 43% of
shareholders vote against his re-election. He stepped down from the board. BP
Chairman Carl-Henric Svanberg saw 15% of shareholders vote against him, but
he managed to retain the confidence of the majority of investors.26
In the aftermath of the event and the loss in equity value, shareholders filed
three derivative lawsuits in the United States against the directors and officers
of BP.27 The lawsuits allege that the blowout, fire, and oil spill could have been
prevented if the directors and officers of BP had paid more attention to safety
issues. The plaintiffs allege that the directors and officers have a fiduciary duty
to put in place and monitor systems that will detect and address those problems,
but the defendant BP officials only went through the motions. They further
allege a pattern of accidents and other close calls should have alerted BP CEO
Tony Hayward and other high-level employees that their cost-cutting measures
left the company vulnerable, but they still ignored the red flags. Last, the suits
allege breach of fiduciary duty and waste of corporate assets.
The plaintiffs sought more than monetary damages. They also asked the court to
force BPs board to institute a long list of corporate governance changes aimed
at improving accountability and transparency at BP.
In September 2011, Judge Keith Ellison of the Southern District of Texas
dismissed the cases, as the English High Court is the more appropriate forum
for this case.28 Yet, as recently as July 2012, investors were still trying to
revive the cases in the United States Fifth Circuit.
BP Executives and Board of Directors

After replacing CEO Tony Hayward with Bob Dudley in July 2010, the
embarrassed board took an active interest in safety oversight. On safety, the
board supported and challenged Bob Dudley and his executive team as they
restructured and enhanced BPs processes, systems, and culture. They also
initiated a review of the way BP manages, reports, and acts on risk, including
board oversight.29
Capital Market Analysts

Nine weeks into the crisis, Moodys slashed BPs credit rating by three notches,
saying its downgrade reflects the worsening impact expected from the oil
pouring into the Gulf of Mexico. Fitch, another rating agency, downgraded the
company to close to junk levels.
Regulators
Over a 12-week span following the explosion, Congress held more than 50
hearings and examined more than 80 bills related to the spill, including some
that would limit BPs future business opportunities.30 Investigations continued,
with U.S. Attorney General Eric Holder stating on April 24, 2012, The
Deepwater Horizon Task Force is continuing its investigation into the explosion
and will hold accountable those who violated the law in connection with the
largest environmental disaster in U.S. history. The first arrest related to the
spill was in April 2012; an engineer was charged with obstruction of justice for
allegedly deleting 300 text messages showing BP knew the flow rate was three
times higher than initial claims by the company, and for knowing that the Top
Kill effort to cap the well was unlikely to succeed, but claiming otherwise.31,32,33
Health, safety, and environment fines and penalties levied by regulators totaled
only $77.4 million in 2011not much more than several past years had cost.34
Penalties and fines, however, are lagging indicators. Under the Clean Water
Act, depending on whether the company is found grossly negligent, BP plc
could be fined between $5.4 billion and $21.1 billion.35 The Department of
Justice signaled that it was looking for an out-of-court settlement of $25 billion.
BP is hoping to settle for under $15 billion. As of June 2012, $11 billion
remained in the fund BP set aside in 2010 for all Gulf-related claims,36 but only
$3.5 billion of that fund was allocated for penalties under the Clean Water Act.
Those could balloon to $21 billion if the Justice Department proves gross
negligence. The Financial Times concluded that a gross negligence finding
would seriouslyperhaps fatallydamage BPs reputation.37
Reputational Value Lost: Summary

The economic consequences of BPs reputational fall after April 2010
underscore how much value BP had created in its reputation and how much it
had placed at risk by not instituting the oversight or operational controls needed
to effect a thorough cultural transformation. Relative to 2009 on a per-barrel
basis,38 in 2011 BP spent 81% more on goods and services, 8% more to produce
and manufacture, 41% more to explore, and 16% more to finance its operations
(Table 2-1). In total, a reasonable estimate of the dollar value lost by BP
amounts to $91 billion in direct and increased costs in 2010 and $124 billion in
inflation-adjusted costs in 2011 for a total of $215 billion of additional costs
over two years relative to 2009. With respect to enterprise value, between 10
March 2010, and 1 June 2012, while the S&P 500 composite equity index
climbed 9.3%, BPs stock price dropped 35.4%. The 44% difference would add
around $54 billion to BPs enterprise value. It is one of the most dramatic
examples on record of a failure of oversight and management of the elements of
reputation.
Table 2-1. Proportional Cost Increases (Decreases) over the 2009 Pre-Disaster BP Group P&L
Statement
Cost Item per Barrel 2010 (%) 2011 (%)
Purchases (expense) 41.57 80.86
Production and manufacturing expense 198.63 7.92
Exploration expense (19.00) 41.24
Finance costs 13.03 16.41

Retrospective
Following the Deepwater Horizon accident, BP entered 2011 facing a range of
uncertainties. These included concerns about its ability to operate safely in
deepwater; meet its financial commitments in the Gulf of Mexico; and, more
broadly, how to recover the trust and reputational value it had lost. The 2011
annual report reflects these concerns and presents a company that is focused on
safety, trust, and risk management at the highest levels of the organization.
These intangible assets are presented in an integrated operational framework.
Innovation, safety, security, and sustainability receive joint mention under the
heading of Reputation and Competitive Advantage:
Our development and application of technology represents [sic] a distinctive

capability that is central to our reputation and competitive advantage. For
us, technology is the practical application of scientific knowledge to manage
risks, capture business value and inform strategy development. This includes
the research, development, demonstration and acquisition of new technical
capabilities and support for the deployment of BPs know-how.
We monitor the potential opportunities and risks presented by emerging

science, interdisciplinary innovation and new players; natural resource
issues and climate concerns; and evolving policy concerns, including the
current emphasis on energy security and efficiency.
In 2011, the company deployed a multi-tiered risk-management solution to

manage three types of risks: strategic, safety and operational, and compliance
and control. Under the heading of safety and operational risks came process
safety, environmental risk, physical security, product quality, cyber security,

and crisis management and business continuity. The purposes of the integrated
solution were to reduce costs, mitigate overall risks, and protect the companys
reputation.
At the group level, the safety and risk management component included targets
for recordable injury frequency, loss of primary containment, and
implementation of change programs. Significantly, safety was now a factor in
the executive bonus plan. This underlined the companys strategic priorities of
reinforcing safety and risk management at the highest executive and board
levels.
BPs board considered reputation from two perspectives: the reputational risks
to the group and the processes the company has in place to manage these risks.
In 2011, the board reviewed external reputation data that looked at BPs
reputation in the United Kingdom and United States. It also discussed the
groups communications strategy and its reputation-management plan.
To underscore how serious BP was about reputation and its risk management,
the annual report employed the term twenty times in the Item 1A. Risk
Factors section of Form 10-K. The term also appeared liberally throughout the
balance of the document (a total of 45 mentions over 20 different pages in the
300-page document). The processes of rebuilding trust and reinforcing value
creation were now focused on external reputation measured by external surveys
and internal morale measured by internal surveys.
All these changes reflected what BP argued was an improvement in its culture
for safety. It was a challenging argument to make in the face on ongoing
regulatory pressures, for, as the Financial Times noted: If the U.S. Department
of Justice does push its accusations of gross negligence against BP to trial,
disinterested observers can look forward to a detailed exploration of the oil
companys culture and management.39
Consider This
Authenticity is important. BP aggressively promoted an
image of the firm that, while aspirational, was at odds with
reality. If you tell the world how great you are, you had
better live up to your hype. Jerry Della Femina, reputedly
an inspiration for the TV series Mad Men,40 observed,
Nothing kills a bad product faster than good advertising.41
Restoring a reputation entails more than marketing.

Implementing authentic operational controls and linking
them to reputation risk and value, as BP reported in their
2011 annual report, was an exemplary demonstration of
evolution in process control and risk management to reduce
reputational volatility and stabilize enterprise value.
When trust is violated, authenticity may require a third
partys validation. BPs long history of reputational crises
will doubtless color its reputational metrics for some time
to come. Stakeholders remain cautious about revaluing the
company until such time as credible third parties or insurers
validate real behavior changes from BPs reputation
restoration efforts.
By the Numbers
BPs story dramatizes the measurability and magnitude of reputational value,
and how each stakeholder impacts that value. In keeping with this books
mission of showing the relationship among reputation, stakeholder behaviors
that are reflected in measures of profit and loss, and stock price, Table 2-2 and
all similarly placed tables at the end of each future chapter recap quantitative
measures introduced in the preceding materials.
Table 2-2. Reputational Value Losses: Additional and Extraordinary Costs of BPs Reputational
Crisis Arising from Stakeholder Behaviors
Stakeholder Effects on BP plc
Customers 2.6% fewer BP, ARCO, and Aral retail brand licensees and 7%
lower branded fuel sales globally than in 2009
Employees Morale: overall employee satisfaction index score (BP internal

metric) for 2011 (62%) was below the score from 2009 (65%);
CEO fired.
Vendors and suppliers $94 billion in additional expenses

Production: 8% increase over 2009
Exploration: 41% increase over 2009
Creditors Liquidity crisis; net cost of credit 16% increase over 2009; credit
default swap spreads August 2012 about 35 basis points higher
(70% higher) than March 2010
Investors Two board members not re-elected; three derivative lawsuits;

and friction over future CEO compensation
Board of Directors Additional responsibilities; new compensation plans with

reputation and safety-linked bonus
Analysts Credit downgrade: S&P AA (stable outlook) before the event to

A (stable outlook) by December 2011
Regulators 50 hearings; 80 bills; and $15$25 billion in fines and penalties
All stakeholders combined Net $54 billion in lost market capitalization
1 BP results hit by $US5b US writedown. Canberra Times. 31 July 2012. Available at:
http://www.canberratimes.com.au/business/mining-and-resources/bp-results-hit-by-us5b-us-
writedown-20120731-23cos.html. Accessed 4 September 2012.
2 Frey D. How green is BP? New York Times. 8 December 2002. Available at:
http://www.nytimes.com/2002/12/08/magazine/how-green-is-bp.html?pagewanted=all&src=pm.
Accessed 17 June 2012.
3 BP CEO Tony Hayward (VIDEO): 'Id like my life back.' Huffington Post. 1 June 2010.
Available at: http://www.huffingtonpost.com/2010/06/01/bp-ceo-tony-hayward-
video_n_595906.html. Accessed 14 June 2012.
4 Fonda D. Is BP really that green? Time. 29 June 2006. Available at:
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5 Solman G. BP: coloring public opinion? Adweek. 14 January 2008. Available at:
http://www.adweek.com/news/advertising/bp-coloring-public-opinion-91662. Accessed 17 June
2012.
6 Elkind P, Whitford D, Burke D. BP: 'An accident waiting to happen.' Fortune. 24 January 2011.
Available at: http://features.blogs.fortune.cnn.com/2011/01/24/bp-an-accident-waiting-to-

happen/. Accessed 22 July 2012.
7Aulds TJ. OSHA slaps BP with record $87M fine. The Galveston Daily News. 31 October 2009.
Available at: http://galvestondailynews.com/story.lasso?ewcd=3a8ab45c2e06da20 Accessed 22
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8 Greenhouse S. BP to challenge fine for refinery blast. New York Times. 30 October 2009.
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9 Regional oil spill response plan Gulf of Mexico. Public Intelligence. 20 May 2010. Available
at: http://publicintelligence.net/bp-gulf-of-mexico-regional-oil-spill-response-plan/ Accessed 15

September 2012.
10Mohr H, Pritchard J, Lush T. BP spill response plans severely flawed. Associated Press. 9 June
2010. Available at: http://www.msnbc.msn.com/id/37599810/ns/disaster_in_the_gulf/t/bp-spill-
response-plans-severely-flawed/#.T9pJzvGN9qI. Accessed 14 June 2012.
11 An oil spill born of complacency. Financial Times. 6 January 2011. Available at:
http://www.ft.com/intl/cms/s/0/2159e888-19cd-11e0-b921-00144feab49a.html#axzz1xzO61Xtp.
12 National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling.
Deepwater: the Gulf Oil disaster and the future of offshore drilling. 11 January 2011. Available
at: http://www.oilspillcommission.gov/final-report. Accessed 15 September 2012.
13 Antczak J. Gulf oil spill yet to affect consumers' gas choice. Associated Press. 5 May 2010.
Available at: http://www.newsvine.com/_news/2010/05/05/4243815-gulf-oil-spill-yet-to-affect-

consumers-gas-choice. Accessed 14 June 2012.
14 Lowe EA, Harris RJ. Taking Climate Change Seriously: British Petroleums Business Strategy.
Ph. D thesis published in Corporate Environmental Strategy. Winter 1998. Available at:
http://www.indigodev.com/BPclim.html. Accessed 15 June 2012.
15Some BP gas station owners believe name change to Amoco might bring back angry customers.
Associated Press. 30 July 2010. Available at:
http://www.cleveland.com/nation/index.ssf/2010/07/some_bp_gas_station_owners_bel.html.
16 Gulf of Mexico oil spill: Tony Hayward's email to BP staff. The Telegraph. 19 May 2010.
Available at: http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/7743054/Gulf-
of-Mexico-oil-spill-Tony-Haywards-email-to-BP-staff.html. Accessed 14 June 2012.
17 Boxell J, Crooks E. Inside BP: a giant wounded. Financial Times. 15 July 2010. Available at:
http://www.ft.com/intl/cms/s/0/bded3254-9048-11df-ad26-00144feab49a.html#axzz1xp9rjZI0.
18 Crooks E. BP pledges to keep spending plans. Financial Times. 4 February 2009. Available at:
http://www.ft.com/intl/cms/s/0/4f3fa228-f25c-11dd-9678-0000779fd2ac.html#axzz1xzO61Xtp.
19 BP: the challenges of strategic multi-sourcing. Computer Weekly. 28 August 2009. Available
at: http://www.computerweekly.com/news/1280096992/BP-the-challenges-of-strategic-multi-
sourcing. Accessed 16 June 2012.
20 Operations lessons from BP. Corp Exec Board Views. September 12, 2010. Available at:
http://cebviews.com/2010/09/12/operations-lessons-from-bp/. Accessed 16 June 2012.
BP counts the political and financial cost of Deepwater Horizon. The Economist. 17 June 2010.
21
Available at: http://www.economist.com/node/16381032. Accessed 16 June 2012.

22 BP: Finger pointing. Mission Intangible blog of the Intangible Asset Finance Society. 29 April
2011. Available at:

http://www.iafinance.org/_blog/MISSION_INTANGIBLE/post/BP_Finger_pointing/. Accessed
17 June 2012.
23 Crooks E. Bad calls preceded Gulf of Mexico blast. Financial Times. 9 November 2010.
Available at: http://www.ft.com/intl/cms/s/0/a51cfcbc-ec0c-11df-b50f-

00144feab49a.html#axzz1AIvCT9ip. Accessed 17 June 2012.
24 Jamieson A. Dying Lockerbie bomber 'could survive for 10 years or more.' The Telegraph. 4
July 2010. Available at:

http://www.telegraph.co.uk/news/worldnews/africaandindianocean/libya/7871234/Dying-
Lockerbie-bomber-could-survive-for-10-years-or-more.html. Accessed 14 June 2012.
25BP shareholder revolt over executive pay plans shrugged off. Personnel Today. 16 April 2010.
Available at: http://www.personneltoday.com/Articles/16/04/2010/55255/bp-shareholder-revolt-
over-executive-pay-plans-shrugged-off.htm#.UAxRskS1_-k. Accessed 22 July 2012.
26 Macallster T. BP faces shareholder revolt over Bob Dudley's pay. The Guardian. 11 April
2012. Available at: http://www.guardian.co.uk/business/2012/apr/11/bp-shareholder-revolt-bob-

dudley-pay. Accessed 22 July 2012.
27 Grimm MR, Herman HR, Herman TR. Director and Officer Insurance and the Gulf Oil Spill.
Clausen Miller. August 2010. Available at:
http://www.clausen.com/index.cfm/fa/firm_pub.article/article/1abaff03-46ad-4092-a974-
7ce99b7bab0a/Director_And_Officer_Insurance_And_The_Gulf_Oil_Spill.cfm. Accessed 22
July 2012.
28 LaCroix, K. BP Deepwater Horizon derivative suit dismissed in favor of English forum. The
D&O Diary. 19 September 2011. Available at:
http://www.dandodiary.com/2011/09/articles/shareholders-derivative-litiga/bp-deepwater-
horizon-derivative-suit-dismissed-in-favor-of-english-forum/. Accessed 22 July 2012.
29 BP Annual Report and Form 20-F 2011 p10.
30 Werdigier J, Mouawad J. Road to new confidence at BP runs through U.S. The New York
Times. 26 July 2010. Available at:
http://www.nytimes.com/2010/07/27/business/27dudley.html?pagewanted=all. Accessed 14 June
2012.
31Rudolf J. Kurt Mix, BP engineer, faces first oil spill charges (UPDATES). Available at:
Huffingtonpost.com. Accessed 14 June 2012.
32Johnson K, Jervis R. Former BP engineer charged in oil spill probe. USA Today. 24 April 2012.
Available at: http://www.usatoday.com/money/industries/energy/story/2012-04-24/bp-oil-spill-
arrest-justice-department/54504158/1. Accessed 14 June 2012
33Lustgarten A. Feds file first criminal charges related to BP Gulf spill. ProPublica 24 April
2012. Available at: http://www.propublica.org/article/feds-file-first-criminal-charges-related-to-
bp-gulf-spill. Accessed 14 June 2012.
34 BP Global HSE fines and penalties. Available at:
http://www.bp.com/sectiongenericarticle800.do?categoryId=9036151&contentId=7066887.
35 Burdeau C. BP oil spill: fines from Clean Water Act will go to restoration. Associated Press. 8
March 2012. Available at: http://www.huffingtonpost.com/2012/03/09/bp-oil-spill-fines-

restoration_n_1333019.html. Accessed 17 June 2012.
36 Hammer D. BP wants to pay less than $15 billion to settle government spill claims, London
paper says. Times-Picayune. 8 June 2012. Available at: http://www.nola.com
/news/gulf-oil-spill/index.ssf/2012/06/bp_wants_to_pay_less_than_15_b.html. Accessed 17 June
2012.
37 Lex. BPstill in deep water. Financial Times. 5 September 2012. Available at:
http://www.ft.com/intl/cms/s/3/b30160b0-f75a-11e1-8e9e-00144feabdc0.html#axzz25h3VSeTG.
Accessed 6 September 2012. According to the FT, Lex is a premium daily commentary service
from the Financial Times. It is the oldest and arguably the most influential business and finance
column of its kind in the world. It helps readers make better investment decisions by highlighting
key emerging risks and opportunities. The column long ago gave up the pretence of being the
work of a single person, and now includes six London-based writers, four in New York and one in
Hong Kong. Most of the team has prior industry experience at investment banks, management
consultancies or research houses, allowing Lex to conduct the primary analysis essential to its
intellectual independence. Lex remains the template that other financial commentary follows; its
alumni have also founded or are running many of the newer columns inspired by Lex, including
Reuters Breakingviews and the Wall Street Journals Heard on the Street.
38 Historical crude oil prices (table). Available at:
http://inflationdata.com/inflation/inflation_rate/historical_oil_prices_table.asp. Updated June 14,
2012. Accessed 23 June 2012.
39 Hill A. DoJs plan to put BPs culture on trial. Financial Times. 5 September 2012. Available
at: http://blogs.ft.com/businessblog/2012/09/dojs-plan-to-put-bps-culture-on-
trial/#axzz26YjLMWYP. Accessed 15 September 2012.
Wikepedia. Jerry Della Famina. Available at: http://en.wikipedia.org/wiki/Jerry_Della_Femina.
40

41 Famous quotes on advertising and copywriting. Available at:
http://www.zagstudios.com/ZagStudios/famous_quotes_on_advertising.html. Accessed 22 June
2012.
CHAPTER
Customers
Repetition makes reputation and reputation makes customers.
Elizabeth Arden
Setting the Stage

Customers are thoughtful people. They have choices. Customers may act on
behalf of themselves or their households, businesses, or government offices. But
regardless of who foots the bill, customers are intelligent decision makers.
When they make a decision, three major factors are in play: price, quality, and
reputation.1,2,3 Moreover, unless price is the only consideration by virtue of a
lowest bid mandate, reputation will reduce customers sensitivity to price,
increase sales volume, and accelerate the speed with which purchase decisions
are made.
This chapter builds on the BP case that illustrated a complex relationship
between customer and company and an evolving reputation. The focus is on
how reputations are formed in the minds of customers; how reputation
valuethe economically relevant actions triggered by reputationimpacts the
revenue line of the Profit and Loss statement; and, ultimately, how these
customers behaviors impact stock price.
The BP case showed how customers responded to a lost reputation. Even
though petroleum products are fungible commoditiesautomobile engines will
2 Chapter 3 | Customers
shamelessly burn 89 octane gasoline drawn from any pumpwith no obviously

discernible features from competitive products, the costs of BPs reputational
crisis were that brand licenses fell off 2.7% and branded fuel sales fell off 7%.
To illustrate the points with noncommodities, we turn to case studies on several
key drivers of reputation. For Rolls-Royce Holdings plc, the dominant concern
for stakeholders is safetyin this case the unerring performance of the Rolls-
Royce aircraft engines. For Zale Corporation, the dominant concern for
stakeholders is quality of service. For Research In Motion Limited, innovation
is the critical dimension of reputation.
Safety
[Safety is] the state of being certain that a set of conditions will not
accidentally cause adverse effects on the well-being of employees, the public,
or the environment. (Table 1-1)
On 4 January 2011, an anonymous poster left an ominous query on

Answers.com: Is the Rolls-Royce Trent 900 engine safe? Nine weeks earlier,
Qantas flight QF32 from Singapore and Sydney was forced to turn back and
make an emergency landing after an explosion in one of the aircrafts Rolls-
Royce enginesa Trent 900. The force of the blowout damaged the body of the
plane, an Airbus A380, and, to put it mildly, heightened the awareness of 433
passengers and 26 crew members. It also rained debris on the Indonesian island
of Batam below.4 A second Qantas flight, a Boeing 747 with the same type of
Rolls-Royce Trent 900 engine, had to return to Singapore a day later, and
shortly thereafter, Qantas reported that it found oil leaks that were beyond
normal tolerances in Trent 900 engines on three additional aircraft. In a story
headlined Rolls-Royces reputation is most of its value, Robert Cole, writing
for Reuters Breakingview, noted that day: Rolls is a business built upon its
ability to forge awe-inspiring technology from plain metals. But it trades to a
large extent on its reputation for the reliability of that technology and the
sturdiness of the metals it uses.5
Rolls-Royce
In a business in which safety is a life-and-death issue, systems for ensuring
safety through quality are the core of reputational value creation and
maintenance. Rolls-Royce Group plc is such a business. Rolls-Royce is iconic.
This $19-billion integrated-power-systems company delivers reliable power that
is mission-critical to its customers. Operating in civil and defense aerospace,

marine, and energy markets, the company serves customers in more than 120
countries. It is a global provider of defense aero-engine products and services,
with 18,000 engines in service for 160 customers in 103 countries. Its marine
business has equipment installed on more than 30,000 vessels worldwide among
more than 2,000 customers including 70 navies. The companys energy
business is a supplier of power systems for onshore and offshore oil and gas
applications.
Reputation Management
Delivering mission-critical power to keep commercial aircraft aloft is an
awesome responsibility. Loss of power in an A380 super carrier places at risk
the lives of 525 passengers in a typical three-class configuration or up to 853
passengers in an all-economy class configuration, plus crew.
Rolls-Royce both understands this responsibility and has developed systems to
address relevant risks. Its asset preservation policy prioritizes the three greatest
things it is protecting: reputation, profitability, and viability.6
The distinction here is Rolls-Royces recognition of reputational benefits of
safety above all elsesafety is the industrys central obsession. In 1985, a
Japan Airlines (JAL) jet plowed into Osutaka Ridge, about a three-hour distance
by car north of Tokyo, marking what is still the worlds deadliest single-plane
disaster. JAL executives have visited the crash site every year since then to
remind themselves of the importance of safety to their industry.7
Process Controls
Rolls-Royce, the second largest maker of aerospace engines behind General
Electric, is an engineering firm. Revered by many in the community for its
technical acumen, Rolls-Royce has long had a reputation for innovation,
quality, safety, and overall engineering excellence. It maintains strong controls
both internally and over its supply chain. The head of one long-term supplier
put it this way to the Financial Times, I think of Rolls-Royce (as) a rather
fussy mother hen.8
Global supply chains are complex, with multiple interrelationships across a
wide network of organizations. While the companys strategy is to simplify
internal and external elements of its supply chain by building long-term
strategic links with fewer, stronger suppliers, risk of disruption remains from
financial or physical causes such as bankruptcy, natural disaster, armed conflict,

or pandemic. Intangible asset risks (ethical, quality, safety, etc.) also arise from
the supply chain, which inevitably flow downstream to Rolls-Royce.
All of Rolls-Royces procedures have teeth: the company has a reputation for
being tough on suppliers whose performance falls below standard. On the Trent
900 explosion, the Financial Times reported, If this [the perpetrator of the
fault] turns out to be a supplier, it will be crucified.9
In its preliminary investigation into the QF32 engine explosion, Australian
investigators, working with Rolls-Royce, Qantas, and Airbus engineers, traced
the likely cause to a badly manufactured oil pipe that cracked, causing oil to
leak and catch fire, leading to the engine over-revving and the turbine disc
being flung through the side of the engine.
While the company worked flat out to rectify the faults and to understand why
the faults were not identified during inspections, it remained remarkably tight-
lipped about crisis management. Aside from noting the existence of a crisis
management plan for supply chain interruption, the 2009 annual report is silent
on the subject. Its as though your maiden aunt has suffered a trauma but is
trying desperately to preserve an air of Victorian composure said the Financial
Times.9 The company refused to expand on a short statement on 12 November
2010 in which Rolls-Royce said it had isolated the problem to a
componentbelieved to be the pipe couplingand had a program in hand to
rectify the faults across all Trent 900 engines.
Few familiar with its culture were surprised by the aero-engine makers
unwillingness to divulge details about the investigation. First, the company is
justifiably worried about others gaining access to its technical secrets. Second,
with its deep engineering heritage, the predominant culture at the company is
against making snap judgments and early pronouncements, preferring to
carefully establish the facts.9
Trent 900 Explosion-and-Aftermath Timeline

By the close of markets 4 November 2010, shares in the engine's manufacturer,
Rolls-Royce plc, fell 5.5% to 618.5 pence on the London Stock
Exchangetheir sharpest fall in 18 months9 and the lowest price since mid-
September 2010. Shares in the European Aeronautic Defence and Space
Company (EADS), which owns Airbus, also fell.10
In the spirit of kicking em while theyre down, the day after the incident,
United Technologies Corp.s Pratt & Whitney jet-engine unit and the third
largest aerospace engine manufacturer, filed patent-infringement complaints
against Rolls-Royce claiming the Trent 900 infringed a patent for a swept-fan
blade.11
The suit was, at a minimum, strategic and designed to capture the attention of
Boeing 787 customers. In the market for engines for the Boeing aircraft, the
apparent low risk of the Trent was competitively advantageous. Both the recent
history of a catastrophic failure and a pending intellectual property lawsuit
posed new risks for a potential customer.
That same day, Qantas reported that 10 affected planes would be out of service
for as long as it takes, Chief Executive Officer Alan Joyce said at a press
briefing in Sydney. At Qantas we are proud to put passenger safety before
profit, he said.12 With its fleet of A830s grounded for several weeks, Qantas
substituted Boeing 747 aircraft.
Reputational crises attract lawyers for a wide range of issues. On 2 December,
Qantas filed a claim to ensure it could take legal action against Rolls-Royce to
recover passenger traffic losses caused by the explosion and the additional costs
due to aircraft substitution. (Rolls-Royce paid Qantas $100 million within 6
months to settle those claims.13)
That same day, Rolls-Royce informed the general public that it seemed to have
gotten its arms around the accidents cause. The company determined that the
direct cause of the oil fire and resulting engine failure was a misaligned counter
bore within a stub oil pipe leading to a fatigue fracture.14 On 10 December,
Rolls-Royce disclosed that it would cost $500 million to repair the defects in a
series of small metal couplings that feed oil to bearings in the Trent 900 engine.
Although the engineering problem may have been solved, the growing
reputation crisis was in full swing. On 23 December, BBC business news
reporter Shanaz Musafer opened a discussion with, Have you ever played that
game where someone says a word to you and you say the first thing that you
associate with it? If not, try these: Toyota, BP, Rolls-Royce, or perhaps even
Heathrow Airport.15
Rolls-Royce Customers
Trent 900 was unknown to those outside of a select few in the industry and
had not been a household word until late 2010. Thats when customers of Rolls-
Royces customerspotential airline passengerstook an extraordinary

interest and turned to the modern-day oracle: Google Search. A Google Trends
chart (Figure 3-1) shows a progressive decline over the years in Web searches
for Rolls-Royce and immediately following the crisis, a marked spike in
searches for the esoteric term, Trent 900.
Figure 3-1. Google trends plot illustrating the November 2010 spike in Web searches for the
terms Trent 900 and Rolls-Royce. Data source: Google Trends.
Within days, equity investors had their say. Indirect stakeholders, airline
passengers, had their say. And the media pundits had theirs. But
notwithstanding Qantass litigation for damages, the engine manufacturers
customers had been silent.
On 6 January 2011, the first customer spoke. In a compelling vote of confidence
from British Airways plc, Europes third-biggest airline, CEO Willie Walsh
agreed to buy Trent 900s for 12 A380s to be delivered starting 2013. British
Airways signed the A380 contract, first flagged in 2007, after Chief Executive
Officer Willie Walsh affirmed his absolute confidence in the Trent 900The
deal took years to seal because of talks over through-life servicing, a BA
spokesman said, declining to reveal if the carrier got a discount on the orders
list price of $5 billion, including seven A380s and 18 787 Dreamliners it has
options to buy.16
Rolls-Royces reputation for engineering safety had produced a miracle. Rolls-
Royce, the worlds largest engine maker after General Electric Co., is pleased
that one of its biggest airline clients continues to trust in its products, CEO
John Rose said. In its 2011 Annual Report, Rose emphasized that no customers
dropped Trent 900 orders, while some had reconfirmed business since
November 2010.17 In 2006, Rolls-Royce had become the sole engine supplier to
Airbus for the 350 series.18 And it still held that coveted distinction19 in June
2011, when Airbus affirmed that Rolls-Royce remained the sole supplier to the
A350 series.20
As to reputational matters, customers tend to act fast. Surprisingly, so can
regulators. On 5 March 2011, Europe's air safety regulator lifted the
requirement for frequent, repetitive engine inspections of Rolls-Royce engines
fitted to the Airbus A380 superjumbo, partly out of concern the inspections
could now be doing more harm than good. The root cause of the [QF32]
incident having been addressed through other adequate measures, it is
considered prudent to cancel these inspections, the agency said.21
Retrospective
Eight weeks out from the catastrophic failure of a mission-critical product,
Rolls-Royce showed the reputational and economic profile of a company with
significant reputation resilience. The media backed off, and the general public
lost interest. Much of the credit for this display of enterprise value preservation
goes to the companys reputation for engineering excellence and its outstanding
intangible asset risk management program.
If one criticism may be levied, it is about weak crisis-communications efforts.
Many communications pundits peppered the blogosphere with the central
message that CEO Sir John Rose should have been much more visible and
forthcoming.
I'm not surprised, explained Jonathan Salem Baskin, noted brand marketer
and author of the Histories of Social Media and Tell the Truth. Rolls-Royce
focused on analyzing and fixing the problem, and was likely having
conversations with numerous stakeholder groups involved in that operational
reality. The world wanted the business focused on business, some outlier
bloggers notwithstanding, and Rolls-Royces successes in its efforts were

obviously recognized and valued.
Eighteen months later, all was going well. In April 2012, the Reputation
Institute reported that the three most reputable companies in Britain are Rolls-
Royce (jet engines), Dyson (vacuum cleaners), and Alliance Boots (drugs and
prawn sandwiches).22 And customers were buying product. The commercial
aviation section that sold Trent 900 engines, among others, reported strong sales
in 2011. Although the costs of the repairs and indemnifications cut deeply into
profits, future sales, deliveries, and revenues were all up substantially in the
year following the explosion, with growth over 2009 of 10.4%, 14.0%, and
24.3% respectively (Table 3-1).23
Notwithstanding great sales and engineering power, Rolls-Royce had not lost
track of what its customers value. Rolls-Royce cited reputation 15 times in its
2011 annual report; the company disclosed that its sources of reputational risk
include failures in sustainability practices, regulatory compliance, innovation
effectiveness, ethical practices, oversight, operational controls (quality and
safety), and IT security. The company also explained its strategy for managing
each of the reputational risks it discloses.
Table 3-1. Percentage Changes in Rolls-Royce Commercial Aviation Sections Orders,

Deliveries, Revenue, and Profits for 2010 and 2011 Relative to 2009
(Relative to 2009 values) 2010 (%) 2011 (%)
Order book 3.2 10.4
Engine deliveries 0.2 14.0
Revenue 9.8 24.3
Profits 20.5 1.2
Consider This
In the aircraft power plant business, a reputation for safety
is a critical asset.
In a globally integrated manufacturing operation, such a

reputation is the product of superior engineering design and
risk management, which includes top-notch supply chain
oversight and operational control.
Notwithstanding other costs associated with a reputational
crisis, a superior reputation can preserve a companys
relationship with customers and protect revenues against
headline risks.
Quality
[Quality is] the extent to which a product is free from defects or deficiencies;
a service meets or exceeds the expectations of customers or clients, and both
products and services conform to measurable and verifiable criteria. (Table
1-1)
Zale Corporation
In 2009, Zale Corporation was one of North Americas largest specialty jewelry
retailers.24 With about 50,000 jewelry retail stores in 2009, the jewelry industry
employed approximately 200,000 individuals. Wal-Mart was the largest U.S.
retailer and the next largest was Zale, with more than 2,000 stores and kiosks.
Zale sells diamond fashion rings, semiprecious stones, earrings, and gold
jewelry, as well as watches and gift items. It operates under three business
segments: Fine Jewelry, Kiosk Jewelry, and All Other. During the fiscal year
ending 31 July 2008, the Fine Jewelry segment generated approximately 88% of
the companys net revenues and the Kiosk 12% of total revenues. Total sales
were $2.1 billion, with earnings of $10.8 million. In September 2008, its share
price peaked at almost $31. Just over a year later, in December, 2009, its share
price had plunged to $3.25 and its market cap to levels as low at $100 million.
What happened?
In Jewelry, Reputation Is Crucial

Fine jewelers sell precious stones and metals that are worked to produce a
product with both emotional and resale value. Since jewelry is seldom branded
and varies widely in design and quality in the mid-market segment, purchasers
require some form of trusted expertise in retail environments. The jewelers

name is the brand: retailers with strong reputations for knowledge, integrity, and
trust attract the most consumers.
In the fine jewelry business, the last 18 inches is crucial. Thats the space
between a salesperson and a customer, just enough room to place the product
(and what it represents) between two human beings and build a trusting
relationship focused on the consumers aspirations, hopes, and dreams. Because
jewelrys intrinsic value is based on a significant amount of knowledge about
how to evaluate quality, most customers must rely on the salespeople across the
18-inch countertop in front of them. In the middle market, the customer must
trust that the price is fair, a factor that includes recoverable or liquidation value
as well. These elements are the essence of quality in fine jewelry.
Damaging Zales Reputation for Quality

The first Zale Jewelers opened in 1924 in Wichita Falls, Texas, founded by
Morris Zale, William Zale, and Ben Lipshy. Their winning strategy was to
provide quality merchandise at the lowest price in its market segment. By 2004,
Zale enjoyed a $2.5 billion market cap. For decades Zale was known for
offering fine jewelry assortments through convenient locations at fair prices.
Their employees were friendly and knowledgeable. The leadership of the
company signaled that it valued its staff by training, development, recognition,
and compensation. The company had also signaled that it valued its customers
by extending credit and standing behind its products through exemplary service.
The company understood the intrinsic value of reputation. It understood why
suppliers supply, why employees perform, and why customers buy. Customers
expectations for a reliable repeatable experience in those last 18 inches were
met with admirable regularity.
In mid-2002, after eight years at the helm, CEO Bob Dinicola stepped down. He
had taken Zale to what turns out to have been the apex of its financial success.
Over the next five years, three CEOs each had his or her own different strategy
for the business. Sadly for Zale, each strategic change diminished the customer
experience and the companys financial performance, and each deterioration in
financial performance paved the way for the next CEO and more decline.
The fourth new CEO, Neal Goldberg, appointed in February 2008, set out to
leave his own mark on Zale and more broadly the jewelry business. He was
quoted as stating, What I see in this business [jewelry] is a sea of sameness.
Its all about price and there is no romance to it. The way the goods are
presented is very flat. I was never inspired walking into any jewelry store to
say: Wow. Look at this presentation. You go into other retailers, other
commodities and you do go, Wow. Apple is probably the pinnacle of that.25
It appears that Goldberg sought to transform both Zale and the business of
selling fine jewelry. He felt that romancean emotional connection typically
associated with the psychological construct of a brandwas the critical element
linking the product to a customer, and that successfully romancing the product
in a store would increase the appeal of products and ultimately sales. It also
appears that he did not understand Apples retail model (discussed in Chapter
4).
His paradigm of romance affected all aspects of the business: product
assortments, advertising, store layouts/design, staffing, etc. It also impacted
qualitynot of the merchandise itself, but rather of the customer experience.
Goldbergs strategy change to enhance the romance between the product and
the customer took precedence over the 18-inch experience between the
salesperson and the customer. Where Zale historically had offered a customer a
trusted person in the store to help him or her make the right choice, these
knowledgeable salespeople were replaced by part-time employees to cut labor
costs and pay for the new store designs.
Result: customers started grumbling (Figure 3-2), stopped shopping at Zale, and
had their needs met at their arch competitor, Signet Jewelers. When Zale then
tried to lure them back by reducing prices, they compounded the confusion.
Heavy discounting with no other rationale for it, such as a store going-out-of-
business sale, cheapens the perceived value of the products offered.
Figure 3-2. Customer sentiments of Zale and Signet in 2009 (Newssift).26
Retrospective
In disappointing customers with a new branding strategy, Goldberg reaffirmed
the lessons learned by The Coca Cola Company when it rolled out New Coke
and enraged its loyal customer base, who defected in droves to Pepsi. Zale
followed the script for ensuring humiliating failure: the company eviscerated its
golden goose and Signet cleaned up.27
The revenue deterioration trend ended with the 2011 fiscal year (Figure 3-3) as
Zale CEO Theo Killion, hired in February 2010, began to make his mark.
Under Killions guidance over the past two years, Zales bottom line improved
$141 million and its reputation has improved. His focus: making the
customers, i.e., guests, feel valued.28
The message: while brand and reputation are cousins, they are not the same and
should not be conflated. Reputation is a cognitive expectation of behavior held
by stakeholders; brand is an emotional relationship. Unfortunately, Zale
apparently has not yet recognized this difference. Although its annual report
cites reputation four times, the company formally acknowledges IT security
breaches as the only source of reputational risk. Future reports afford potential
for expanded institutional self-awareness.
Figure 3-3. Stagnation followed by a rapid deterioration in revenue at Zale Corporation. Values
are reported in relation to 2001 sales revenue and adjusted for annual inflation. Consumer
confidence data are drawn from the June 2011 values of the University of Michigan Index of
Consumer Sentiment.29
Consider This
Zales changed its strategic direction when it sought to
engage the customer through an emotional relationship
based on romance rather than a cognitive relationship based
on the companys reputation for quality.
The actions to accomplish the transformation siphoned off

resources from those that had for the better part of a century
supported Zales reputation for quality. At the end, they
subverted retail experiences and wreaked havoc on the
companys reputation among its customers.
The Zales tale underscores the fact that brand promise and
reputation expectation are not the same. Zales invested in
the former at the expense of the latter. By damaging a
reputation for quality valued by the customer, it lost both
pricing power and sales volume.
Innovation
[Innovation is] the design, invention, development and/or implementation of

new or altered products, services, processes, systems, organizational
structures or business models for the purpose of creating new value for
customers and financial returns for the firm. Intellectual Property is part of
this. (Table 1-1)
A reputation once broken may possibly be repaired, observed Bishop Joseph

Hall. But the world will always keep their eyes on the spot where the crack
was.30 As the world focuses on the cracked reputation for innovation that is
plaguing Research In Motion, their culture for value creation is called into
question.
Research In Motion
Buried among the headlines during the first week of November 2011 was this
eye catcher: RIM as wounded puppy trails book value with faith fading.31
The Chief Investment Officer of a New York fund explained, Theyve been
losing business, thereve been operating technology problems. There isnt a lot
of customer loyalty anymore. That day, for the first time in nine years, the
companys market value dipped below book value.
Its not as if Research In Motion isnt trying. The 2010 fiscal year was the
second year in a row the Waterloo-based BlackBerry-maker headed the list of
the top 100 corporations in Canada for research and development spending. In
2010, RIM actually boosted its spending on research and development by 26%
to $1.3 billion, or about 6.8% of its revenue.
But while the innovation process is well financed, the process itself has failed to
produce value. John Goldsmith, a money manager with Montrusco in Toronto,
said the pricing collapse shows RIM has lost its competitive advantage. RIM
was a market leader in terms of smartphones, he said. There are a lot of guys
out there able to commercialize a product at a significantly lower cost.32
What about the patents? In addition to its organically grown patent portfolio,
RIM has also been actively acquiring them. When the auction of the patent
portfolio of Canadas previous technology giant, Nortel, ended on 30 June
2011, the winning bid was an eye-popping $4.5 billion. Research In Motion was
among the consortium of winning bidders comprising Apple, EMC, Ericsson,
Microsoft, and Sony.
Goldsmith was not impressed. The book value, is it well stated? A lot of stuff
has happened over the past five to ten years, he said. The technology patents
might not be worth as much as the now-inflated book value.48
Research In Motion was a superstar as it started the hand-held computing
revolution. In 1984, Mike Lazaridis and his co-CEO, James Balsillie, led RIM
as it produced its first BlackBerry in 1998. With a six-line display that let users
send and receive basic e-mail, the device changed business communications
forever. By 2002, the BlackBerry had added voice and data capabilities, and
RIM stood virtually alone in the nascent smartphone industry.
A 2002 press release said it best: RIM pioneered the market for enterprise
wireless email in 1999 and has propelled adoption and innovation since that
time. With over 14,000 organizations already using BlackBerry, RIM is now
delivering the next generation of wireless enterprise solutions with converged
voice and data services. RIM has maintained its industry leadership with the
only complete 2.5G wireless enterprise solution ready to address the needs of
both users and IT departments.33
And therein lies the rub. RIM targeted the corporate IT department as its
customer. By 2008, no less a figure than Barack Obama was musing about his
BlackBerry addiction, and whether he could break it upon entering the
presidential security bubble. But the U.S. government did not issue the
president a mobile device, so he got one for himself. Like many other
companies, and governments, RIM missed the power shift from the corporate IT
department to the individual worker. Today, most workers do not want
company-issued BlackBerrys: they want iPhones and the like.
Amitabh Passi, who covered the smartphone sector for UBS, said RIM
stumbled. They need to introduce exciting products. Theyre not there. They
need to hit the time-to-market windows. Theyre not there, he said. They need
to rejuvenate and reenergize the brand. Theyre not there. I think its partially a
management issue. Partially its a culture issue. Partially its really getting a
better sense of consumer psychology and what drives consumer decisions.34
Can a well-funded innovation process that creates and buys many patents be
not there? If you define innovation along the lines of the 2008 Report to the
Secretary of Commerce by the Advisory Committee on Measuring Innovation in
the 21st Century Economy, cited at the head of this section, the answer is yes.
Patents are but an artifact of innovation, and their value is suspect if they do not
create new value for customers, and financial returns for the firm. By that
definition, RIMs innovation process is failing.
RIM is facing three major challenges, said Pierre Ferragu of Sanford
Bernstein. On its historic customer base, BlackBerry is a broken brand; RIMs
business with corporate clients is ex-growth and under attack; and RIMs
premium profitability is at risk. In other words, BlackBerrys are not generally
seen as being cool.35
Retrospective
RIMs deteriorating reputation for innovation was something many of its
corporate customers were prepared to tolerate, if not value. Incompetence was
another story. To stumble the day before RIMs then-top competitor, Apple,
rolled out a new productthe iPhone 4swas even worse. Apple CEO Steve
Jobs had died the day before and the iPhone quickly became known as
4Steve.
The headlines hurt: Is Steve Jobs crowing in heaven over RIMs week from
hell?36 Continuing the story, The Toronto Globe and Mail noted: RIM is in
what charitably might be called a rough patch. Its quarterly results disappointed
investors, to put it mildly, the launch of its PlayBook tablet was weak, and there
are questions dogging the Waterloo, Ont., group about its management
structure. In the midst of the product and management crises, RIM had a major
operational failure, what Queens University marketing professor John
Pliniussen dubbed the Blackout-Berry as the company publicly struggled for
three days the same week to get its broken e-mail, instant message, and
Internet services back up and running for millions of BlackBerry users around
the world.37
Never mind the millions of unhappy customers. The investors with clout were
taking notice. Fast-moving Jaguar Financial is breathing down the neck of
Research In Motion (Nasdaq: RIMM), and if the BlackBerry maker isnt

careful, it could see a dramatic change in its board of directors and potentially
management as early as three months from now. Canadian securities laws give
investors significant power: Investors holding a 5% stake in a
companyeither individually or as a groupare allowed to call a special
meeting, says Chris Makuch, vice president at the Canadian office of proxy
solicitation firm Georgeson.38
Its said of war that there are no winners, only survivors. Yes, Research In
Motion out-survived Steve Jobs. But it sure isnt winning. As of the end of
2011, its revenue was falling faster that the decrease in product sales, indicating
a simultaneous loss in pricing power (Figure 3-4).
RIM doesnt appreciate the value a reputation for innovation confers upon its
enterprise. It mentions reputation 27 times in its 2012 annual report. It
discloses reputational risks with respect to failures in IT security, sustainability
or ethical behaviors, service or product quality, and regulatory compliance.
Inexplicably, the company did not link innovation failure with reputational risk.
Figure 3-4. Growth in RIMs revenue, normalized to 2007 revenue and adjusted for inflation, and
the number of devices sold each year. With damage to its reputation for innovation, its revenue is
decreasing faster than its sales volume, indicating a simultaneous erosion of pricing power.39
Consider This
RIM failed to recognize that the identity and needs of its
customers were evolving, and therefore failed to innovate
to meet emerging customer expectations.
A reputation for innovation is a source of revenue-driven
value. For RIM, it brought greater volumes of sales and
increased pricing power.
When a broad range of stakeholders perceive failure, a
firms once stellar reputation for innovation may be
permanently damaged, with a resulting impact on enterprise
value, if not overall company viability.
Guidance
Companies typically invest many years and significant capital to develop a
reputation that is recognized and valued by customers. Reputations are formed
in part by what customers experience as consumers of products and services,
and in part by what customers expect to experience based on prior
messagingword of mouth, advertising, etc. What companies do on a tactical
level is generally specific to the industry sector; what they do strategically to
build a reputation can be generalized to a few principles.
Rolls-Royce built a reputation for safety through engineering controls that
provided the company both oversight and operational control of its supply
chain. The companys culture reflects a deep appreciation for both the
importance of its engineering and the value of its reputation. As a result,
customers both expect and receive engineering excellence and safe products. It
appears that much of what Rolls-Royce does, and the way it does it, are guided
by its deep respect for engineering excellence and reputation protection.
Zale built its reputation for quality by delivering a trusted service that mitigated
consumer risk for the middle-market customers of fine jewelry. In their own
words, Zales reputation for customer service for over 85 years fosters an
image of product expertise, quality and trust among consumers. By confusing
image with actual operations and service delivery, Zale risked that reputation
to deliver a different type of experience to its customerone that customers
neither appreciated nor valued.
Last, RIM built a reputation for innovation that it exploited into a near-
monopoly. Believing it had a lock on its customers, the company found itself
struggling after three major stumbles. First, it had put all its marbles on the
corporate IT customer and failed to appreciate that corporate IT was being
disintermediated. Second, it failed to appreciate the speed at which its market
was evolving technologicallyit wasnt getting new products to market
quickly. Third, notwithstanding ample evidence and prior examples of sudden
corporate death, it did not appreciate that a failure to deliver critical IT services
was a potential death sentence.
Each of these exemplary companies established reputations that customers
appreciated and valued. That appreciation, often comprising an expectation of a
benefit to come, translated into extraordinary sales, pricing power, near-
monopoly status, and fast sales cycles. Awareness of the importance of its
reputationand how it was establishedhelped Rolls-Royce rebound from a
crisis; conversely, both Zale and RIM stumbled badly when they failed to
understand and exploit the cultural sources of prior success.
By the Numbers
The case studies illustrate how reputation can affect value-creating and value-
destroying actions by customers and how that reputational value is ultimately
recognized and appreciated by stockholders (Table 3-2).
Table 3-2. Reputation Effects on Customer-Driven Revenue
P&L Effect Stock Price EffectInterval Gains

(Losses)
Rolls-Royce Sustained sales Rolls-Royce S&P500

volume and pricing
power 01-Nov-10 0 0
15-Nov-10 (8.7%) 1.1%
28-Sep-12 41.2% 20.3%
Zale Precipitous decline in Zale S&P500

sales volume and
pricing power; 01-Feb-08 0 0
reversed with new
leadership 01-Feb-10 (87.9%) (21.9%)
28-Sep-12 227.0% 32.3%
Research In Precipitous decline in RIM S&P500

Motion sales volume and
pricing power 01-Feb-08 0 0
01-Feb-09 (39.4%) (40.8%)
28-Sep-12 (86.6%) 74.5%
1The considered purchase decision. TriComB2B/University of Dayton School of

Business. 2011. The full research report is available at http://tricomb2b.com/about-
us/Our-2011-B2B-Research.
2Li K, Geng Q, Shao B Warranty. Designs and brand reputation analysis in a duopoly.
California Journal of Operations Management. 2011;9(1):3442.
3Corporate imagebenefits, importance of corporate image, theory of corporate image.
Encyclopedia of Business, 2nd ed. Available at:
http://www.referenceforbusiness.com/small/Co-Di/Corporate-
Image.html#ixzz20h9xZKD8. Accessed 15 July 2012.
4Familys terror as debris from exploding Qantas superjumbo engine tears 6ft hole in
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5 Cole R. Rolls-Royces reputation is most of its value. Reuters. 8 November 2010.
Available at: http://blogs.reuters.com/breakingviews/2010/11/08/rolls-royces-
reputation-is-most-of-its-value/. Accessed 27 June 2012.
6 Rolls-Royce Holdings plc Annual Report 2009, p. 62.
7 Cooper C. JALs $8.5 billion rebirth took lessons from crash-site morgue. Bloomberg.
13 September 2012. Available at: http://www.bloomberg.com/news/2012-09-13/jal-s-8-
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2012.
8Marsh P, ODoherty J. Rolls-Royce scrambles to pin down problem. Financial Times.
20 December 2010. Available at: http://www.ft.com/intl/cms/s/0/3e5a2254-0c67-11e0-
8408-00144feabdc0.html#axzz20bj70q2d. Accessed 15 July 2012.
9Mustoe H, Rothman A. Rolls falls most in a year after engine failure grounds A380s.
Bloomberg. 4 November 2010. Available at: http://www.bloomberg.com/news/2010-
11-04/rolls-falls-most-in-a-year-after-engine-failure-grounds-a380s.html. Accessed 15
July 2012.
10Madslien J. Qantas emergency points spotlight at Airbus and Rolls-Royce. BBC
News. 4 November 2010. Available at: http://www.bbc.co.uk/news/11692362. Accessed
15 July 2012.
11Layne R, Decker S. Pratt & Whitney sues to block Rolls-Royce engines. Bloomberg.
5 November 2010. Available at: http://www.bloomberg.com/news/2010-11-05/pratt-
whitney-sues-to-block-rolls-royce-engines.html. Accessed 15 July 2012.
12Easdown G. Rolls-Royce Trent 900 engine linked to three mid-air emergencies.
Herald Sun. 5 November 2010. Available at: http://www.heraldsun.com.au/news/rolls-
royce-trent-900-engine-linked-to-three-mid-air-emergencies/story-e6frf7jo-
1225948178631. Accessed 27 June 2012.
13Koranyi B, Smith M. Rolls-Royce, Qantas settle A380 engine dispute for $100
million. Insurance Journal. 22 June 2011. Available at:
http://www.insurancejournal.com/news/international/2011/06/22/203682.htm. Accessed
15 July 2012.
14Govindasamy S. Pipe fatigue behind Qantas A380 Trent 900 failure: ATSB.
Flightglobal. 2 December 2010. Available at:
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failure-atsb-350414/. Accessed 15 July 2012.
Musafer S. 2010: A year some companies would rather forget. BBC News. 23
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December 2010. Available at: http://www.bbc.co.uk/news/business-11828093.

16Mustoe H, Rothwell S. British Airways picks troubled Rolls engine for A380s.
Bloomberg. 6 January 2100. Available at: http://mobile.bloomberg.com/news/2011-01-
06/rolls-royce-wins-british-airways-order-for-trent-plane-engines. Accessed 15 July
2012.
17Rolls-Royce counts cost of Trent 900 failure. Asian Aviation. 1 March 2011.
Available at: http://www.asianaviation.com/articles/109/Rolls-Royce-counts-cost-of-
Trent-900-failure. Accessed 28 June 2012.
18Kaminski-Morrow D. Rolls-Royce becomes first engine supplier for Airbus A350,
with formal development of 'Trent XWB' powerplant. Flightglobal. 4 December 2006.
Available at: http://www.flightglobal.com/news/articles/rolls-royce-becomes-first-
engine-supplier-for-airbus-a350-with-formal-development-of-trent-xwb-powerplant-
210894/. Accessed 27 June 2012.
19 Michaels D, Sanders P. Rolls-Royce isn't on board with Airbuss engine plan. Wall
Street Journal. 19 August 2010. Available at:
http://online.wsj.com/article/SB10001424052748704557704575437391200860352.html
. Accessed 27 June 2012.
20ODoherty J. Rolls-Royce to redesign Airbus A350 engine. Financial Times. 6 June

2011. Available at: http://www.ft.com/intl/cms/s/0/7347ad96-9057-11e0-9227-
00144feab49a.html#axzz1z39pzroC. Accessed 27 June 2012.
21 Heasley A. A380 engine inspections may be doing more harm than good. Sydney
Morning Herald. 5 March 2011. Available at: http://www.smh.com.au/travel/travel-

news/a380-engine-inspections-may-be-doing-more-harm-than-good-20110305-
1biip.html. Accessed 11 August 2012.
22Whats in a name? Why companies should worry less about their reputations.
Economist. 21 April 2012. Available at: http://www.economist.com/node/21553033.
23 Rolls-Royce Holdings plc Annual Report 2011, p. 18.
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2012.
Bates R. We need a compelling shopping experience. JCK. November 2008.
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Kossovsky N. Why Zales must learn a quality lesson (case study). Intellectual Asset
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27 Schumpeter. How to make a megaflop. Economist. 31 March 2012. Available at:

28Zale CEO accepts Visionary Merchant award. Mays Business Online (Texas A&M).
July 2012. Available at: http://maysbusiness.tamu.edu/index.php/Zale-ceo-accepts-
visionary-merchant-award/. Accessed 29 July 2012.
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http://www.sca.isr.umich.edu/main.php. Accessed 28 June 2012.
Joseph Hall. Wikiquote. Available at: http://en.wikiquote.org/wiki/Joseph_Hall.
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31Miller J, Walcoff M. RIM as wounded puppy trails book value with faith fading.
Bloomberg. 3 November 2011. Available at: http://www.bloomberg.com/news/2011-
11-03/rim-as-wounded-puppy-trails-book-value-with-investors-confidence-shaken.html.
32RIM falls below book value for first time. Profitimes. Available at:
http://profitimes.com/value-investing/rim-falls-below-book-value-for-first-time/.
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2012.
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July 2012.
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http://www.ft.com/intl/cms/s/2/61e899ec-7415-11e0-b788-
00144feabdc0.html#axzz20bj70q2d. Accessed 15 July 2012.
36Is Steve Jobs crowing in heaven over RIMs week from hell? Globe and Mail. 14
October 2011. Available at: http://www.allvoices.com/news/10614357-is-steve-jobs-
crowing-in-heaven-over-rim146s-week-from-hell. Accessed 15 July 2012.
37Kossovsky N. Reputation for innovation lost: RIM and Kodak (case study).
Intellectual Asset Management. 2012; 51:(January/February): 7582.
38Kawamoto D. Jaguar could bag Research In Motion soon. Motley Fool. 14 October
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bag-research-in-motion-soon-.aspx#.UAL-YHC1_-k. Accessed 15 July 2012.
39 Research In Motion Annual Reports 2007-2012, composite.
CHAPTER
Employees
Lose money for the firm, and I will be understanding; lose a shred of
reputation for the firm, and I will be ruthless.
Warren Buffet to his employees1
On or about 13 April 2009, in a small Dominos Pizza franchise in North

Carolina, two employees uploaded a two-minute prank video to YouTube of the
duo offensively tampering with the food they were preparing. Within a few
days, the power and reach of social media triggered more than a million views
on YouTube and a viral spread of the subject on Twitter. No surprise that a
Google Trends report showing a 50% increase in searches for Dominos Pizza
was not accompanied by a surge in orders for freshly baked pizza pies. A
national study conducted by HCD Research using its Media Curves website
found that 65% of respondents who would have previously visited or ordered
Dominos Pizza were less likely to do so after viewing the offensive video.2
Employees is a term for workers and managers working for a company,
organization, or community. They are the staff of the organization, hired by an
employer to do a particular job, and they are critical to a companys ability to
deliver its products and services to customers. Often they are also both the
largest expense (payroll) and the greatest source of risk. It is usually the actions
of employees that trigger failures in ethical practices, lapses in quality and
safety, breaches in security, and ineptitude in innovation.
2 Chapter 4 | Employees
This chapter explains how the behavior of corporate employees impacts specific
lines of the profit and loss (P&L) statement and helps determine a companys
stock price. Working backwards from there, we explain how the expectations
employees hold about their company help shape that companys reputation, how
a companys actions shape its employees expectations, and how a companys
reputation affects employees behavior. We illustrate the points with case
studies: on ethics, News Corp. and Barclays plc; on innovation, Apple Inc. and
Goldman Sachs Group, Inc.; and on quality, Dominos Pizza Inc.
Well also explore the interrelationships among a companys culture, reputation,
and employees. Tony Hsieh, who sold pizza as a student3 and is now CEO of
the online shoe and clothing shop Zappos.com, observed: Businesses often
forget about the culture and, ultimately, they suffer for it because you can't
deliver good service from unhappy employees.4 Nor, as we show in this first
case study, can you expect employees to protect the enterprise if they are
misdirected by incentives.
Ethics
[Ethics are] the moral principles by which a company operates; integrity is
the act of adhering to those moral principles. Ethics are an integral part of
governance that, along with integrity, affect the reputation value of all other
intangible assets. Ethics are also the keystone intangible asset because they
form the basis for trust and confidence. (Table 1-1)
For company after company, there have been rising waves of press attention
that each crest in a critical massthe threshold where seemingly little things
trigger a major event, the tipping point, as Malcolm Gladwell theorizes.5 The
cumulative effects of business process failures on the reputation of a
corporation produce the proverbial straw on the camels back.
Such effects from serial transgressions are nowhere greater than in a businesss
ethical failure. Costly ethical failures tend to have three features in common:
Failure of ethical controls resulting from misalignment of
short-term interests among employees, management, and
potential regulators
Tolerance for an ethically flawed underlying business
model and the culture of an industry
An ultimately expensive, culturally driven purification

ritual, causing a pile on of litigators, regulators, and
bloggers
News Corp.
Rupert Murdochs News Corp., a U.S.-listed global media company, is the
worlds second largest media conglomerate behind only Walt Disney, with
operations spanning film, television, and publishing. It would be unusual to find
someone on the face of this planet who has not been touched by one of its
products. It produces and distributes movies through Fox Filmed Entertainment,
and its FOX Broadcasting network boasts more than 200 affiliate stations in the
United States. The company owns and operates more than 25 TV stations, as
well as a portfolio of cable networks. Its publishing businesses include
newspaper publisher Dow Jones (The Wall Street Journal) and book publisher
HarperCollins. Through its U.K. news group, News International, it publishes
The Times (of London) and the Sun, and published, past tense, the now-defunct
tabloid, News of the World.
In July 2011, News Corp., through its then-subsidiary, News of the World, was
swept into a classic Gladwell tipping point. Two events over a span of nine
years were the triggers. In March 2002, schoolgirl Milly Dowler, 13,
disappeared in the London suburb of Walton-on-Thames. Her remains were
found in September.6 Investigation of her murder, one of the most notorious of
the decade, came to an official end on 23 June 2011 when Levi Bellfield, a
convicted double killer, was found guilty.7
Eleven days later, on 4 July, The Guardian reported that a lawyer for Dowler's
family, Mark Lewis, claimed that he learned from police that Milly Dowler's
voicemail messages had been hacked, possibly by a News of the World
investigator, while police were searching for her. The lawyer claimed that some
of her voicemails had been deleted to make room for more messages,
misleading police and her family into thinking Milly was still alive and
complicating the police investigation. Lewis described the News of the Worlds
activities as heinous and despicable.8 The next day, News International
chief executive Rebekah Wade Brooks, whose organization oversaw News of
the World, said she was appalled and shocked that Milly Dowlers phone was
hacked. U.K. Prime Minister Cameron called it a truly dreadful act.6
News of the World reporters had been accused before of illegally accessing
messages from the mobile phones of celebrities and politicians. In fact, in 2006,
detectives arrested the News of the World's royal editor Clive Goodman and
private investigator Glenn Mulcaire over allegations that they hacked into the
mobile phones of members of the royal household. Three years later, the Press
Complaints Commission concluded that there was insufficient evidence to
suggest anyone at the News of the World other than Goodman and Mulcaire
hacked phone messages, or that the papers executives knew what the pair was
doing.
It took the conviction of the child murderer to precipitate a full-blown
reputational crisis. Bribery, illegal wiretapping, interference in a murder
investigation, political blackmail, and rampant disregard for both the truth and
basic decency is the choice phrasing Elliot Spitzer used in a 12 July 2011
column.9 The behavior of Rupert Murdochs News Corp. in Britain has
shocked even his closest allies and cynical British journalists. Mr. Spitzer, like
Captain Renault in the film Casablanca, well understood how unethical
behavior had the power to shock. The former NY State attorney general, whose
meteoric career rested on his high-profile prosecutions of white-collar crime,
had been the 54th governor of New York until exposure of his own ethical
lapsea client relationship with a high-priced prostitution ringforced his
resignation.
The Buildup of Straws

While various existing codes of journalistic ethics have some differences, most
share common elements including the principles of truthfulness, accuracy,
objectivity, impartiality, fairness, and public accountability as these apply to the
acquisition of newsworthy information and its subsequent dissemination to the
public. Phillip Crawley, Publisher and CEO of The Globe and Mail, describes
his core business as Canadas most trusted source of news.10 Tony Burman,
ex-editor-in-chief of CBC News, said it this way in 2001: Every news
organization has only its credibility and reputation to rely on.11
But what about a tabloid U.K. paper like the Sun? Mainstream media outlets,
such as the Globe or The Wall Street Journal, are generally believed to be
dedicated to objective reporting and to honoring the tenets of ethical journalism.
In contrast, a tabloid paper is fundamentally about spilling dirt, appealing to
prurient interest, stirring controversy, and digging up personal laundry that
public figures would rather keep private. Christopher Hitchens wrote that News
of the World became a paper where the question was not how low can poor
human nature sink, but rather is there anything, however depraved, that a
reporter cannot be induced to do?12
Everyone knew that News of the World had been a guilty pleasure for at least
three generations of Britons. The paper operated in a muddled gray area of
impropriety. Its headlines and scoops regularly challenged the truth, and its
methods of discovery were questionable. Though few readers cared enough to
ponder the implications, victims of its coverage did, and they regularly sued the
paper. For everyone else, its muckraking was something readers tolerated
because they enjoyed it.
In this environment, an ambitious executive with a lifelong passion for
journalism saw the obvious path to success: superior muckraking. Rebekah
Mary Wade was born in 1968 in Warrington in the north of England and grew
up an only child. At age 20, the future Rebekah Brooks, who would become
editor of the News of the World and The Sun, talked her way into a job with the
features editor of The Post, a now-defunct tabloid. I am going to come and
work with you on the features desk as the features secretary or administrator.13
Within seven years, she was the deputy editor of the News of the World.
By most measures an alpha female,14 she worked hard, played carefully, and
mastered the art of power politics in a male-dominated profession. Shed get
you to do things, said a former News of the World reporter. She had this
charisma, this magnetic attraction. She would praise to high heaven, make you
feel like you were on top of the world. It was only afterwards that you realized
you were manipulated.15
By the end of 1996, she reportedly first met Rupert Murdoch, chairman of the
enterprise for which she worked. Taking a page from Nina Godiwallas
playbook, Suits: A Woman on Wall Street, the newly minted Rebekah Wade
Kemp understood that doing a good job (was) expected of (her), but its the
relationships that (would) help (her) succeed.16
Observers believe Rebekah (Wade Kemp) Brookss remarkably swift rise in
the company was due not so much to her talents as a journalist but to her single-
minded ruthlessness and her dazzling, feline ability to charm. Rebekah
schmoozes in one direction only up, says one of her oldest acquaintances. I
dont know anyone who is better at love-bombing, when it matters. I wouldnt
think Rupert stood a chance.17 Commented a former News of the World
reporter, From the way she acted, you would think she wanted to sleep with
you.13
In 2000, Murdoch fired Phil Hall, the editor of the News of the World, and gave
his job to Wade Kemp. At just 32 she was the youngest national newspaper
editor in the country. In a vivid demonstration of the power of the press (and of
Rebekah Wade Kemp), she began a campaign as muckraker-in-chief to name
and shame alleged pedophiles.6 Some alleged offenders found themselves

terrorized by angry mobs. In 2003, Murdoch installed Wade as the editor of
daily tabloid The Sun, sister paper to the News of the World and Britain's biggest
selling daily newspaper. She told the staff on her first day it was the job she had
dreamed of ever since she was a child.13 In 2009, at age 41, the soon-to-be
Rebekah Brooks was appointed CEO of News International, the U.K. arm of
News Corp.s Newspapers and Information Services business.
Within the span of about 24 months, she became one of the most powerful
women in Britain; married the former racehorse trainer and international
playboy Charles Patrick Evelyn Brooks; oversaw the closure of News of the
World; resigned from her post with News International; and was arrested on
suspicion of phone hacking and corruption.
An aggressive editor backed by an aggressive chairman makes for a powerful
force in a business that rewards muckraking. Reuters reported that, according to
a senior police officer who was asked to investigate the matter in 2009, illegal
voicemail hacking was standard practice at Britains best-selling Sunday
newspaper, and then covered up by executives.18 Accusations that journalists
working for News Corp. illegally paid police for information have also been
brought to light. The Financial Times reported: The Sun had a culture of
corrupt payments to a network of public officials which was authorized at a
senior level, the police testified at an inquiry into press standards. Deputy
Assistant Commissioner Sue Akers said evidence showed that payments were
frequent, regular and on occasion significant sums of money were involved.19
As part of the fallout, Prime Minister David Cameron announced two inquiries
relating to the scandal. One of them, led by a judge, was charged to look at the
way the police investigated the allegations against News of the World and the
relationship between newspapers and the police.
Along the way, the government had preferred to look the other way. After Wade
Kemp had moved to The Sun, Andy Coulson became News of the World editor.
Coulson was subsequently hired by Prime Minister David Cameron as his press
secretary. The tabloid press in Britain is very powerful, and its also
exceedingly aggressive, and its not just News Corp.; The Mail is very
aggressive, said John Whittingdale, a Conservative member of Parliament who
is chairman of the Culture, Media and Sport Committee as quoted in The New
York Times. They do make or break reputations, so obviously politicians tread
warily. 20
Politicians have always been most afraid of the two News Corp. papers, The
Sun and its Sunday sister (until it closed), News of the World. They go on little
feeding frenzies against various politicians, said Roy Greenslade, a professor

of journalism at City University London. Until the floodgates opened, when the
outrage over the latest phone-hacking revelations had politicians voicing disgust
in a cathartic parliamentary session, most members of Parliament were terrified
of crossing Mr. Murdoch.20
It may be asking too much of the police and the government to serve as a check
and balance on the press. Christopher Hitchens, writing for Slate, confessed,
Admittedly, it isnt usually the job of these institutions to keep the press
honest. (Indeed, I could swear that I read somewhere that the whole concept
was the other way about.)21
Many would agree with Hitchens, and might suggest that reputation for ethics
could in the long term survive only in an ethical culture. It's a very personal
thing, but throughout my career from my time as a teacher, to my time as a
banker I have seen just how important culture is to successful organizations,
offered Robert Diamond, CEO of Barclays plc. Culture is difficult to define, I
think its even more difficult to mandate but for me the evidence of culture is
how people behave when no one is watching.22
Diamond got it partially right, as the following case study on Barclays shows.
Culture comprises values and is evidenced, in part, by how people behave when
no one is looking and they have an opportunity for unethical behavior. But this
is really a definition of morality. Morality is reflected in the actions of an
individual in the face of an unethical opportunity.
On an institutional basis, culture means establishing behavioral norms,
monitoring conformance, and mitigating deviations from the norms. These may
reaffirm the moral principles of employees; they may rectify them as well.
Employees who find the institutional culture incompatible with their own
morals will either conform or leave.
At least in principle, boards and management have the potential to reduce
opportunity for deviation by imposing strong internal controls and
compliance mechanisms and to reduce motive and rationalization for deviation
through appropriate incentive-setting, articulation of corporate values, and tone
at the top. They also have a legal duty. That role has been acknowledged and
incorporated into a range of regulatory, commercial, and justice guidance
materials, including the Federal Sentencing Guidelines in the U.S., the Ministry
of Justice Guidance pertaining to the Anti-Bribery Statute in the UK, and the
2010 OECD Good Practice Guidance on Internal Controls, Ethics, and
Compliance, noted Michael D. Greenberg, director of the RAND Center for
Corporate Ethics and Governance (CCEG).23
The Broken Back

The News of the World ethical scandal damaged every part of the Murdoch
empire, as shown in Table 4-1.
Table 4-1. A Full-Blown Reputational Crisis Is One in Which Every Stakeholder Is Impacted
Quote Authority Stakeholder
Phone-Hacking Scandal Damaged News Claims filed by News Corp. Investor

Corp.s Image24 shareholders led by
Amalgamated Bank
I think the UK hacking scandal has the Jay Ottaway, whose family Investor
potential to damage The Wall Street owned 6.2% of Wall Street
Journals reputation.25 Journal publisher Dow Jones
& Co before it was sold to
News Corp.
I think the benefit of the (Wall Street) Doug Arthur, a long time Analyst
Journal is its above the fray. Its carved out newspaper analyst now with
such a strong reputation for so long, he Evercore Partners
said, but added, You cannot completely
separate it from the muck.23
Rupert Murdoch is torching the reputation Arthur Yann, vice president of Media observer
of all of his brands.26 public relations for the Public
Relations Society of America
(PRSA)
The reputation of the company we love so Resignation memo from News Employee
much, as well as the press freedoms we International chief executive
value so highly, are all at risk.27 Rebekah Brooks
He has too much power over British public Opposition Labour Party Regulator
life. Weve got to look at the situation leader Ed Miliband, calling for
whereby one person can own more than 20 a breakup of the media empire
percent of the newspaper market, the Sky
platform and Sky News. I think its
unhealthy.28
Our committee has jurisdiction to look into Rep. Bruce Braley (D-Iowa), Regulator
these very troubling allegations against who sits on the House
News Corp. and find out whether any Oversight and Government
federal laws were violated such as the Reform Committee
Foreign Corrupt Practices Act.29
It was totally wrong, and I regret it and Rupert Murdoch, Chairman of Chairman of the
Ive said its going to be a blot on my News Corp., testifying before Board of
reputation for the rest of my life.30 Lord Justice Leveson Directors
Tabloids are declining to publish Celebrity publicist Max Customers

sensational stories about the private lives of Clifford speaking to the
celebrities as they fear a backlash from London Times
readers disgusted by the revelations of the
Leveson Inquiry.31
Expenses Arising from Employee (In) Action

Costs to settle the growing number of claims for hacking are not insignificant.
News Corp. could end up paying a total of 120 million pounds in damages and
legal fees, said Niri Shan, a media lawyer at U.K. law firm Taylor Wessing.
Shan based that figure on an average settlement of 30,000 pounds for each of
the 4,000 victims identified by police.32
Analysts projected costs in the range of $1 billion. As of April 2012, according
to The Independent, the legal costs associated with phone hacking totaled
approximately $37.7 million to date, while $88.2 million went to restructuring
after News of the World was shut down in July. News Group, the subsidiary that
owned the tabloid, also took a $254 million write-off when the paper closed.33
Other Costs
On 4 July 2012, The Huffington Post summarized34 the transformations in
Murdochs empire after a 60-year journey that began with a single newspaper in
Adelaide, Australia. During the year that followed disclosure of the Milly
Dowler affair:
The News of the World newspaper has been closed.
A parliamentary committee declared Rupert Murdoch not
fit to lead a major international company.
A protester assaulted Rupert Murdoch with a shaving-
cream pie.
Rupert Murdoch has apologized repeatedly for the scandal,

sent police after his own employees, abandoned his dreams
of buying a lucrative satellite company, and made plans to
cut off his beloved newspapers from the entertainment
properties that keep him enriched.
In addition to Murdochs personal challenges:
Murdochs son James, his heir apparent, has seen his
reputation crash and burn due to his role in the scandal.
Murdochs trusted deputy Rebekah Brooks has been
arrested.
Murdochs trusted editor, Andy Coulson, who then became
top communications adviser to Prime Minister David
Cameron, has been arrested.
More than 40 other people connected with phone hacking
or the bribery of public officials have been arrested.
Brooks, her husband, and Coulson are facing criminal
trials.
The head of Scotland Yard has resigned.
Police in the United Kingdom are running three separate
investigations into illegal activity by the media.
The Department of Justice in the United States is probing
News Corp.s operations.
Most painful for Murdoch, according to Robert Monks, founder of Institutional
Shareholder Services, the foremost proxy advisor, is that the empire Murdoch
had amassed will likely not be passed on to the children. The family business
is simply kaput.35
Unethical behavior by a handful of employees, both reporters and their
supervisors, who pursued their craft aggressively, co-opted police, and lied to
Parliament, operating within a small part of a media empire that generated
around 5% of its net income, wiped out 32 times that value. Succinctly, a
reputational crisis triggered by the behavior of employees erased 10% of the
total News Corp. value in less than two weeks (Table 4-1). The bottom line is
$4.4 billion lost.
By ignoring employee deviations from ethical journalistic practices, News

Corp. showed that it was suffering from a challenged culturea corrupt culture
as headlined in the Financial Times.19
Barclays
Ironically, Barclays CEO Robert Diamonds failure to distinguish between
individual morality and institutional culture cost him personally. His downfall
was precipitated by a scandal involving 14 employees at Barclays, along with a
handful of employees at other banks, who fiddled with a reference standard
called LIBOR (London Interbank Offered Rate) that in 2012 underpinned $360
trillion of global securities.36 After brewing for months, the alleged
improprieties became widespread public knowledge in late June 2012 when
Barclays was fined a record 290 million pounds ($453.4 million).

Days later, Diamond and the banks COO stepped down. In the first week, the
reputational crisis also wiped $5 billion in market capitalization from the bank
ranked second in the United Kingdom by assets. Clearly there was behavior
that was reprehensible, Diamond acknowledged in testimony to Parliament.37
As this volume goes to press, Barclays is conducting an internal review into
what it called flawed business practices while the Serious Fraud Office is
investigating the prospect of criminal charges.
And yes, the personal costs mounted. In addition to losing his job, Diamond
agreed to forgo up to 20 million in bonuses and shares. And although he
walked away with around 2 million in salary and pension payments, the
hearings before Parliament cast a shadow. The comments made at todays
hearing have had a terribly unfair impact upon my reputation, which is of
paramount concern to me, Diamond said.38
Employee Benefits of an Ethical Culture

Employee behavior is one of the most important determinants of an
organizations reputation. At an institutional level, both the behavioral norms
and the systems designed to foster conformance speak to organizational culture.
In an ethical culture, trust and credibility are essential for employee
engagement, stabilizing overall culture, and in turn, its reputation.
Although trust can be difficult to define and measure, high levels of trust
correlate with high levels of employee engagement. Research has shown that a
10% increase in trust is equivalent to a 36% increase in monetary compensation.
If a company is able to increase trust by 10%, it has the equivalent effect on

employee life satisfaction as handing out a 36% raise in salary or bonus.39
In addition to engaging existing employees, a good ethical reputation can help
recruit employees. According to Kelly Services, Inc. the workforce
management services firm, Major public issues such as a companys reputation
for strong ethical practices have become critical factors in choosing where to
work, even to the point where many employees are prepared to sacrifice pay or
promotion in order to work for organizations that are actively engaged in good
social responsibility practices. More specifically, concerns about ethical
behavior outweigh concerns about the environment by all generations, when
making employment choices.40 Key findings that can impact both recruiting
and future salary costs include:
Almost 90% of respondents say they are more likely to
work for an organization that is considered ethically and
socially responsible, something that is consistent across all
generations.
Eighty percent are more likely to work for an organization
that is considered environmentally responsible, a figure that
is considerably higher among people in older age groups.
In deciding where to work, an organizations reputation for
ethical conduct is considered very important by 65% of
Gen Y, 72% of Gen X, and 77% of baby boomers.
Forty-six percent of Gen Y would be prepared to forgo
higher pay or promotion to work for an organization with a
good reputation, rising to 48% for Gen X and 53% for baby
boomers.
Consider This
Organizational culture, the driver of reputation, is a force
that can reduce the variances of otherwise unconstrained
behaviorsbut only to the extent that management and the
board care to both monitor and enforce it. Ignorance is
tantamount to culpability.
In any organization, a small group of employees may

exercise ethically deviant behavior. Call this group
rogues.
When the unethical behavior of a group of individuals
impacts the institutions overall reputationthat is, when
an institution rather than a group of employees is perceived
to be culpablethe financial consequences can be
catastrophic.
A strong culture that establishes organizational norms, and
a board of directors that will support management even in
the face of placing revenue at risk, are essential for driving
consistently ethical behavior and mitigating the risk from
rogues.
Innovation
[Innovation is] the design, invention, development and/or implementation of
new or altered products, services, processes, systems, organizational
structures or business models for the purpose of creating new value for
customers and financial returns for the firm. Intellectual Property is part of
this. (Table 1-1)
For employees seeking an experience at the cutting edge of their respective

fields, a reputation for a culture of innovation is an attraction that facilitates
both engagement and alignment. Engagement means lower operating costs as a
result of less expensive recruitment and retention incentives, less turnover, less
internal friction, and greater effectiveness. Alignment means lower risk-related
costs because employees better conform to the companys behavioral
guidelines.
Apple Inc.
Profitability on tablet computers that compete with the iPad mini was the topic.
How does Samsung make money in tablets, when Google is partnering with
Asus to make a product that makes no money? asked rhetorically Shaw Wu, an
analyst at Sterne Agee & Leach Inc.41 He had a point. Amazon loses money on
every Kindle Fire it sells, with the aim of profiting from sales of books and
other digital media. Microsoft, which, with Google, has long worked with
Samsung as a hardware partner, was also rolling out a tablet computer under its
own brand name.
The challenge as Wu saw it was that Apple had a huge profit advantage. The
company had a pricing advantage with consumers and could charge more
without sacrificing sales. Moreover, as we explore in Chapter 5, Apple was
realizing benefits from its vendors and was able to realize a 37% margin on its
larger iPads. Ever since the iPad went on sale in April 2010, Apple has
dominated the tablet marketa $66.4 billion market in 2012, of which Apple
has a 61% bite.41
Apple understands the power of margins. The value of Apples reputation for
innovation, earned by actually being innovative, is that while the most respected
company in the world commands only 4% of the telephone handset market, it
commands 50% of the profits.42 Thats pricing power in the extreme, a benefit
of a superior reputation valued by customers.
For most stakeholders, Apple Inc. has exploited its reputation with innovation,
to support tremendous margins. Equally importantly, Apple has exploited that
reputation for innovation to engage its employees, create significant enterprise
value, and bolster its stock price.
Working for Apple Inc.

Apple Inc., ranked 17th in the 2012 Fortune 500 league table, was launched on
April Fools day 1976 by high school chums Steven Wozniak and Steven Jobs.
Pooling the technological expertise of the former, then with Hewlett-Packard,
and the marketing vision of the latter, then with Atari, the two college dropouts
promoted their garage-built hardware product to the delight of the Silicon
Valley hobbyist market.
By 1981, the company employed several thousand, was engaged in international
sales, and was expanding with the aid of professional investors. That year, the
potential for personal computers that Jobs had recognized mushroomed into
massive demand. Waves of competition soon followed, including a market
behemothIBM.
Two major projects influenced by IBMs presence were evolving in the
background. On the technology side, the vision of a graphical user interface
initially pioneered by Xeroxs Palo Alto Research Center was morphing into the
Macintoshthe anti-corporate user-friendly computer. On the business side, the
reality of competition set Jobs in search of a CEO who could help Apple punch
above its weight. He recruited John Sculley, the then CEO of Pepsi.
In 1984, Apple threw down the gauntlet. During the third quarter of the Super
Bowl, Apple aired its famous 60-second commercial introducing the Macintosh.
Directed by Ridley Scott, the Orwellian scene depicted the IBM world being
shattered by a new machine.43 Jobs combative spirit captured the markets
attention and gave birth to an Apple culture that today is the underpinning of its
success. When Sculley was less enthusiastic about the innovative technology,
Jobs was bought out. Sculley won the battle in 1985 but lost the war.
By 1993, Sculley was out, followed by two more CEOs who came and went. In
1997, Jobs returned to the helm, wiser and even more passionate. The company
was reinfused with a more focused entrepreneurial culture.
Today, Apples success rests on a number of intangibles; foremost among them
is a built-in fan base that ensures a steady supply of employment applicants and
a culture that frames work as a noble mission. Its a proven model. A 10-year
study of the worlds 50 best businesses, including Apple, shows that founders
who centered their businesses on a culture of improving peoples lives had a
growth rate triple that of competitors in their categories.44 It also found that
The percentage of engaged employees in world class organizations is double
that of average organizations.45 This is why Apple can do something unique
in the annals of retailing: pay a modest hourly wage and no commission, to
individual employees who typically have college degrees and who at the highest
performing levels can move as much as $3 million in goods a year (Figure 4-
1).46 Apple Inc.s employees move nearly $500 per square foot of retail space
per dollar of employee base pay. On an annual basis, the company generates
$6,123 per square foot compared to Best Buys $801 and JC Pennys $135.47
It works in reverse, too. In the U.S. alone, Gallup estimates that the cost of
disengaged employees in lost productivity is $370 billion per year.48
Figure 4-1. Apple retail employees are extremely effective moving nearly $500/sq ft retail
space/$1 hourly base pay and dwarfing the performance of other retail operations.
Recruiting Engaged Employees

Denyelle Bruno, then an executive at Macys West, was one of the first hard-
core Apple fans hired for the nascent chain. Charged with building a retail sales
force, known internally as specialists, she soon took advantage of Apples better
reputational mousetrap, and people beat a path to the Apple door. Application
numbers were so great that statistically it was harder to land a job at an Apple
Store than to get into Stanford.
From the outset, Apple recruited candidates who were affable and self-directed
rather than tech-savvy. (Technology can be taught, is the theory, while
personality is innate.) Those innate advantages are then enhanced with role-
playing and pointers on the elaborate etiquette of interacting with customers.
The phrase that trainees hear time and again, which echoes once they arrive at
the stores, is enriching peoples lives. The idea is to instill in employees the
notion that they are doing something far grander than just selling or fixing
products. If there is a secret to Apples sauce, this is it: the company ennobles
employees. It understands that a lot of people will forgo money if they have a
sense of higher purpose.46
Apple does not incentivize its sales force with commissions. According to Ms.
Bruno, the idea was that such incentives would work against the companys
primary goalsfinding customers the right products, rather than the most
expensive ones, and establishing long-term rapport with the brand. It was also
thought that commissions would foster employee competition, which would
undermine camaraderie.
One two-pronged argument supporting Apples compensation strategy goes like
this: First, pay-for-performance rules crowd out concern for others welfare
and for ethical rules, making the assumption of selfish opportunism a self-
fulfilling prophecy. Second, industries and firms that emphasize incentive pay
tend to attract individuals whoare more inclined to selfish behavior than the
average.49
Empirical evidence supports these arguments. Financial incentives work well
for employees who are financially motivatedwith the attendant risks. Bradley
C. Birkenfeld, the UBS banker who used a variety of ruses to court American
clients and help them dodge taxes, told Judge William J. Zloch that the bonus
incentives were irresistible. At his sentencing hearing in 2008, he admitted
being troubled by the ethics of his actions. It did concern me, your honor, Mr.
Birkenfeld said.50 He knew he was breaking the law, he told Zloch, but did so
because of the incentives UBS offered him.
Retaining Engaged Employees

When youre working for Apple you feel like youre working for this greater
good, says a former salesman who asked for anonymity because he didnt want
to draw attention to himself.46 As Apple Inc. explained to the New York Times,
Thousands of incredibly talented professionalsdeliver the best customer
service in the world. The annual retention rate for Geniuses, the designation
for Apples most advanced salespeople, is almost 90% while the average
retention rate in retail sales for the year ending April 2012 was 74%, according
to the U.S. Bureau of Labor Statistics.51
The company also offers very good benefits for a retailer, including health care,
401(k) contributions, and the chance to buy both company stock and Apple
products at a discount. Whats more, Apple can be a strong credential to have
on a rsum.
In a tight job market, this intangible benefit can be invaluable. It is the modern-
day analog to doing tours of duty with GE or Procter & Gamble. As P&Gs
communications department proudly boasts, More than 130 current and former
chief executives at many of the worlds top companies began their careers and
often spent many years at P&G.52 David Wiser of Cincinnati-based search
consultant Wiser Partners added, P&G is still a golden ticket in terms of
leveraging where youve been and where you want to go.
The Other Side of Engagement

And then there is Microsoft. Once, Microsoft was the cool innovator that ran
circles around IBM. They used to point their finger at IBM and laugh, said
Bill Hill, a former Microsoft manager. Now theyve become the thing they
despised.53
It wasnt always so. In 1975, a year before Wozniak and Jobs started selling
hardware, Paul Allen and Bill Gates started writing software. The program was
called BASICBeginners All-purpose Symbolic Instruction Codeand that
year it generated for the duo $16,000. It was a humble start for Microsoft,
ranked in 2012 as no. 37 on the Fortune 500 league table.
Microsofts founders saw evolving before them a computer market divided into
hardware and software. They had established a solid reputation with the BASIC
language that was on most computers of the day. When they were invited to
IBM in New York to discuss developing an operating system for the mainframe
behemoth that saw no real future in PCs, they made what might be one of the
most fateful decisions in the history of the computer industry.54 Rather than
developing the operating system and then selling it to IBM, they would license
it to them. Every computer that IBM would sell would include that operating
system, and in turn they would pay Microsoft a licensing fee. Both IBM and
Microsoft were confident that were making the better deal.
IBM marketing muscle pushed the Microsoft operating system into the market.
As PC use grew, Microsoft saw that Apples graphical user interface was the
future. Enter Windows and the second fateful decision. Microsoft made it easier
for third-party developers to create software that ran on Windows. Applications
running on Windows proliferated, to the disadvantage of all other operating
systems. The clincher, though, was Microsofts vision of an office suitethe
ability to not only work with the applications simultaneously, but also to copy
information from one and seamlessly paste it into anotherwhile maintaining
the proper format. That was the heart of the Microsoft monopoly known as
Microsoft Office, and it took the company to its peak value of more than $0.55
trillion in 2000.
The principal importance of interoperability and seamless integration remains a
key market discriminator. Today, though, the lead provider is Apple, and
interoperability is expected to extend across various forms of hardware, all
enabling software, and all venues of service including cloud computing. Two
Apple productsthe iPhone and iPadalone generate as much revenue as all
of Microsofts wares combined. Microsoft since 2000 . . . has fallen flat in
every area it entered: e-books, music, search, social networking, etc., etc.55
What happened?
Change for the worst, Jobs would say. He laid it out in 2004, seven years into
the return of Apple Inc. as an innovation powerhouse. After Jobs return as
CEO after an exile engineered by former CEO John Sculley, he told
Businessweek magazine:
People always ask me why did Apple really fail for those years, and its easy
to blame it on certain people or personalities. Certainly, there was some of
that. But theres a far more insightful way to think about it. Apple had a
monopoly on the graphical user interface for almost 10 years. Thats a long
time. And how are monopolies lost? Think about it. Some very good product
people invent some very good products, and the company achieves a
monopoly.
But after that, the product people arent the ones that drive the company
forward anymore. Its the marketing guys or the ones who expand the
business into Latin America or whatever. Because whats the point of

focusing on making the product even better when the only company you can
take business from is yourself?
So a different group of people starts to move up. And who usually ends up
running the show? The sales guy. John Akers at IBM is the consummate
example. Then one day, the monopoly expires for whatever reason. But by
then, the best product people have left, or theyre no longer listened to. And
so the company goes through this tumultuous time, and it either survives or it
doesnt.
Q: Is this common in the industry?

A: Look at Microsoft whos running Microsoft?
Q: Steve Ballmer.
A: Right, the sales guy. Case closed. And thats what happened at Apple, as
well.56
Losing its focus on innovation was bad for Microsoft. Fostering a culture that
drove employees to focus on survival made things worse. Losing its reputation
for innovation was one of many casualties.
In the August 2012 issue of Vanity Fair, Kurt Eichenwald describes how a
corrosive management system known as stack ranking effectively crippled
Microsofts ability to innovate. The program forced every unit to declare a
certain percentage of employees as top performers, good performers, average,
and poor.
Every current and former Microsoft employee I interviewedevery onecited
stack ranking as the most destructive process inside of Microsoft, something
that drove out untold numbers of employees, Eichenwald writes. If you were
on a team of 10 people, you walked in the first day knowing that, no matter how
good everyone was, 2 people were going to get a great review, 7 were going to
get mediocre reviews, and 1 was going to get a terrible review, says a former
software developer. It leads to employees focusing on competing with each
other rather than competing with other companies.
The differences in employee engagement, driven at Apple by a reputation for
innovation and a culture based around the benefits of innovation, have financial
consequences. In 2011, Apple Inc. spent 7% of its $108 billion in revenue on
sales and general administrative expenses, while Microsoft spent 32.6% of its
$69.9 billion on the same types of activities (Figure 4-2). This difference helps
explain why equity investors on 6 July 2012 valued Apple 34% more than
Microsoft for every dollar of net income, and why Apple Inc. on 20 August
became Wall Streets all-time MVPthats Most Valuable Property with the
worlds highest ever market valuation of $624 billion.57
Figure 4-2. Sales, corporate, and other general administrative costs at Apple and Microsoft as a
% of revenue. Source: Apple and Microsoft 2011 annual reports. With engaged employees, Apple
is able to spend significantly less of its revenue on sales and administrative activities.
Consider This
Recruiting employees who share an institutions culture
tends to create an aligned workforce that is more productive
and less costly.
A consistent, credible reputation, once earned and
appreciated, will ensure a steady supply of committed and
engaged employees.
Goldman Sachs Group

Standing at Londons St. Pauls Cathedral, Goldman Sachs International adviser
Brian Griffiths stated: The injunction of Jesus to love others as ourselves is an
endorsement of self-interest. We have to tolerate the inequality as a way to
achieving greater prosperity and opportunity for all.58 The lady doth protest
too much, methinks, you say? Remember, it was not 20 years ago that the
intellectual challenge, power, risk, and reward of investment banking was an
alluring sirens song to a generation of some of the most creative, aggressive,
and intellectually gifted young adults on the face of this planet.
In financial services today, no institution has a better reputation for attracting
the best of the best than Goldman Sachs. In the 1970s, which was a turbulent
period when some firms thrived and many others withered on the vine,
Goldman was at the center of cutting-edge financial and policy innovation.59
The firm exuded Gordon Gekkolevels of bravado: We make the rules, pal.
The news, war, peace, famine, upheaval, the price per paper clip. We pick that
rabbit out of the hat while everybody sits out there wondering how the hell we
did it.60
Its innovative bankers were once dubbed billionaire boy scouts because of
their talent for making fortunes while maintaining a guilt-free, cherubic image.59
Becoming a partner at the firm remains the dream of most ambitious financial
executives, while joining its ranks remains the goal of most wannabe bankers
the world over.61 In short, over the past 30 years, Goldman has emerged as the
iconic innovative bank. Goldman has the banking equivalent of the celebrity
it factor.62
The Company
The Goldman Sachs Group, Inc. (NYSE: GS)the company changed its
name from Goldman, Sachs & Co. after it went public in 1999has been
active in the capital markets sector of the financial services industry for more
than 100 years. The company operates as a leading global investment banking
and securities firm with two main divisions. The first division is Global Capital
Markets, which includes investment banking, financial advisory services,
trading, and principal investments. The second division is Asset Management
and Securities Services, a business unit responsible for investment advisory
services. Goldman Sachss clients include corporations, financial institutions,
governments, and wealthy individuals. The company operates more than 40
offices across the globe.
The company was founded by Marcus Goldman, a Bavarian school teacher,
who immigrated to the United States in 1848. After supporting himself for some
years as a salesman in New Jersey, Goldman moved to Philadelphia, where he
operated a small clothing storehe was in the rags business.
After the Civil War he moved to New York City, where in 1869 he began
trading in promissory notes. Goldman would assume the credit risk borne by
merchants in lower Manhattan, purchasing at a discount customers promissory
notes from jewelers on Maiden Lane and from leather merchants in an area of
the city called the swamp. Goldman would then sell these jewelry and leather-
collateralized loans to commercial banks at a lesser discount.
The Goldman story is the epitome of rags to riches. In the early 1880s,
Goldmans son Henry expanded the firms range of credit exposures and set up
operations in Providence, Hartford, Boston, and Philadelphia. In 1887,
Goldman, Sachs expanded internationally through a relationship with the
British merchant bank Kleinwort Sons. For the next 100 years, the partnership
expanded into international commercial finance, foreign-exchange services, and
currency arbitrage. As business operations became driven by innovations of
increasing complexity, leveraged transactions demanded an ever larger balance

sheet.
In early May 1999, the company listed on the New York Stock Exchange,
raising $3.6 billion. In 2002, then CEO Henry Paulson, who would go on to be
the U.S. Treasury Secretary under President George W. Bush, laid out the
companys strategy, declaring, We want to be the premier global investment
bank, securities, and investment management firm. We want to have a
disproportionate share of the business of the most important clients in the most
important markets. Businessweek magazine memorialized those words, adding:
The company must gain a lock on providing financial advice to marquee
corporations, government authorities, and superrich individuals in the world's
major economiesthe U.S., Germany, Britain, Japan, and China.63 Within
four years, Paulsons strategy had propelled the firm to the top spot in global-
equities underwriting and M&A advisory. The trading unit that included fixed
income, currency, and commodities generated record net revenues of $5.6
billion, while equities trading added another $1.74 billion. The company
generated an annual profit of more than $3 billion, nearly surpassing its
earnings at the height of the bull market.64
Innovation at Goldman Sachs

When John Havens assumed command of Citigroups securities and investment
business after the 2008 crash, he looked around at his competitors and
concluded that Goldman Sachs became a global powerhouse by offering
corporate clients smart ideas, innovative products, and flawless execution.65 Bill
Cassano, vice president in the economic derivatives group at Goldman Sachs,
concurred: Financial innovation over the last 25 years has all been about taking
the risks that are embedded in assets, isolating them and making them
transferable so you can hold the asset, but not hold the risk that isnt part of the
reason you're investing.66 Theres money to be made in capturing certain
reward while selling uncertain risk.
To strip reward from risk and capture it to the benefit of clients, Goldman Sachs
has been introducing financial innovations for more than a century. Initial
public offerings are one such model. In the early 20th century, Goldman Sachs
established itself as a major player in the initial public offering (IPO) market.
Selling shares to the public was innovative; buying them back and structuring
retirement options, as Goldman did in the early teens, was even more
innovative.67 Since it was already expert in buying and selling credit, selling and
buying equities came naturallyand thus Goldman Sachs found itself in
investment banking in the 1930s. In the 1950s, it became a pioneer of certain

types of hedging strategies, the precursors to the complex derivative trades that
many argue helped to bring about the global financial crisis in 2008.
Innovation is a process driven first and foremost by people. Our assets are our
people, capital and reputation.68 That quote on page 2 of the 2011 Annual
Report makes explicit the link between employees and reputation at Goldman.
Innovation is cultural. Goldman Sachs was one of the first financial institutions
to recruit MBA graduates from the worlds leading business schools, helping it
earn a reputation as hiring only the very brightest and most capable. Innovation
is enshrined in the firms credothe 5th of the 14 Principles:69
5. We stress creativity and imagination in everything we do. While

recognizing that the old way may still be the best way, we constantly strive to
find a better solution to a clients problems. We pride ourselves on having
pioneered many of the practices and techniques that have become standard
in the industry.
Financial Success Metrics

In 2006, Goldman Sachs made more money than any other Wall Street
investment bank in history. Its staff shared in a $16 billion bonus pool. The
bank was at the top of the global M&A adviser rankings for yet another year,
and it was named bank of the year in the International Financing Review (IFR)
awards.
The bank won praise for the way it has developed its private equity and hedge
fund businessand for the way it combines its roles as adviser and financier
with that of co-investor. Goldman was also named equity house of the year and
won a new category: Leveraged finance house of the year. That award,
introduced to reflect the increasing variety and complexity of financing
associated with leveraged buyouts may or may not turn out to be a good win for
Goldman.70 It occurred just as the doom-mongers predicted rising defaults for
the next year, a contraction of risk appetite, and an end to the ample global
liquidity seen in 2006.
The bank even won an award for the way it engineered the exit of one of its
corporate directors who had become an embarrassment. Andrew Hill for the
Financial Times wrote about how Goldman Sachs distanced itself from BPs
Lord Browne: It is rare, for one thing, that Goldman Sachs offers an innovation
to the world of business without charging a fee for it. But next time a company
chairman wants to hint to a distinguished director that time is up, he need only
slide a piece of paper across the boardroom table with two words on it: John
Browne.71
Fast forward to 2010, and reputational resilience is still evident.
Notwithstanding the terrible bruising suffered by the industry in general and
Goldman Sachs in particular, the BBC was still paying tribute to the world's
most revered commercial financial institution. Goldman Sachs topped the
industry league tables for financial advice, with 22.8% of the market share and
$555 billion in deals72 (Figure 4-3a). Goldmans average deal size was 15%
larger than the average of its peers; and its total deal value was 42% greater than
the average of its peers. Goldman Sachs was also the favorite counterparty of
the U.S. Federal Reserve. The company received 22.1% of the Feds Treasury
dealings. The next two major traders, Citigroup and Credit Suisse, received
14.5% and 10.2% respectively.73 In 2011, notwithstanding a profound
slowdown in banking activity, Goldman continued to lead in IPOs (Figure 4-
3b).74 Last, at the end of Q1 of 2012, Goldman Sachs led merger and acquisition
advisory services, with 29% of the $1.08 trillion in deals.75
For all its faults, challenges, and public missteps, customers still prefer
Goldman Sachs and they reward the firm with bigger and better deal
opportunities, on which Goldman (generally) effectively delivers. Said William
Barker of Brand Finance to the Financial Times, My guess is that their
customers are probably very happy with them.76 As one analyst noted,
Nobody is going to stop doing business with Goldman Sachs. Theyre just not
going to do itbecause Goldman is just better than everybody else. And thats
the bottom line.77 To underscore that point, on 29 September 2012, Barrons
magazine cover featured Goldman Sachs in a story titled, Built to Win.78
Figure 4-3a. 2010 Financial Advice League table showing Goldman Sachs advice helped shape
more deal value, and that the average value of each deal was greater than that of its closest
competitors.
Figure 4-3b. 2011 Financial Advice League table showing Goldman Sachs services helped raise
more capital more deal value, and that the average value of each deal was greater than that of its
closest competitors.
Enmity from Non-Stakeholders

Goldman Sachss reputation for innovation and ubiquity, as well as its superior
return among the biggest banks, has made it a target for much of the anger and
frustration arising from the global economic chaos. This is best illustrated by
the colorful descriptor penned by Matt Taibbi in Rolling Stone magazine in July
2009.79
In an article titled, The Great American Bubble Machine, Taibbi charges:
From tech stocks to high gas prices, Goldman Sachs has engineered every
major market manipulation since the Great Depression and they're about to do
it again. He then characterizes Goldman Sachs as a great vampire squid
wrapped around the face of humanity, relentlessly jamming its blood funnel into
anything that smells like money.
The following month, the Financial Times reported that research it
commissioned from Brand Asset Consulting comprising a survey of 17,000
Americans found that Goldmans statureas measured by several gauges of
brand strengthhad suffered in 2008 and 2009.75 A similar finding was
reported in early 2010 by Harris Interactive in their 2009 Reputation Quotient
survey, which placed Goldman Sachs near the bottom of a list of 60 highly
visible companies. As an aside, Chapter 9 presents survey data showing that
Goldmans peers were more favorably disposed to the company.
Passion and Engagement from Employees

Despite the slide in Goldman Sachs reputation among the general public,
among its employees the company remains an icon. The company seeks to
recruit diverse, driven, and innovative team players who have an interest in
financial markets, management, and process design. And rather than operate a
company of individual stars, it operates a star company.
This is important. Even in investment banking, where many firms coddle top
performers, corporate culture is valued by employees. According to Vault
Finance, a 2010 survey of financial service employees showed the following:
Percentage of respondents who say firm culture was the
single most important factor in deciding to accept their
firms offer over others: 35
Percentage who say prestige was the most important factor:
18
Percentage who say compensation was the most important:

980
Goldmans culture helps explain why it is a fixture of Fortunes 100 Best
Companies to Work For list, a survey-based study involving around 250,000
employees globally. In 2011, Goldman Sachs moved up a slot to no. 23. While
thats lower than its 9th place ranking before the financial crisis, Goldman is
one of only 13 companies to have earned a spot on the list every year since it
debuted in 1998.81
The same perceptions go for potential employees. The bonuses and profits that
led Goldman Sachs to be labeled a great vampire squid are cited by business-
school students as proof of the companys strength. And they want to work
there. In annual surveys by Universum Group, a Stockholm-based marketing
company, as reported by Fortune, Goldman Sachs ranked no. 3 or no. 4 among
approximately 6,000 MBA candidates at more than 50 business schools
worldwide (Figure 4-4).
Figure 4-4. MBA students consistently rank Goldman Sachs as their choice investment bank
employment opportunity, and as one of the top five employment opportunities consistently.
Source: Universum Group annual surveys.
Its not just the fringe benefits nor is it the money. Goldman, for instance,
doesnt offer employees free cafeteria chow like Google, ranked the no. 4
choice by existing employees in 2011. It does not provide complimentary
recreation and fitness areas like the no. 1 company on the list, SAS. Even
Goldmans compensation, though higher than that of many companies, isnt
dramatically different from that of other investment banks. (As one former low-
level Goldman strategist puts it, Their compensation system pays you $1 more
than whatever is your threshold for leaving Goldman Sachs.80)
Its the culturewhat many call corporate brandand what we believe at
Goldman Sachs comprises its reputation for innovation. As Stefan Stern who
writes on management for the Financial Times, summarized: When it comes to
retaining good people or attracting new ones, your image and reputation count.82
Last, as every senior executive appreciates, engaged and motivated employees
produce more and turn over less. Weve seen that Goldman outproduces. What
about turnover?
Among financial service companies ranked as one of the top 100 places to
work, Goldman turnover was 9.4%; overall industry turnover rates are 10.7%.
The 12% lower turnover rate at Goldman translates to lower direct and indirect
costs associated. Direct costs that would appear in the Selling, General and
Administrative (SG&A) sections of the P&L statement include advertising,
headhunter fees, temporary work, overtime pay, signing bonuses, relocation
costs for new employees, and training costs. Indirect costs that would appear
subtly in the Revenue line of the P&L statement include customer service
disruption, emotional costs, loss of morale, burnout/absenteeism among
remaining employees, loss of experience, continuity, and corporate memory.
Goldman Sachs understands explicitly that a good reputation among employees
makes for a good corporate reputation and fosters greater productivity and
above-average returns.
Goldman Sachs has one reputation. It can be affected by any number of

decisions and activities across the firm. Every employee has an equal
obligation to raise issues or concerns, no matter how small, to protect the
firms reputation. We must ensure that our focus on our reputation is as
grounded, consistent and pervasive as our focus on commercial success.83
Goldman Sachs also benefits from this empirically (Figure 4-6). Over the
trailing three years, costs in its investment banking division to generate $1 were
consistently lower and no less than 4% lower than the average of its peers
(Figure 4-5). The exception is the 2011 cost/revenue ratio at JP Morgan Chase
which, while better for that year, was offset by an $5.8 billion trading loss in
2012.84
Figure 4-5. Operating costs as a % of revenue generated in the investment banking segments of
Goldman Sachs and selected peers illustrating how employee engagement reduces costs. Source:
Goldman Sachs, JP Morgan Chase, Morgan Stanley and UBS 2011 Annual reports. JP Morgan
Chase, while apparently an exception to the rule in 2011, may have taken risks that manifested
only in 2012.83
Also, as of mid-July 2012, for every $1 in expected net income, equity investors
valued Goldman Sachs more than its six closest competitors: 15% more than JP
Morgan Chase, 19% more than Morgan Stanley, 22% more than UBS, 34%
more than Citigroup, 64% more than Credit Suisse, and 78% more than
Deutsche Bank.85
Figure 4-6. Equity investors value Goldman Sachs more. For every $1 of expected future net
income, equity investors give Goldman Sachs anywhere from a 15% to a 78% premium over its
closest competitors.
Retrospective
Goldman Sachs is an iconic firm respected for its innovation (and the cerebral
power behind it). This reputation, and the culture surrounding it, is one that is
valued by its employees, and it has enabled the company to sustain its
reputation and reap the benefits.
In the capital markets sector, a reputation for innovation is an important
differentiator. Goldman Sachs is well aware of the importance of reputation to
its value and its ability to compete successfully.
Goldman continues to dominate notwithstanding the great public enmity,
increased regulatory scrutiny, and general slowdown, all of which have been
adversely impacting the industry as a whole.
Consider This
Even in industry segments in which compensation is a
central motivator, corporate culture is both a competitive
differentiator and a primary motivator.
Engaged and motivated employees outperform their peers,
and in most businesses, that is the key to financial success
and market domination.
Stakeholders own a firms reputation. When customers,
clients, and the company are all authentically on the same
page, all will benefit from the value generated.
Quality: Domino Pizza Redux

1-1)
The prank impugning the quality of Dominos pizza recorded and uploaded to
YouTube on Easter Sunday, 2009, jeopardized Dominos $490 million in
domestic revenues and $1.4 billion spent on brand-building during the
preceding five years and precipitated a 10% fall in market capitalization in the
period immediately following. Trading volume surged.
Yet according to an earnings call transcript by Seeking Alpha, the company lost
no more than 2% in domestic same-store sales for the second quarter of 2009.
Within one year, Dominos equity value was higher than it had been in years.
Tim McIntyre, vice president of communications at Dominos, who helped
shepherd the company through the viral video incident, is on the lecture circuit
advising directors that their duties of oversight include social media. Is there a
connection? Might it be the $2 million insurance payment the company received
following the event? Or perhaps the stock surge is due to the December 2009
launch of new crust, new sauce, and new cheese? After all, quality is a major
driver of intangible asset and reputational value in the food sector.
The company did roll out an aggressive campaign to restore its reputation. How
effective was it? Simple answer: its returns beat those of two of the three most
highly ranked firms in the restaurant sector from that period.
Process: The Secret Sauce

While many might attribute the rebound to excellent marketing, a more
satisfying explanation for Dominos reputation resilience was evidence of
substantive business processes that engaged its employees to create a quality
product, and a communications effort that allowed stakeholders to appreciate its
value.
Those quality processes are systems that improve managerial motivation,
provide time for managerial oversight, and incorporate technology that
enhances quality while reducing opportunities for adverse human intervention,
malicious or otherwise.
Dominos greatest reputation risk lurks in and among the employees of the
franchisees. Its strategy to mitigate that risk comprises two creative HR-focused
processes. First, it requires that every franchise owner be 100% committed to
the businessno outside (distracting) revenue opportunities. Dominos wants
the fortune of its franchise owners to depend on the success of the franchise.
Second, it provides vertically integrated dough manufacturing and supply chain
systems that allow the franchise owner to dedicate more time to human resource
management rather than engage in the back-of-store activity typical of the
industry.
Dominos is also constantly innovating to increase quality. It has led the
industry with a sturdier corrugated pizza box, a mesh screen that helps cook
pizza crust more evenly, and, introduced in 1998, the Dominos HeatWave hot
bag that keeps pizzas hot during delivery.
Consider This
In a business in which quality means meeting customers
expectations for high levels of product or service, processes
and controls that drive product quality by engaging
employees are proven sources of enterprise value.
Risk management processes that anticipate and head off
crises can reduce volatility. Authentic processes that isolate
rogue activities for what they areroguesfoster
reputational resilience.
Guidance
From the perspective of employees, companies reputations manifest in
corporate culture. Culture is what employees experience in their day-to-day
operationsthe human environment within which instructions are conveyed,
goals are set, operations are monitored, and results are rewarded or punished.
These experiences establish employee expectations that then inform employee
actions ranging from ethical decisions to sales execution to, well, making
fabulous pizza.
Culture comes from the top. News Corp.s top leadership came from the rough-
and-tumble world of Australian journalism. Within tabloid press, an especially
seedy part of the Murdoch empire, an unholy alliance between a capable
executive and the head of the enterprises center of governance lubricated an
already slippery slope. Bad behavior was rewarded. There was no internal
governor to arrest its proliferation. Consequently, when the ethical problem was
exposed, the enterprise had no defense and was found culpable. The full costs
are yet to be determined.
Barclays is a similar story. The cost is in the range of half a billion dollars in
fines, a few jobs, and the CEOs reputation. The bad behaviora cultural
failuredoes not seal the case for more regulation in the financial sector. On
the contrary. If a regulator enforces culture, You get a police state with
compliance on the surface and subversion underneath.86
As destructive as rogue employees can be to an enterprises value, engaged

employees can create significant value. Apples culture is a reflection of the
values of its founders. Its strong culture attracts employees whose behavior
reinforces its reputation for innovation. While that has created significant value
by reducing operational costs and boosting revenues, the future will be one in
which professional management is at the helm. The world will be watching to
see if the culture of innovation will long outlive its original creator.
Microsoft went through the transition to professional management, and the
cultural effects on the employees have been well documented. Innovation has
been one of many casualties.
Goldman Sachs stands in contrast to Barclays. It has been pilloried in the press,
reviled by the general public, parodied by modern-day gonzo journalists, and
yetits customers, employees, and prospective employees hold it in high
regard. And this consistently translates to market domination. Say what you
wish, but Goldman Sachs reputation is incredibly resilient.
Dominos shows that employee engagement and a reputation for quality is a
consequence of operational controls and properly designed incentives. It shows
that authentic controls can protect reputation by enabling a company to distance
itself from rogues.
Each of these exemplary companies established reputations that employees
understood, valued, and exploited. Awareness of the importance of its
reputationand how it was establishedhelped Apple and Goldman Sachs
dominate their sectors and helped Dominos rebound from a crisis. Conversely,
ethical failures poisoned the reputations and accelerated the falls from grace at
News Corp. and Barclays.
There are practical steps a company can take to prevent employees from
exploiting control weaknesses and placing an enterprises reputation at risk.
Supervisors can ask boards to provide evidence of healthy culture, such as
functional whistleblowing practices, customer surveys, and employee
engagement surveys. The enterprise can invest in systems for challenging
group think at the board level and technology solutions that provide
management and boards with both operational controls and oversight
dashboards. Last, a company might consider reputational value insurances
where underwriting assesses reputational practices and culture and signals to all
stakeholders that the organization is in operational control.
By the Numbers
These case studies illustrate how reputation can affect value-creating and value-
destroying actions by employees, and how those economic effects either impact
SG&A expenses or create one-time extraordinary charges (Table 4-2).
Table 4-2. Effect of Reputation on Employee-Associated Costs
P&L Effect Stock Price Effect
News Corp. More than $360 million in fees and $4.4 billion lost
write-downs
Barclays $452 million (290 million) in one- $5.77 billion (3.7 billion) lost
time extraordinary charges
Apple Store sales are 280% more efficient Apple 270% 3-year returns
than the average of a reference group.
Microsoft: 32%; Nasdaq: :
SG&A costs are 65% lower than at 50%; Google: 39%
Microsoft
Goldman Sachs Average deal size 15% larger than the Forward P/E multiples
average of its peers; total deal value 15%78% greater than all
42% greater than the average of its major rivals
peers.
Operating costs per $/revenue no less
than 4% lower than average of rivals
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wednesday/. Accessed 12 July 2012.
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July 2012.
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not-being-hit-where-it-hurts.html. Accessed 14 July 2012.
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CHAPTER
Suppliers
The complexity of supply chains puts your reputation in the hands of the
lowest common denominator.
John Hurrell1
Just as a steel chain is only as strong as its weakest link, so it is with a supply
chain. A chain with uniformly strong links reduces risk and provides important
benefits to the whole enterprise; but a broken link jeopardizes all.
The strongest chain is one in which each supplier considers his or her
downstream buyer to be his or her preferred customer. As a 2005 survey made
explicit: 75% of the respondent suppliers regularly put their preferred customers
at the top of allocation lists for materials or services in short supply; 82% said
that these customers consistently get first access to new product or service ideas
and technologies; and 87% of the suppliers offer cost reduction opportunities to
their most-preferred customers first.2 A supplier to Volvo explained:
preferred customers are receiving better prices than their other customers.
They also place their best employees and mechanics with their preferred
customers primarily, and respond quicker to the needs of their preferred
customers.3
Such benefits translate to financial gains that vary in size depending on the
dynamics of the buyer/supplier relationship. All things being equal, the benefits
2 Chapter 5 | Suppliers
of becoming a customer of choice have the potential to deliver value

equivalent to an additional 2%4% of savings off of the companys total spend
base, according to the Procurement Strategy Council.4
This chapter explores the role of reputation in establishing preferred customer
status. It looks at how expectations that suppliers hold about a company help
shape that companys reputation; how a companys actions in managing ethics,
innovation, quality, safety, sustainability, and security shape suppliers
expectations; what behaviors and benefits result; and how strategies for
leveraging reputation to build customer-of-choice positions create enterprise-
wide benefits that turn into shareholder value.
At one time, companies such as Ford operated under one roof, sourcing raw
materials and producing finished goods through an assembly line. Then as
assemblies begat subassemblies and supply companies, major manufacturers
such as Toyota set them up just outside their gates in what became Toyota City.
As logistics and coordination improved, the path from raw material to finished
good evolved and extended into a global supply chainthe collection and
distribution of all the inputs to the production process.5 Boeings 777 jet, for
example, is assembled from 3 million parts sourced from more than 500
suppliers around the world.6
Supply chains have transformed business, reducing labor costs and eliminating
warehousing, and they have elevated logistics management to a fine art and
information technology to a vital global utility. As supply chains became an
increasing source of both value and risk to the penultimate buyer, they also
radically transformed the business-to-business relationships between buyers and
their suppliers. As a source of competitive advantage, maintaining oversight
and control of the supply chain to ensure quality at every step has become an
overarching concern.
In general, two variables exist in types of relationships between a buyer and a
seller in the supply chain: (1) importance of the supply to the buyers aggregate
revenue and (2) scarcity of the supply. 78
When supplies are important to the business model, but generally easy to
obtain, a buyer can push down costs and pit one supplier against another. But
when supply is scarce and sources are limited to few suppliers, the buyer will
generally prefer a close relationship with a select number of suppliers. For
companies that emphasize quality, such as McDonalds, Coca-Cola, Toyota,
and Peets, the supply chain relationship tends to follow the closer/fewer model.
When supplies are not especially important points of differentiation in the

business, the purchasing strategy may follow one of two paths. When the
products are not readily available, a buyer may try to create alternative sources,
but when there are alternative sources, the buyers strategy is to reduce
administrative (transactional) costs. Known well to students of Coases
theorem, these transactional costs can radically alter the total cost of product
acquisition and supply chain operations.
One companys transactional cost, however, may be another companys profit
margin. On the other hand, squeezing a supplier too hard can transform a
relatively low-value item into a source of extraordinarily high risk.
Reputation Risks in the Supply Chain

The supply chain is a system that creates a complex matrix of
interconnectedness. And a weak link can create havoc.
Lead paint on childrens toys, melamine in a variety of food and consumer
products, and tainted pharmaceuticals are examples of remote suppliers creating
headline risks for iconic firms. The physical movement of goods from sellers to
buyers, the financial information linked to the transactions that relate to the
goods purchased, and the business chain process are so rapid and multifarious
that todays business processing systems cannot properly integrate the
information.
The systems in use, which in the case of many multinationals comprise several
generations of computer hardware and software, were not designed to support
the current level of global sourcing and distribution. In many ways, this is
similar to the failure of systems in the banking sector to identify risk in certain
modern complex financial instruments.
With computer system variances and multiple unrelated businesses supporting
the global supply chain, inefficiencies are inherent to the system and risks are
rampant. The inability of disparate computer systems to extract, transform, and
associate data leaves management without full operational control and exposes
almost all businesses to an unacceptable range of quality and ethical product
perils, credit risks, compliance failures, theft, fraud, and reputational risk.
A report by Mactavish, a consultancy, concluded: The network of corporate
risks is far more systemic than was the case even 510 years ago as companies
operate in an ever more complicated and interconnected value chain.1 Among
other risks, the Mactavish report identified systemic supply chain disruption
caused by company failures and a plethora of efficiency measures throughout

the trading system that are reducing resilience and increasing product quality
risks.
Iconic firms such as Toyota are invariably the ultimate and most visible bearers
of supply chain risk. Regardless of where that risk originated in the chain, it is
Toyotas reputation that takes the hit.
Mitigating the operational risks in the supply chain and reducing the risk that an
operational event will mature into a reputational event is a two-step process.
The first consists of basic mainstream managerial strategiesestablishing
systems that improve visibility and foster control. A 21st-century supply chain,
however, requires visibility and control on a scale and scope not yet
successfully tackled by any one company. Four challenges stand in the path of
success:
Operational Inflexibility. Internal information systems in
most companies are optimized for inventory management,
transactional processing, and balance sheetoriented
financial reporting. These systems often are composed of
entrenched legacy systems that do not easily associate new
types of information vital to efficient control of supply
chain operations.
Security. Concerns over IT system security make it difficult
for most companies to acquire supply chain information
that is external to their information systems.
External/Internal Linkage. Associating external data with
internal data to provide a coherent view of operations,
operational risks, and reputational risks is exceedingly
difficult.
Siloed Structures. Enterprise software solutions have
broken down the IT barriers separating most operational
departments. However, most corporate departments
overseeing enterprise-wide issues such as safety, security,
ethics, and risk still operate in technology silos.
The challenges in no way reduce the substantial potential benefits, which
include overall cost reduction, cost avoidance, revenue enhancement, improved
stakeholder service, improved risk management, regulatory risk mitigation,
market differentiation, and, ultimately, increased enterprise value (Table 5-1).
These potential benefits continue to spur innovative solution frameworks. The

Global Trademaster Company, a company in which this books author has an
economic interest, is one of many emerging solutions.
Table 5-1. Operational and Reputation Benefits Arising from Improved Supply Chain Visibility
and Control.
Category of Benefit Type of Benefit
Cost Reduction Reduced repetitive data entry
Decreased inventory
Increased opportunity for sourcing
Lower insurance rates based on risk distribution resulting from

aggregation and analysis of anonymized supply chain data
Improved supply chain performance at operating level
Cost Avoidance Improved planning due to a more stable planning environment
Improved supply and distribution channel performance
Potential Green Lane (accelerated border crossing) based on proven

transparency and reliability of reporting from the participants
supply and financial chain transactions
Revenue Enhancement Enhanced transparency of end-to-end supply chain enabling more

effective marketing based on predictability of delivery
Improved market intelligence
Better system status and performance using third-party metrics
Improved turnover of inventory
Improved Service Improved velocity resulting from analysis to resolve choke points
and closer integration with manufacturers and carriers
Greater control for supply chain managers
Better visibility into the supply chain for operators and customers
Neutral provision of data on the supply chain
Risk Management Legal Compliance
Improved resilience resulting from visibility and ability to re-route

shipments to alternative ports not affected by terrorists or natural
disasters
Better security through increasingly better known suppliers
Regulatory Mitigation Influence over forthcoming regulatory activities and better insight
into regulatory objectives and plans
Enhanced reputation with Customs and Border Protection &

Department of Homeland Security
Market Differentiation Market signaling of a superior (more secure) offering
Enterprise Value Enhanced reputation value arising from operational improvements

Appreciation in processes that ensure safety, security, and quality and potentially
capture conformance data on ethics and sustainability
The second step in reducing supply chain risks, which reduces the risk that an
operational event will mature into a reputational event, is one of engaging
supply chain partners. Cases involving McDonalds, Yum! Brands, Coca-Cola,
Pepsi, Toyota Motors, and Peets Coffee illustrate a range of potential
strategies.
Quality: McDonalds and YUM!

1-1)
Quality products and services are key success factors for the two largest fast-
food franchises: McDonalds Corporation and Yum! Brands. Their reputations
for quality are due in no small part to the support they receive from their
suppliers. The consequences of their differing supply chain engagement
strategies are the centerpiece of this section.
McDonalds Corporation
McDonalds Corporation began humbly in 1955 with three restaurants, several
milk-shake mixers, the two McDonald brothers, and a visionary appliance
salesman named Ray Kroc. Six years into the venture, brothers Dick and Mac
exited with $2.7 million. In 1963, Krocs growing enterprise had sold a billion
burgers, realized net income in excess of $1 million, and was quickly becoming
an American icon, Two years later, the company went public. 9
Today, operating in 119 countries around the world, McDonalds Corporation is
the global icon of fast-food franchises and restaurants. McDonalds branded
restaurants serve a menu at various price points. As of December 31, 2011,
McDonalds had 33,510 restaurants: 27,075 franchised or licensed and 6,435
operated by the company.10
McDonalds and its franchisees purchase food, packaging, equipment, and other
goods from numerous independent suppliers. From its beginning, the company
understood the crucial importance of fresh ingredients and nearly on-time
delivery and has focused strongly on the supply chain on which those depend.
By exercising close oversight and operational control of its supply chain, the
company has established and strictly enforces product specifications with high
quality standards. A quality-leadership board, composed of the companys
technical, safety, and supply chain specialists, provides strategic global
leadership for all aspects of food quality and safety. The company conducts
ongoing product reviews and on-site supplier visits working out of quality
centers around the world. In addition, the company works closely with suppliers
to encourage innovation, ensure best practices, and drive continuous
improvement. By leveraging scale, supply chain infrastructure, and risk
management strategies, the company also collaborates with suppliers toward a
goal of achieving competitive and predictable food and paper costs over the
long term.
Independently owned and operated distribution centers, approved by the
company, distribute products and supplies to most McDonalds restaurants.
Restaurant personnel are trained in the proper storage, handling, and preparation
of products and in the delivery of customer service.
McDonalds oversight extends to the corporate arena. When RHM, the U.K.
food group, was divesting itself of its Golden West subsidiary, a provider of
burger buns, tomato ketchup, and soft drink syrups, the two firms bidding to
acquire RHM first had to be approved by McDonalds.11
McDonalds restaurants once offered a menu that was substantially uniform the
world over in order to meet customers expectations of a substantially uniform
experiencea quality experienceanywhere in the world. Today, McDonalds
delivers the same standard quality experience to an international smorgasbord
of menus designed to cater to different national tastes. McDonalds calls this
value proposition remaining a trusted brand.12 It is called here protecting
McDonalds reputation for quality.
Consistency does not mean McDonalds is not open to change. The company
works hard to identify, implement, and scale innovative ideas that meet
customers changing needs and preferences. Suppliers play a central role in
innovation. It was a McDonalds supplier, after all, that perfected the frozen
French fry and the famous secret sauce for the Big Mac. And it was suppliers
who saved the day by figuring out how to get chicken into Asia when the other
restaurants ran out during the avian flu crisis.13 McDonalds also engages
suppliers in research activities that benefit the company, its franchises, and
suppliers.
In recent years, McDonalds has recognized that sustainability has become an
important ingredient in its reputation recipe. It works closely with suppliers to
more quickly conform to much anticipated climate changeassociated
regulations and other government-led initiatives.
The companys approach to its relationship with suppliers reflects its ethical
culture and the innovations Kroc brought to the business. From the Harvard
Business School case study on McDonalds supply chain:
Unlike most contemporary fast-food franchisers who profited significantly by

marking up the goods they required their franchisees to buy, Kroc aligned
McDonalds interests with its franchisees by profiting from excellent
restaurant operations. He refused all gifts and special favors offered by
suppliers; instead, he focused exclusively on securing the consistent supply,
excellent quality, and volume pricing that would facilitate success in the
restaurants.
Kroc and his staff made other supply chain innovations. Unlike other food
retailers at the time, McDonalds established strict standards for the
ingredients and appearance of each product; McDonalds staff often visited
suppliers without warning to ensure their compliance. Kroc terminated those
suppliers that could not consistently provide high quality and dedicated
service but he rewarded those that did with loyalty and volume. In effect, he
made his suppliers partners in his quest for fast-food greatness.14
Krocs goal continues into the present: being a company the public can trust15
is borne out, for most of its stakeholders, by fulfilled expectations for quality
products as well as ethical behavior and other operational drivers of reputation.
Trust and commitment are the foundation of supply chain management.16 Both
parties are involved; they understand that the relationship and behaviors of each
will work to mutual benefit. Trust is conveyed through faith, reliance, belief, or
confidence in the supply partner and includes a willingness to forgo
opportunistic behavior. Trust is an expectation that ones supply chain partner
will act in a consistent manner, will do what he or she says he or she will do,
and will maintain the reputation of both partners.
The highest corporate levels of McDonalds are charged with trust assurance.
The company brings corporate boardlevel oversight and operational control to
its reputation through the Corporate Responsibility Committee, which advises

on all policies and strategies that affect product safety, workplace safety,
employee opportunities and training, diversity, and environment and sustainable
supply chain initiatives. One step below the corporate board of directors, five
corporate-level operational committees monitor and manage reputationally
relevant issues on a day-to-day basis.16 These committees have helped
McDonalds implement authentic changes to its supply chain operations,
wherever they are regarded as beneficial for the McDonalds brand even
when they involve additional costs.17
Since 2007, consumers and suppliers have been expecting more authentic
transparency and accountability from businesses.18 According to Ben Boyd,
Executive Vice President of Edelman, the public relations firm, the most
important corporate reputation factors in the 2011 annual survey were:
Maintains transparent and honest practices.
Offers high-quality products or services.
Is a company I can trust.19
Collaboration with supply chain partners minimizes risk and maximizes
transparency. Rick Blasgen, chief executive of the Illinois-based Council of
Supply Chain Management Professionals, says, You have to trust your partners
with information that in the past you might have considered proprietary.19
The comfort afforded by reputation holds in check ones fear of self-serving
behavior on the part of the others in the supply chain.20 Commitment is the
mutual belief that the trading partners are willing to devote energy to sustaining
this relationship21 and will not act in ways that might adversely affect overall
supply chain performance. Trading partners throughout the chain become

integrated into their major customers processes and more tied to their
overarching goals.22 The bottom line is: trust, transparency, and collaboration
are essential for the most value to be realized from a supply chain.
A classic fable is illustrative. A pig and a chicken are walking down the road.
Chicken says, Hey Pig, I was thinking we should open a restaurant! Pig
replies, Hm, maybe, what would we call it? Chicken responds, How about
Ham-n-Eggs? Pig thinks for a moment and says, No thanks. Id be
committed, but youd only be involved!23
Yum! Brands, Inc.

Yum! Brands may not be instantly recognized by most people as a quick-
service restaurant company even though it has approximately 37,000 outlets in
more than 120 countries and territories. But the brands it operates sure are:
KFC, Pizza Hut, and Taco Bell. It was already a big company in 1977 when it
was named Tricon Global Restaurants, Inc., and spun off from PepsiCo.
Under the trademarked aegis of Colonel Sanders, Yum! Brands has been
cooking big time ever since. China typifies the Kentucky Fried
Chickenification of the middle classes in the worlds emerging economies.24 A
key to their success, explained R. J. Hottovy, an analyst at Morningstar, is that
they built up their supply chain and their distribution system quickly, and that is
giving them a real competitive advantage.25 Yum!s China operations, for
example, increased from 2% of operating profits in 1998 to 33% in 2009.25
From the outset, Yum! Brands has operated under a worldwide code of conduct
that set behavioral standards for many of the reputationally relevant processes
of corporate life. A set of polices governs a spectrum of reputationally related
processes and stakeholder relationships.
In Yum!s operations, programs that foster sustainable practices are given major
emphasis. Yum! regularly collaborates with its brand leadership teams,
franchisees, Unified Foodservice Purchasing Co-op, suppliers, and consultants
to help better manage environmental programs and responsibilities. In addition,
several markets across the globe are including environmental sustainability as
part of Yums! proprietary Supplier Tracking and Recognition (STAR) audit
system, recognizing suppliers who have made improvements in this area.
Many premium suppliers of Kids Meal branded products practice environmental
principles throughout their organizations and with their factory partners. Such
initiatives include the use of environmentally friendly materials whenever

possible, including water-based paints, soy-based inks, use of recycled paper for
packaging and paper premiums, and the use of nonphthalate plasticizers and
lead-free material. Also, key supplier factory partners have implemented
initiatives to reduce energy, pollution, and waste.
McDonalds vs. Yum!

There are major strategic differences in how these casual-dining giants
approach their businesses. On capital structure, Yum! is more heavily leveraged
than McDonalds. On marketing, the company is the brand at McDonalds,
whereas at Yum! the corporate enterprise is secondary to the companys several
brands.
Yum! benefits from the lower cost structure associated with its China focus.
McDonalds appears to be controlling its global supply chain costs better
through better overall supplier engagement. McDonalds supply chain is a well-
oiled machine that turns over inventory 150 times per year and outpaces Apple
Inc., the second most active supply chain, by a factor of 3 (Figure 5-1). In 2011,
its second year in the Gartner annual Supply Chain Top 25, McDonalds ranked
8th in a survey of best supply chain operators.25
The Gartner survey identifies the companies that best demonstrate leadership
in applying demand-driven principles to drive business results.26 Apple ranked
no. 1, an achievement led by Tim Cook, soon thereafter appointed Apple CEO.
The centrality of that operation to overall corporate value has led some to opine
that Cooks appointment may have been one of (Steve) Jobs most astute
moves.27
In the 2012 survey, Apple retained its no. 1 spot. McDonalds climbed to no. 3
just behind Amazon. Yum! Brands didnt make it to the top 50.
Figure 5-1. Supply chain excellence. Among the most highly ranked firms recognized for their
supply chain excellence by Gartner in 2011, McDonalds ranked 8th but had a transactional
volume of more than 140 turns per yearoutdistancing its closest competitor, Apple Inc., which
ranked no. 1.25,26
McDonalds has other badges of distinction valued by its suppliers. McDonalds

ranked 49th on Corporate Responsibility Magazines 2010 Best Corporate
Citizen 100 league table compared to Yum!s 62nd, and McDonalds trounced
Yum! in the 2010 Newsweek Green Rankings 79th to 337th.28,29 For other
customers who value evidence of sustainability practices, McDonalds
reputation and credibility lend substantial weight to professional
recommendations.30 They gain some of McDonalds reflected glory.
The value of a multi-stakeholder strategy and better supplier relationships to
McDonalds is lower overall supply chain operating costsand that makes a
difference in the bottom line and its stock price. In the contest to win the hearts
and minds of analysts and investors, all things being equal, McDonalds
consistently appears to pay less in food and paper goods per dollar of labor
costs than Yum! (Figure 5-2). In 2009, the cost advantage was about 6%. In
2011, McDonalds cost advantage climbed to more than 10%.
As for the bottom line, in mid-July 2012, McDonalds trailing 12-month profit
margin of 20.26% was about 10% higher than Yum!s 11.69%. This cost
advantage helps explain why equity investors priced McDonalds 48% higher
than Yum! for every trailing month dollar of sales.
Figure 5-2. Cost of food and paper relative to cost of labor at McDonalds (MCD) and Yum!
Brands (YUM) operations. McDonalds pays 10% less for food and paper goods per dollar in
wages than its closest fast foods competitor, Yum! Brands.31
Retrospective
The secret sauce of McDonalds success is found in the long-term transparent
relationships the company has forged with its suppliers. Numbers never tell the
whole story, but they provide interesting color. Some of McDonalds deep
collaborative relationships with its suppliers have lasted more than 25 years.
McDonalds obsession with qualitya reliable, repeatable, trustworthy, and
engaging casual dining experienceis transparent, and it is a value that extends
to its dealings with its suppliers. Suppliers have long recognized McDonalds
obsession with quality as an authentic manifestation of its corporate culture and
the underpinning of its reputation. Its suppliers appreciate and value its efforts
to deliver consistently that which matters most to its stakeholders. They bestow
the coveted status of preferred customer on McDonalds, whose bottom line
benefits.
Consider This
Quality, the consistent delivery of products and services
that meet expectations, is a foundation for trust and an
authentic reputation.
In supply chains, trust and an authentic reputation help
establish long-term relationships, reduce transaction costs,
and secure customer-of-choice status.
Customers-of-choice receive myriad benefits that speak to
the bottom line.
Safety: Coke and Pepsi

[Safety is] the state of being certain that a set of conditions will not
accidentally cause adverse effects on the well being of employees, the public,
or the environment. (Table 1-1)
With combined market capitalizations in excess of $US quarter trillion (Table

5-2), the two beverage companies sell many millions of cans of soda each day.
The risks of food safety scares are well appreciated and feared by the two giants
in the soft drink producers and bottlers industry: PepsiCo Inc. (NYSE:PEP) and
The Coca-Cola Company (NYSE:KO).
Table 5-2. Several key metrics of comparison between PepsiCo Inc. and The Coca-Cola
Company
PepsiCo Inc. The Coca-Cola

Company
Main Exchange NYSE NYSE
Market Capitalization March 98.2 157.5

2012 ($US billion)
Profit Margin (ttm) 9.69% 18.42%
Operating Margin (ttm) 15.60% 23.41%
Equity Short % of Float 0.5% 0.6%

Employees 297,000 146,200
Data source: Yahoo Finance and Google Finance.
A study in March 2012 by the Center for Science in the Public Interest showed
that high levels of the chemical 4-methylimidazole, part of caramel coloring,
were found in both Pepsi and Coke products. Pepsi products, regular Coca-
Cola, and Diet Coke had levels high enough to require a warning notice in the
state of California. Coke and Pepsi, with the acquiescence of the FDA, are
needlessly exposing millions of Americans to a chemical that causes cancer,
said CSPI executive director Michael F. Jacobson. The coloring is completely
cosmetic, adding nothing to the flavor of the product. If companies can make
brown food coloring that is carcinogen-free, the industry should use that.32
Commenting on the allegation, Douglas Karas, FDA spokesman, said that
FDA has no reason to believe there is any immediate risk from the substance.
A consumer would have to drink more than a thousand cans of soda in a day to
match the doses administered in studies that showed links to cancer in rodents.33
Then a new safety sheriff rode into town. The American Cancer Society wrote
four months later to U.S. Health Secretary Kathleen Sebelius and drew parallels
between the hidden dangers of the worlds favorite beverages and the formerly
hidden dangers of the worlds second-favorite vice product tobacco. The
Society called for a comprehensive safety review along the lines of the U.S. top
doctor's landmark report on the dangers of smoking in 1964.34
Defining Experience
In June 1999, more than 100 Belgian children were hit by sudden illness, with
symptoms of nausea and headaches, after drinking Coca-Cola products. Almost
immediately, the Belgian Health Ministry banned the sale of all Coca-Cola
beverages and ordered the withdrawal of a range of suspect soft drinks
produced by the company in Belgium, France, and Holland, where exports from
the Belgian plants are widely sold.
The Coca-Cola Company did not appreciate the magnitude of the storm
looming over the safety of its products. The company first declared, After
thorough investigation, no health or safety issues were found and attributed the
problems to others. They blamed a defective supply of the carbon dioxide gas
used at its Antwerp plant and also claimed that a wood treatment agent used on
transportation pallets had caused an offensive odor on the outside bottom of
the can.35 The manufacturers of the gas, Swede Aga Gas, denied Coca-Colas
claims of bad CO2, saying that the gas was perfectly normal, and that it could
provide it with samples of the batch delivered to Belgium.
The companys assertion that it had pinpointed the problem, noting that there
was no serious health risk, lacked credibility. Germany refused Coca-Cola
imports from Belgium, Saudi Arabia erected barriers, and The Netherlands and
Spain raised alerts. Aggravating Coca-Colas situation, the problems fed into
Europe-wide food sensitivity.
Coca-Colas slow response to a contaminated product lot is an object lesson in
the cost of failure to localize a food-safety incident and deal with the
consequences of a perceived systemic problem. Recall costs to the company
were estimated at $200 million. Costs to the distributor, Coca-Cola Enterprises,
were estimated at $130 million. But the real costreputational value
lossesexpressed as the losses to the value of the global brand, at that time
estimated at $83.8 billion, was $11 billion.
It is generally understood by todays business leaders that the average cost of an
adverse reputational event is about 7% of market capitalization.36 Coca-Colas
1999 experience arising from the failure of a quality process was even more
expensive at 11%. Coca-Cola learned valuable lessons, and these are apparent
in the firms current risk disclosures.
The Coca-Cola Company

The Coca-Cola Company defines itself narrowly as a beverage company. It
originated in 1886 when Atlanta-area pharmacist John Pemberton was
experimenting with powerful stimulants, including cola nuts and coca leaves, to
add to soda water. The inspiration for his work and that of fellow pharmacists
was said to have come from observations of Bolivian Indian workers who
chewed coca leaves to ward off fatigue and by West African workers who
chewed cola nuts as a stimulant. Pembertons formula and brand were bought in
1889 for $2300 by Asa Candler, who incorporated The Coca-Cola Company in
1892.
Pembertons work and Candlers marketing were, by any measure,
inspirational, and today the company owns or licenses and markets more than
500 nonalcoholic beverage brands, primarily sparkling beverages but also a
variety of still beverages, such as waters, enhanced waters, juice drinks, ready-
to-drink teas and coffees, and energy and sports drinks. It owns and markets
four of the world's top five nonalcoholic sparkling beverage brands: Coca-Cola,
Diet Coke, Fanta, and Sprite.
From a sales and distribution perspective, The Coca-Cola Company is unique in
not being directly exposed to retail behemoths. In general, the company and/or
subsidiaries only produce syrup concentrate, which is then sold to various
bottlers throughout the world who hold a Coca-Cola franchise. Coca-Cola
bottlers, who hold territorially exclusive contracts with the company, produce
the finished product in cans and bottles from the concentrate in combination
with filtered water and sweeteners. The bottlers then sell, distribute, and
merchandise the resulting Coca-Cola product to retail stores, vending machines,
restaurants, and food service distributors. It is the worlds largest beverage
distribution system.
As a franchise leader, the financial health and success of its bottling partners are
critical to the company's success. The Coca-Cola Company works with its
bottling partners to identify system requirements that enable the team to quickly
achieve scale and efficiencies, and the company shares best practices with all its
bottling partners. The company also designs business models for sparkling and
still beverages in specific markets to ensure that it shares the value created by
these beverages with its bottling partners.
One notable exception is in the United States, where the company acquired the
domestic bottling operation and is responsible for the manufacture and sale of
fountain syrups directly to authorized fountain wholesalers and some fountain
retailers.
Among Coca-Colas intangible assets underpinning its reputation is product
safety. This has become a driving focus that allows the company to charge a
price premium for its sugar water, a focus attributable to the heightened
sensitivity sparked by the 1999 Belgian incident. The company now
acknowledges, Our success depends on our ability to maintain consumer
confidence in the safety and quality of our products.
The company is also sensitive to global ethics issues with a number of
transparent commitments to respect all human rights. These are apparent in its
Human Rights Statement and Workplace Rights Policy and Supplier Guiding
Principles, its participation in the United Nations Global Compact and its
LEAD program, and its participation in the Global Business Initiative on
Human Rights.
There is no doubt that reputation risk is top-of-mind. The company is one of the
355 S&P 500 Composite Index constituent members to overtly disclose over the
past year the materiality of reputation risk to its operations: If product safety or
quality issues, or negative publicity, even if unwarranted, damage our brand
image and corporate reputation, our business may suffer.37
Reputation risk disclosures from their most recent annual report highlight the
importance of maintaining customer confidence in the safety and quality of its
products, and effectively managing its supply chain.
Last, in a disclosure involving operations other than the production of
consumable products, the company noted the growing risks of cyber-security
breaches. If we are unable to protect our information systems against service
interruption, misappropriation of data or breaches of security, our operations
could be disrupted and our reputation may be damaged.37
PepsiCo Inc.
In a very competitive business, PepsiCo is one of Coca-Colas primary
competitors in many countries including the United States. Formed in 1965
through the merger of beverage and snack businesses, its origins trace back to
the late 1890s when Caleb Bradham, a New Bern, North Carolina, pharmacist,
formulated a cocktail to sooth upset stomachs (excess pepsin) without making
any overt medical claims. He named the business Pepsi Cola and incorporated
in Delaware in 1919.
PepsiCo, Inc. is a global food and snack as well as beverage company. The
snack business traces its roots through Frito-Lay, Inc., which was formed by the
1961 merger of two companies first formed in 1932: the Frito Company,
founded by Elmer Doolin, and the H. W. Lay Company, founded by Herman
W. Lay.
Today, PepsiCo is a leading global food and beverage company with hundreds
of brands that are household names throughout the world. Either independently
or through contract manufacturers or authorized bottlers, PepsiCo makes,
markets, sells, and distributes a variety of foods and beverages in more than 200
countries and territories. Globally recognized brands include Quaker Oats,
Tropicana, Gatorade, Lays, Pepsi, Walkers, Gamesa, and Sabritas.
In addition to Coca-Cola, other significant Pepsi competitors include, but are
not limited to, Nestl, Dr. Pepper Snapple Group, Inc., Groupe Danone, Kraft
Foods Inc., and Unilever. In certain markets, competition includes beer
companies. The company also competes against numerous regional and local
companies and, in some markets, against retailers that have developed their own
store or private label beverage brands.
While competing on two fronts with both beverages and foods might appear to
be inefficient, as analysts have suggested, Pepsi reaffirmed as recently as
February 2012 its commitment to remaining an integrated food and beverage
company. Indra Nooyi, the PepsiCo CEO, declared the group financially and
operationally benefits from its Power of One strategy, which was devised
last year to bring its food and drink operations in the United States closer
together. She told analysts that the idea of splitting the company in two has been
taken off the table.38
For Pepsi, two operational issues stand out. From a sales and distribution
perspective, PepsiCo is heavily exposed to Walton family stores. In 2011, sales
to Wal-Mart Stores, Inc. (Wal-Mart), including Sams Club (Sams),

represented approximately 11% of PepsiCos total net revenue. Its top five retail
customers represented approximately 30% of its 2011 North American net
revenue, with Wal-Mart (including Sams) representing approximately 18%.
These percentages include concentrate sales to independent bottlers that were
used in finished goods sold by them to these retailers.
Its largest competitor is The Coca-Cola Company, but its beverage, snack, and
food brands compete against global, regional, local, and private label
manufacturers and other discount-price competitors. Pepsi charges a price
premium for its sugar watera capability enabled by the value-add of the
companys intangibles. Of the six major intangible assets comprising business
processes underpinning reputation, Pepsi emphasizes sustainability (Table 5-2).
In 2011, PepsiCo earned a place on the prestigious Dow Jones Sustainability
World Index for the fifth consecutive year, the North America Index for the
sixth consecutive year, and in the Food and Beverage Supersector was ranked
number one.
Reputation risk is top-of-mind for Pepsi. Any damage to our reputation could
have a material adverse effect on our business, financial condition and results of
operations.39
The disclosure details how failures in ethical controls, quality, safety,
innovation, security, and sustainability could each damage PepsiCos
reputation.
Most of the disclosures focus on business processes that would be of concern to
consumers of the companys products and they conclude with the
acknowledgment that damage to PepsiCos reputation or loss of consumer
confidence in products for any reason could result in decreased demand for
products and could have a material adverse effect on the business, financial
condition, and results of operations, as well as require additional resources to
rebuild the companys reputation.
Implications for Reputation Management

The Pepsi-Coke rivalry is legendary. Although some suggest the feud really
heated up with the Pepsi Challenge in 1975, the brands have been fighting each
other for more than a century. For many, this battle for the hearts, minds, and
palates of the global consumer has been all about brand.
Today, it is about more. A brand is a promise that creates expectations. Those
expectations create an impression among stakeholders we encapsulate in the
term reputation.
Unlike the marketing-driven communications of the brand wars, reputation-
shaping communications travel through a range of nontraditional channels. In
our social mediadominated environment, informal, incidental, and
nontraditional channels of communication are more likely to be used to report
to stakeholders on a firms ethics, quality, innovation, safety, security, and
sustainability practices. As outlined in Table 5-1 and as implied in the list of
reputation risks disclosed by each of the firms, many operational decisions
produce outcomes that communicate something about the firm to its
stakeholders.
In 2010, both Pepsi and Coca-Cola took full ownership of their North American
supply chain partners, explaining that they needed more flexibility and direct
control of production, distribution, and new product innovation cycles. PepsiCo
was first to do so, acquiring both Pepsi Bottling Group Inc. and PepsiAmericas
Inc. for $7.8 billion. Coca-Cola followed later with its acquisition of the North
American operations of Coca-Cola Enterprises for $15 billion.
Creating Reputation Value

It cannot be overstated that many improvements in the process underpinning
reputation create visible improvements on the profit and loss (P&L) statement
that translate to additional enterprise value. Hence todays cola wars, whose
battles for the hearts and minds of stakeholders are being waged by the
operational teams that manage the supply chain; ensure ethical conformance;
drive innovation; ensure quality; and drive safety, security, and sustainability.
They are also being waged at the level of the board of directors through superior
oversight, risk management, and the perpetuation of a corporate culture that is
obsessed with delighting the firms stakeholders.
Retrospective
McDonalds understood the value of a committed and integrated supply chain
from the outset. The Coca-Cola Company learned the lesson through trial by
fire. But once learned, as with the food icons, the economic effects of the
different relationships the beverage companies have with their supply chains
appear on the P&L statement. Mirroring the benefits realized from closer
operational integration and trust, Cokes costs for producing and distributing
products at The Coca-Cola Company are lower than Pepsis (Figure 5-3).
Figure 5-3. Combined costs for production and distribution represented as a fraction of revenues.
Notwithstanding PepsiCos Power of One strategy, The Coca-Cola Company consistently spends
less on making and distributing its products than it arch rival.40
Consider This
Management of complex supply chains is a source of
competitive advantage.
Authentic integration and commitment to supply chain
oversight and management, sources of real value, are
benefits of a reputation for ethical collaboration.
Once burned, never again.
Toyota Motor Corporation

Echoing observations in the food and beverage industries, a recent study of the
automobile supply chain showed that supplier trust in the buyer creates value. In
a sample of 344 supplierautomaker exchange relationships in the United
States, Japan, and Korea, perceived trustworthiness substantially reduced
transaction costs. The most trusted automakers spent significantly less in face-
to-face supplier interaction time on contracting and haggling when compared to
the least trusted automaker. This translated into procurement (transaction) costs
that were five times lower for the most trusted automaker.41 In January 2010,
Toyota learned how those costs multiply when that trust is broken.
In the automotive industry, Toyota Motor Corporation is an iconic firm.
Commencing operations in 1933 as the automobile division of Toyota
Industries Corporation (formerly, Toyoda Automatic Loom Works, Ltd.),
Toyota became a separate company on August 28, 1937. In 1982, the Toyota
Motor Company and Toyota Motor Sales merged into one company, the Toyota
Motor Corporation of today.
Toyotas automotive operations include the design, manufacture, assembly, and
sale of passenger cars, minivans, and commercial vehicles, such as trucks, as
well as related parts and accessories. Toyota also provides financing services to
dealers and their customers for the purchase or lease of Toyota vehicles, and
provides retail leasing through the purchase of lease contracts originated by
Toyota dealers.
As of March 31, 2009, Toyota operated through 529 consolidated subsidiaries
and 229 affiliated companies through 53 overseas manufacturing companies in
27 countries and regions. The company also has an extensive supply chain
through which raw materials are transformed into parts and subassemblies by
unaffiliated companies.
In fiscal 2009, Toyota sold 7.56 million vehicles in more than 170 countries and
regions, and the company had net revenues of 20,529.5 billion ($208.9 billion)
and a net loss of 436.9 billion ($4.4 billion) (see Table 5-3).
Table 5-3. Key Financial Performance Indicators for Toyota as of End of February, 201042
Performance Indicator Value
Market Cap (intraday) $114.66 billion
Profit Margin (ttm) 3.89%
Revenue (ttm) $US $190.76 billion
Qtrly Revenue Growth (yoy) 10.20%
Gross Profit (ttm) $21.11 billion
EBITDA (ttm) $8.89 billion
The Toyota Supply Chain

Toyota purchases parts, components, raw materials, equipment, and other
supplies from several competing suppliers located around the world. Toyota
collaborates with its suppliers to encourage technological innovation, cost
reduction, and other competitive measures. During fiscal 2009, no single
supplier accounted for more than 5% of Toyotas consolidated purchases of raw
materials, parts, and equipment, with the single exception of an affiliate of
Toyota, Denso Corporation, which supplied approximately 10% of Toyotas
purchases.
Toyota procures parts and components locally in the country of the production
site as well as in third-world countries. In order to realize timely and efficient
distribution through an increasingly complex system at the same time keeping
total costs at a minimum, Toyota developed a standardized system of global
distribution and supports the operation of the system at each production base.
This system is at the heart of Toyotas famous manufacturing process (Table 5-
4).
Table 5-4. An Overview of the Automobile Industry Supply Chain
Process Step Value Example

Added
Design High Demand-driven process of satisfying consumer wants and

needs. Yield prototypes or concept cars.
Raw Materials Low These include rubber, glass, steel, plastic, and aluminum.
Parts Medium Tires, windshields, and air bags are examples of parts.
Assembly Medium An unenviable gray zone with subassembly and major

assembly steps subject to the greatest pressures to cut costs.
Marketing High Marketing is a major basis for consumers perceived values.
Distribution and High First step of the customer experience.

Sales
As Toyota acknowledged in its 2009 annual report, its ability to continue to

obtain supplies in an efficient manner is subject to a number of factors, some of
which are not in Toyotas control. These include the ability of its suppliers to
provide a continued source of supplies and the effect on Toyota of competition
by other users in obtaining the supplies.
Parts and assembly are among the lowest sources of added value and the
greatest potential sources of cost savings. Appropriately, Toyota is working to
improve profitability and enhance operating efficiencies by continuing to pursue
aggressive cost reduction programs.
Design changes to achieve the reduction in the number of platforms used in
vehicle production are one approach. Because platforms are the essential
structures that form the base of different vehicle models, by using a common
platform for the production of a greater number of models, Toyota decreases the
substantial expenditures required to design and develop vehicles.
Toyota also continues to focus on other methods of increasing the commonality
of parts and components used in different models. Steps include reducing model
variations and the number of parts used in each model. A common global
database to enable plants in different areas of the world to purchase parts and
materials from the most competitive sources is utilized in order to increase the
efficiency of procurement from outside suppliers.
Toyotas Business Philosophy

Harmony, honor, and a near fanatical devotion to quality have characterized the
companys business philosophy for nearly half a century. The values of
harmony and honor were memorialized in 1962 in a pact between management
and labor that created a unique cooperative work environment present nowhere
else in the industry. The four-point Labor and Management Resolutions for the
21st Century were summarized as follows in the unedited translation:43
As a global company, we will endeavor for the progress of
the world economy, and at the same time contribute to
international society.
The relationship between labor and management shall be
based upon mutual trust and respect.
In order to create a company environment in which workers
can fully utilize their potential and additional value can be
obtained, we, labor and management will endeavor to
faithfully perform the roles entrusted to us, while standing
on common ground.
We will contribute to the realization of a truly affluent
society and life for working people, taking into
consideration the future of Japan as a whole.
This unique team approach, in turn, enabled a cooperative company-wide effort
to reduce the costs of defects and waste in accordance with the quality
principles of Edward Deming. In 1965, Toyota won the Deming Application
Prize for quality control. In 1992, Toyota issued a seven-point credo. Key
intangible values addressed include honor, respect, safety, quality, and
innovation. The last three are among the six major business processes that drive
reputation value.
The Perfect Storm

The largest automobile assembler in the world operated for 50 years with
business processes that ensure harmony, honor, and quality for all under its
direct corporate control. But it faced increasing cost pressures as the U.S. and
European markets became saturated and price-sensitive Asian markets came on
line. Then more cost pressures came as the global financial markets melted
down. Toyota management created further cost pressures in pursuit of market
share and its obsession with outgrowing General Motors. Rather than sow
discord in its own labor force, Toyota pursued two cost reduction strategies: (1)
standardize parts across a greater range of vehicles and (2) squeeze parts
suppliers aggressively.
Lean supply chain strategies are coming back to haunt manufacturers.

Manufacturers simply dont have the tools to manage the suppliers they
depend on.
Jim Lawton, General Manager,

Dun & Bradsteet Supply Management Solutions
Toyotas aggressive tactics following 2008, its first year of loss in 59 years,
drove suppliers profits down to negligible levels. Toyota slashed production
and even hired private detectives to identify suppliers at risk for bankruptcies
who would need to be quickly replaced. Bloomberg quoted Kazushi Kawabata,
president of Toyota supplier Comco Holdings, as saying: The suppliers are
totally in Toyota's grip.44
On the software front, information systems began to exert a greater influence on
vehicle safety than the underlying mechanical systems. Experts voiced fears that
old-style quality controls over manufacturing were outdated and inadequate for
cyber risks.
Things started failing. Lacking adequate oversight and visibility in post-
production follow-up, problems associated with common components began to
crop up globally and go unobserved. The dots were not connected until third
parties began to bring pressure to bear. The results: headline risks were realized,
and failed components forced the recall of more than 8 million vehicles.
Toyotas reputation sank, and the financial consequences of the recall began
manifesting.
Adding to the woes were concerns of ethical lapses, consequences that
potentially included civil and possibly criminal penalties. Internal Toyota
memos tell how the automaker saved more than $100 million by negotiating
with U.S. federal regulators to stop an investigation into accelerator complaints
in exchange for a product recall in September 2007.45
Ethics, safety, and qualitya headline risk-trifecta. The thing about headline
risks and reputation perils, of course, is that they can snowball. Toyota was
facing both headline-generating criminal probes and Congressional
investigations into its safety problems. Both were overshadowed by the myriad
class-action lawsuits filed. Moreover, automobile insurers were preparing to
subrogate past auto accident claims involving Toyota vehicles. This is the pile-
on of the trial lawyers and regulators and the mommy-bloggers, said Chris
Gidez, Director of Risk Management and Crisis Communications at the
marketing firm Hill and Knowlton.46
In late January 2010, Toyotas stock price tanked, taking with it approximately
$25 billion in market capitalization. On the credit side, five-year credit default
swaps (CDSs) on Toyota Motor Corp. debt were quoted at 95115 basis points
(bps) early February, up 38 bps from the month before. The equivalent CDS on
Honda Motor Corp. was quoted at about 82 bps according to Markit. In
addition, in early February Toyota Motors five-year CDSs briefly dropped
below AA-rated Japans sovereign five-year CDSs for the first time on data
going back to 2007.
Although the recall notice didnt come until late January, Toyota sales for the
month fell 16%, to their lowest level in more than a decade, while sales of other
cars were rising by 6%. And Toyotas market share fell to 14%, dropping from
17% for 2009. According to Kelley Blue Book, which tracks tens of thousands
of new and used-car transactions each week based on data from manufacturers,
dealers, and wholesalers, prices for new Toyotas moved lower and were closer
to dealer invoices.
Reputation loss was also affecting Toyotas pricing power for vehicles not
affected by the recallused cars. Data from Kelley Blue Book showed prices
for used Toyotas fell by 1.5% in the first week after the recall, and by the third
week, another 1.5% drop.47
Retrospective
This case study on risk and reputation management looks at what happened
when executives at an iconic firm in the automobile industry, Toyota, subverted
their culture, and in doing so, lost visibility and control of the human behaviors
impacting critical elements of their supply chain. It traces how Toyotas famed
standard for supply chain management excellence was compromised by senior
managements focus on other metricsgrowing market share, aka profit
without purpose. The quality and safety failures arising were then compounded
by potential ethical lapses in internal assessment and reporting. The impact is
quantified in metrics memorializing the costs of damaging three major pillars of
reputation value: quality, safety, and ethics.
Risk lurks at the periphery of vision. That which is not seen or is ignored, and
thus not controlled or managed, can wreak havoc when it impacts a critical
source of intangible asset and reputation value. Supply chains sweep in
worldwide risk from suppliers, licensees, franchisees, and other partners and it
all lands at the doorstep of the large iconic global assemblers, retailers, and
distributors. When risk manifests and is headline-grade, the financial impact can
be substantial or even catastrophic. All companies that depend on a supply

chain are exposed.
Toyota faces headline risk highlighting ethics, safety, and quality issues. Equity
costs as of February 2010 were in the $25 billion range. Pricing power dropped
around 3%. Market share fell another 3% for 2010, and sales in January 2010
fell 16% to their lowest level in a decade.47
Operating costs are difficult to estimateit was in Toyotas effort to control
them that risk arose. Adding to future expected operating costs will be
regulatory costs, possible fines and penalties, litigation costs, insurance
subrogation costs, and inferior vendor terms. Credit default swap pricing is up
almost 30% foreshadowing higher credit costs. All told, the estimated early
reputational impact was an immediate $2 billion cost to earnings and a $25
billion cost to market capitalization (Table 5-5).
Table 5-5. Toyotas Reputation Losses: Income Statement Impact.47
P&L Entry Description $US

Billions
Revenue
Lost sales 26.75
Lost pricing power 4.21
New lost gross profit 0.90
Operating Expenses
Nonrecurring 0.50
Other Expenses
Additional interest expense 0.07
Additional depreciation expense 0.54
Net Cost
Cost to earnings 2.01

Supply chainbased headline risks will continue to haunt iconic global firms.
Outsourcing has created dependencies that currently exceed managements
capacity to oversee and control, and these risks will persist until the global
supply chain evolves a complementary information management system.
Increasingly, suppliers are analyzing the cost to serve their key accounts. In
some cases, they are de-prioritizing, or even de-selecting, highcost-to-serve
customers. Removing burdens on suppliers from unnecessary cost-to-serve
situations improves end-to-end supply chain economics for all concerned and
helps to secure customer of choice status.
Consider This
The network of corporate risks is far more systemic than
ever as companies operate in an ever more complicated and

interconnected supply chain.
Reputational risk exacerbates operational risk. It can
threaten the future of companies wounded by operational
failures.
Controls mitigate risk. An integrated view of operational,
financial, and reputational risk can give management and
corporate boards the level of visibility they, and their
stakeholders, now demand.
Sustainability: Peets Coffee & Tea Inc.

[Sustainability is] the making, using, offering for sale or selling products and
services that meet the needs of the present without compromising the ability
of future generations to meet their own needs. (Table 1-1)
Peet's Coffee & Tea is a small specialty coffee roaster and marketer of fresh-
roasted coffee and tea. It was named for Alfred Peet, who founded the company
in Berkeley, California, in 1966 and who later mentored Starbucks co-founder
Gerald Baldwin, who subsequently sold the Starbucks chain and bought Peets.
Baldwin served as Peets chief executive officer for about 23 years and remains
a board member after more than four decades.
In late July 2012, investors were wagering that rival bidders would attempt to
top a near $1 billion takeover offer that already ranks as the most expensive
U.S. beverage deal. Including net cash, the $941 million offer valued the owner
of specialty cafes and grocery products at 21 times earnings before interest,
taxes, depreciation, and amortization, the richest multiple for an American
maker of nonalcoholic drinks in deals larger than $500 million, according to
data compiled by Bloomberg.48 The expected winning bidder was Starbucks,
with its market value of $36 billion (Table 5-5). Peets is perceived actually as
a more premium offering than Starbucks on the grocery shelf, and they have
consistently been able to charge $1 more per 12-ounce bag on the grocery
shelf... That is something that Starbucks covets., said Nick Setyan, a Los
Angeles-based analyst at Wedbush.49 Sales of beans through grocery stores
generated net revenues of 22.5%; Peets coffee sold through one of its 196 retail
stores generated margins of only 4.5%. The pricing power has been something
that Starbucks coveted and may be willing to pay 32 times expected forward
earnings. Starbucks traded late July 2012 at 20.36 times forward earnings.50
Table 5-5. Several Key Metrics of Comparison Between Peets Coffee & Tea Inc. and Starbucks
Corporation
Peets Coffee & Tea Starbucks Corporation

Inc.
Main Exchange NDAQ NDAQ
Market Capitalization August 0.99 33.2

2012 ($B)
Profit Margin (ttm) 4.14% 10.67%
Operating Margin (ttm) 7.34% 13.25%
Equity Short % of Float 35.5% 1.1%
Employees 811 149,000
Data source: Yahoo Finance and Google Finance.
The secret to Peets value is its supply chain management strategy, all focused
on relationships on the delivery-to-customer end of the chain. Peets distributes
through a network of grocery stores, mass merchandisers, and club stores
through a direct store delivery (DSD) selling and merchandising system in
which DSD route sales representatives deliver directly to their stores anywhere
between one and four times per week, properly shelve the product, rotate the
stock to ensure freshness, and forge store-level selling relationships. Peets also
ships directly to certain customers, offering them fresh-roasted coffee shipped

directly from its roastery to their doors and a wider selection of coffees than is
available in their retail stores or at grocery store partners.
Through its customer service representatives and coffee experts, the customer
service team provides in-depth coffee information to guide customers through
their coffee explorations. Data compiled by Bloomberg indicate that sales from
Peets grocery-store business increased more than 92% in three years to $98.9
million in 2011.
On the supplier side, Peets competes with procurement giants. In addition to
Starbucks, JM Smucker Co.the $8.4 billion maker of Folgers coffeeand the
$70-billionmarket-valued Kraft Foods Inc.which sells Maxwell House and
Yuban brand coffee productshave significant buying power and could
leverage that power to become preferred customers. But Peets relationships top
all.
In coffee-producing countries, the coffee crop undergoes weather-related
changes in quality. Furthermore, as a trade commodity, coffee prices can
fluctuate depending on weather conditions in various coffee-producing
countries, economic and political conditions affecting those countries, foreign
currency fluctuations, the ability of coffee-producing countries to agree on
export quotas, and world economic conditions that make commodities more or
less attractive investment options.
Peets procures coffee from 23 countries, with a large percentage of coffee
coming from Central and South America from more than 30 different exporters,
brokers, and growers. They purchase only high-quality Arabica coffee beans,
which are considered superior to beans traded in the commodity market.
Arabica beans tend to trade on a negotiated basis at a substantial premium
above commodity coffee prices, depending on the supply and demand at the
time of purchase.
Peets access to high-quality Arabica beans depends on its relationships with
coffee brokers, exporters, and growers, with long-term relationships helping
ensure a steady supply of coffee beans. Peets believes that its reputation built
over 45 years gives them access to some of the highest-quality coffee beans
from the finest estates and growing regions around the world. They are also
occasionally offered opportunities to purchase unique and special coffees.
Given their common heritage, its not surprising that both Peets and Starbucks
emphasize sustainable practices that inure to the benefit of their suppliers.
Peets website provides details on the companys commitment to sustainable
business practices. Starbucks, to help ensure sustainability and future supply of

high-quality green coffees and reinforce its leadership role in the coffee
industry, operates Farmer Support Centers in Costa Rica and Rwanda, among
other locations. These Farmer Support Centers are staffed with agronomists and
sustainability experts who work with coffee farming communities to promote
best practices in coffee production designed to improve both coffee quality and
yields.
Starbucks reputation is closely associated with its Corporate Social
Responsibility programs, balancing profitability with a social conscience. This
umbrella program provides social benefits to many stakeholders and
encompasses the sustainability programs.
By the Numbers
The case studies in this chapter illustrate how reputation can affect value-
creating and value-destroying actions by vendors and suppliers (Table 5-6).
Table 5-6. Effects of Reputation on Supplier and Vendor-Associated Costs
Automotive sector: 2%4% lower cost of goods sold Increase

customer of choice
status
McDonalds: supply 10% lower adjusted costs for food and 48% premium over Yum!
chain engagement paper goods than Yum! Brands Brands for every trailing
strategy month of dollar sales
10% higher profit margin
Coca-Cola: supply 4% lower cost of sales, bottling, and 2009: crisis erased 11% of
chain engagement distribution than Pepsi market cap
strategy
2011: 13% greater equity value
per expected $1 of net income
than Pepsi
Toyota: supply chain Credit default swap prices up $25 billion lost
operational event 0.6%0.7%
evolving into a
reputational event 16% fall in monthly sales
14% fall in annual market share
3% fall in secondary market pricing
power (inventory value)

Total P&L impact of $2 billion
Peets Higher pricing power for store-bought Shares at pending acquisition

coffee beans currently priced at a 50%
premium to expected earnings
relative to Starbucks
1Davies PJ. John Hurrell (Chief Executive, Association of Insurance and Risk Managers)
quotation from Not out of the woods yet. Financial Times. 12 February 2010. Available at:
http://www.ft.com/intl/cms/s/0/146fea72-17ef-11df-a74d-00144feab49a.html#axzz20ybGaDCE.
2Lindwall C, Ellmo A, Rehme J, Kowalkowski C. Increasing customer attractiveness through
upstream brand equity. The International IPSERA workshop on Customer attractiveness, supplier
satisfaction and customer value. 2526 November 2010. Available at:
http://urn.kb.se/resolve?urn=urn:nbn:se:liu:diva-63092. Accessed 17 July 2012.
3 Skogman L, Tiselius K. Developing strategic supplier relationships at Volvo Powertrain.
Master of Science thesis in the Master Degree Program Supply Chain Management 2012.
Department of Technology Management and Economics, Division of Industrial Marketing.
Chalmers University of Technology. Report No. E2012:029.
4Bew R. The new customer of choice imperative: ensuring supply availability, productivity gains,
and supplier innovation. 92d Annual International Supply Management Conference, Las Vegas,
May 2007.
5Supply-chain management. Economist. 6 April 2009. Available at:
6Boeing 777 Facts, 777 Family. Available at:
http://www.boeing.com/commercial/777family/pf/pf_facts.html. Accessed 20 July 2012.
7 Van de Rijt J, Sanema SC. A conceptual model for interactions between suppliers and buyers:
from uni-faced to multi-faced B2B sales organizations. Paper presented at the International
IPSERA Workshop on Customer Attractiveness, Supplier Satisfaction and Customer Value,
November 2010, University of Twente.
8Kraljic P. Purchasing must become supply management, Harvard Business Review 1983;
SeptemberOctober: 109117.
9 A brief history of McDonalds. Available at:
http://www.mcspotlight.org/company/company_history.html. Accessed 18 July 2012.

10McDonalds Corporation. Google Finance. Available at:
http://www.google.com/finance?cid=22568. Accessed 18 July 2012.
11Urry M. RHM receives two Golden West bids. Financial Times. 26 March 2005. Available at:
http://www.ft.com/intl/cms/s/0/eb54ac20-9d9d-11d9-a227-
00000e2511c8.html#axzz20ybGaDCE. Accessed 18 July 2012.
12 McDonalds Corporation 2011 Annual Report (Form 10K), p. 8.
Vitasek K, Manrodt V. What five great economists can tell us about Outsourcing. Supply Chain
13
Management Review. July/August 2012 pp 18-25.

Goldberg RA, Yagan JD. McDonalds Corporation: managing a sustainable supply chain.
14
Harvard Business School. 16 April 2007. Case 9-907-414.

15McDonalds 2009 Worldwide Corporate Responsibility Report. p. 14. Available at:
http://www.scribd.com/doc/93473994/1/Corporate-Governance-Ethics. Accessed 18 July 2012.
Lee HL, Billington C. Managing supply chain inventories: pitfalls and opportunities. Sloan
16
Management Review. 1992; Spring: 6573.

17Fletcher C. McDonalds pledges sustainable Filet-O-Fish in Europe. Bloomberg. 8 June 2011.
Available at: http://www.bloomberg.com/news/2011-06-07/mcdonald-s-pledges-sustainably-
sourced-filet-o-fish-in-europe.html. Accessed 18 July 2012.
18 Jackson A-L, Feld A. Dominos brutally honest ads attract sales as consumer spending falters.
Bloomberg. 17 October 2011. Available at: http://www.bloomberg.com/news/2011-10-

17/domino-s-brutally-honest-ads-offset-slowing-consumer-spending.html. Accessed 19 July
2012.
19Taylor P. Supply chain is a strategic discipline. Financial Times. 25 January 2011. Available at:
http://www.ft.com/intl/cms/s/0/eb1cf8ca-2749-11e0-80d7-00144feab49a.html#axzz20ybGaDCE.
20 Nooteboom B, Berger H, Noorderhaven N. Effects of trust and governance on relational risk.
Academy of Management Journal. 1997; 40(2):838.

21Dion P, Banting P, Picard S, Blenkhorn D. JIT implementation: a growth opportunity for
purchasing. International Journal of Purchasing and Materials Management. 1992; 28 (4):33.
22Spekman RE, Kamauff JW, Myhr N. An empirical investigation into supply chain
management: a perspective on partnerships. International Journal of Physical Distribution &
Logistics Management. 1998; 28(8):630650.
23The Chicken and the Pig. Wikipedia. Available at:
http://en.wikipedia.org/wiki/The_Chicken_and_the_Pig. Accessed 18 July 2012.
Foley S. How Yum! Brands is conquering the world. Bloomberg Businessweek. 14 July 2010.
24
Available at: http://www.businessweek.com/globalbiz/content/jul2010/gb20100714_088544.htm.

25Taylor P. Supply chain leaders identified. Financial Times. 25 July 2011. Available at:
http://www.ft.com/intl/cms/s/0/509f9722-b6db-11e0-a8b8-00144feabdc0.html#axzz20ybGaDCE.
26 Gartner supply chain top 25. Gartner Research. Available at:
http://www.gartner.com/technology/supply-chain/top25.jsp. Accessed 20 July 2012.

27Plimmer G. Supply-chain experts arrive at the top. Financial Times. 26 October 2011.
Available at: http://www.ft.com/intl/cms/s/0/718ad57c-ef76-11e0-941e-
00144feab49a.html#axzz20ybGaDCE. Accessed 18 July 2012.
28100 best corporate citizens. Corporate Responsibility Magazine. Available at:
http://www.thecro.com/content/100-best-corporate-citizens. Accessed 20 July 2012.
29 Green Rankings 2010: U.S. Companies. Daily Beast. Available at:
http://www.thedailybeast.com/newsweek/2010/10/18/green-rankings-us-companies.html.
30Salminen RT, Arpalo J, Pekkarinen, O, Jalkala A, Mirola T. Characteristics of a good customer
reference for a process equipment supplier. 2008. Presentation of the RELI project Developing
Reference-based Business. Available at: http://www.tbrc.fi/eng/projects/?PCID=32&PID=58.
31 Data source: Compiled from the respective 2009, 2010, and 2011 annual reports for
McDonalds Corporation and YUM! Brands.
32Lab tests find carcinogen in regular and Diet Coke and Pepsi. Center for Science in the Public
Interest. 5 March 2012. Available at: http://www.cspinet.org/new/201203051.html. Accessed 20
July 2012.
33 Consumer group claims soda-cancer link. Bloomberg 5 March 2012. Available at:
http://www.chron.com/news/article/Consumer-group-claims-soda-cancer-link-3383014.php.
34 Cancer group asks U.S. to study sugary drinks, obesity. Reuters. 4 July 2012. Available at:
http://in.reuters.com/article/2012/07/03/usa-obesity-soda-cancer-idINL2E8I3AO120120703.
35 Hays CL. Coke Products Are Ordered Off the Shelves in Four Countries. New York Times. 16
June 1999. http://www.nytimes.com/1999/06/16/business/coke-products-are-ordered-off-the-
shelves-in-four-countries.html?pagewanted=all&src=pm. Accessed 10 October 2012.
36 Greenberg MD. On breaking the log jam: the how and why of corporate reputation leadership.
Corporate Finance Review. 2012; 17(1):1117.

37 The Coca-Cola Company Annual Report, 2011.
38 Russell M. In the spotlight PepsiCo's plans beg more questions. Just Food. 10 February 2012.
Available at: http://www.just-food.com/analysis/in-the-spotlight-pepsicos-plans-beg-more-

questions_id118218.aspx. Accessed 31 August 2012.
39 PepsiCo. Annual Report, 2011.
40 Data source: Compiled from the respective 2009, 2010, and 2011 annual reports for The Coca-
Cola Company and PepsiCo.
41 Dyer JH, Chu W. The role of trustworthiness in reducing transaction costs and improving
performance: empirical evidence from the United States, Japan and Korea. Organization Science.
2003;14 (1): 5768.
42Compiled from Yahoo Finance company statistics.
http://finance.yahoo.com/q/ks?s=TM+Key+Statistics. Accessed February 2010.
43Labormanagement relations. Toyota. Available at:
http://www.toyota.co.jp/en/environmental_rep/03/jyugyoin.html. Accessed 1 September 2012.
44Kitamura M, Horie M. Toyota partmakers in Japan hire detectives to hunt bankruptcies.
Bloomberg. 1 May 2009. Available at:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aGcEKX2DBZ4M&refer=japan.

45 Memos show regulators cut short Toyota probe in 2007. Reuters. 22 February 2010. Available
at: http://www.reuters.com/article/2010/02/22/retire-us-toyota-nhtsa-idUSTRE61L4TC20100222.
46 McDonald C. Toyota, Tylenol recalls 'Worlds Apart,' crisis mgt. expert says. Property Casualty
360. 5 February 2010. Available at: http://www.propertycasualty360.com/2010/02/05/toyota-

tylenol-recalls-worlds-apart-crisis-mgt-expert-says. Accessed 10 August 2012.
Kossovsky N. Foggy supply chain claims another victim (case study). Intellectual Asset
47
Management. 2010; 41(May/June): 1927.

48Barinka A. Peets seen tempting Starbucks to top richest Java bid: real M&A. Bloomberg. 31
July 2012. Available at: http://www.sfgate.com/business/bloomberg/article/Peet-s-Seen-
Tempting-Starbucks-to-Top-Richest-3752232.php. Accessed 1 August 2012.
49 Franklin M. Could Starbucks Acquire Peet's Coffee? The Daily Meal, 30 July 2012. Available
at: http://www.thedailymeal.com/could-starbucks-acquire-peets-coffee. Accessed 10 October
2012.
50Yahoo Finance, SBUX, Key Statistics. Available at:
http://finance.yahoo.com/q/ks?s=SBUX+Key+Statistics. Accessed 2 October 2012.
CHAPTER
Creditors
A man I do not trust could not get money from me on all the bonds in
Christendom.
J. P. Morgan1
John Pierpont Morgan, patriarch of the banking dynasty, famously asserted that
credit was based on trust. Knowing whom he was lending to was more
important than either cash or property collateral, he explained to Congress in
1912. In todays commercial relationships, trust still denotes an expectation of
behavior that is the foundation for commercial credit.
One hundred years after Morgans statement, superior reputations that foster
trust are still associated with better credit terms. Today, when it is no longer
clear exactly who owns any given security, when buyer and seller usually
never meet, and where there is never any apparent opportunity for trust to
develop, reputations matter even more to borrowers and creditors.2 Risk is the
issue. High trust, or reputation, translates into lower credit risk. Lesser
reputation means higher credit risk.
Yet today most of the finance literature focuses on the hard aspects of credit
risk, including such quantifiable elements as repayment history and credit
ratings, which tend to constrict the meaning of reputation. Neglect of the
intangibles may explain why the literature has not been very successful on the
subject of pricing credit risk. Prior studies have been able to explain only a
small fraction of the variation in credit spreads.3,4,5,6 Reliance on hard
2 Chapter 6 | Creditors
information, such as balance sheet and market data, ignores such intangible
factors as firm reputationthat which J. P. Morgan considered essential. Alan
Greenspan spoke of this issue when he lamented, I am distressed at how far
we have let concerns for reputation slip in recent years.7
Volkswagen AG
The Volkswagen Groups August 2012 acquisition of Porsche illustrates how
reputation can trump oversimplified quantitative world views. The largest
carmaker in Europe, the VW Group aspires to surpass both General Motors and
Toyota and become the largest carmaker in the world. In 2011, it delivered 8.3
million vehicles, up by 1 million from the year before. Sales revenue increased
by 25.6% to 159.3 billion ($212 billion), and operating profits rose to 11.3
billion ($15 billion)a new record.
The Group, better known to generations of aging hippies as the manufacturer of
the Beetle and the Microbus, consisted of ten brands from seven European
countries: Volkswagen Passenger Cars, Audi, SKODA, SEAT, Bentley,
Volkswagen Commercial Vehicles, Scania, MAN, Bugatti, and Lamborghini.
Each brand has its own character and operates as an independent entity to meet
the specific needs of different market segments and countries.
On 3 August 2012, Volkswagen added to its stable of brands Porsche
Zwischenholding GmbH as the 11th in the VW Group. In the lead up to the
deals closing, credit markets held differing opinions about the economic
benefits of adding Porsches reputation to the Group. On 9 July 2012,
Bloomberg reported that VW had committed to spending 4.46 billion ($5.5
billion) of cash to add to its 49.9% stake and complete its acquisition of Porsche
SE, and that it also took on 2.5 billion ($3.2 billion) of debt along with the
50.1% of the iconic sports carmaker that it didnt already own. Moodys was
dubious, commenting that the cash payment created a deterioration in VWs
leverage ratio, with adjusted net debtto-earnings ratio rising to 0.7 times from
0.4 times before the transaction. Fitch was more optimistic, affirming its
existing ratings and revising Volkswagens outlook to Positive from Stable.8
But investors, more attuned to reputation, were unabashedly enthusiastic. They
concluded that the acquisition of a premium brand made Volkswagen more
creditworthy and they pushed VWs bonds to record highs. VWs 1.25 billion
bonds with a face value of 2.75% rose in price, cutting the yield to 1.3%. Credit
default swaps (CDSs) protecting the companys debt were the most traded of
any corporate contracts globally in the week through June 29 and fell the most
compared with other European auto firms in July, according to Credit Market
Analysis (CMA), a part of S&P Capital IQ.9
Reputation Matters
There are a few academic studies that quantify the relationship between credit
costs and the six business pillars that underpin reputation. These pillars are
among the categories of corporate investments that have no visibility on
traditional balance sheets yet represent essential economic competenciesa
term used by Charles Hulten, professor of economics at the University of
Maryland.10 Bauer and Hann showed that credit costs correlate with reputation-
associated operational risks in safety and sustainability.11 Using information on
the environmental profile of 582 U.S. public corporations between 1995 and
2006, and controlling for numerous credit risk determinants, they showed that
firms with questions about their environmental performance pay a premium on
the cost of debt financing and have lower credit ratings. The corporate activities
underlying this sustainability connection were related mainly to regulatory and
climate change issues. In contrast, firms with a reputation for proactive
environmental engagement are charged a lower cost of debt.
Commitments to innovate and execute practices with environmental benefits are
also associated with lower bond spreads, as observed for firms in industries both
that are traditionally low and high in environmental risk. Also, the relevance of
corporate environmental management has increased over recent years as a result
of the growing climate change concerns and investors awareness of associated
regulatory risks.
Scott Mitchell, Chairman of Open Compliance and Ethics Group (OCEG), a
not-for-profit performance management think tank, argues that the Enron and
WorldCom scandals forced investors to consider extra-financial factors.
Creditors are looking for high financial performance, but with a degree of both
responsibility and integrity. Companies that are seriously committed to driving
principled performance through integrated governance, risk, and compliance
activities based on publicly vetted tools and resources invariably end up with
better reputations.12
Reputational risk should not be conflated with moral risk. All other things being
equal, there is no evidence that companies operating in the alcohol, gaming, or
adult entertainment industriesso-called sin industriesface a higher cost of
debt or a lower bond rating. However, the tobacco industry does because of
additional regulatory risks.13 In October of 2011, S&P reminded corporate
boards and managers that its analysts take corporate safety measures into
account when rating creditworthiness.14 While they may not have the tools to
estimate improved cash flows from enhanced reputations, the credit ratings
agencies are not unaware of the risks to cash flows from the failure of any of the
six business processes underpinning reputation enumerated in Table 1-1.
A few academic studies do quantify the relationship between credit costs and
reputation directly. Each year, Fortune magazine surveys industry experts along
dimensions such as the quality, integrity, and character of a firms managers;
the innovativeness of the firm; the quality of its products; and the firms ability
to attract, retain, and train talented workers. They use these as important factors
for gauging reputation. Their ranking of Most Admired Companies, described
further in Chapter 9, is used by academics in a number of disciplines as a
measure corporate reputation.15,16
Another survey-based ranking of the worlds Most Respected Companies is
published by Barrons. Unlike the Fortune survey, Barrons limits its survey
respondents to professional money managers. In May and June 2012, 116
investors nationally scored each of the worlds 100 largest companies on a scale
of 1 to 5. One key question asks the degree they respect, or dont, the worlds
largest companies.
Research based on these reputation scorings consistently shows that a favorable
reputation correlates with lower expectations for adverse credit eventsa
benefit factored into credit pricing. In a 2011 study, using the Most Admired
Company rankings as a proxy for reputation, Anginer et al. found a robust
inverse relationship between a firms reputation as measured by the Fortune
survey and the credit spread on its bonds: 17 A higher reputation score was
associated with lower monthly credit spreads. A half-point (0.5) improvement
in the reputation score, or moving up one quintile in the Fortune reputation
rankings, reduced the cost of debt capital by 1020 basis points (bps), even
taking into account all other firm-level and macro-level variables affecting
credit risk.
In the pricing of CDSs also, firms with superior reputations benefit. Marc
Lucier, a director of Deutsche Bank, reported in 2009 that companies with
higher reputation rankings tend to have lower credit costs, reflected in lower
spreads of CDSs. The converse is also true: 49% of the variance in the average
relative CDS cost was explained by the average reputation rankings.18
A 2012 study for this book using the Barrons survey data as the proxy for
reputation showed that lower CDS prices correlated with higher levels of
respect. In an analysis of 30 of the worlds largest companies, two variables,
the Barrons respect scores and the Total Debt/earnings before interest, taxes,
depreciation, and amortization (EBITDA) ratio, explained 15% of the variance
in pricing of CDSs. Controlling for the Debt/EBITDA ratio, the Barrons
Respect score explained 12% of the CDS pricing variance, and a move one full
notch up the Respect scale moved the 3 August 2012 CDS price down 15.6 bps
(Figure 6-1).
Figure 6-1. Correlation of CDS prices 3 August 2012 with the Barrons Respect Score. The debt
of companies with better reputations can be insured at a lower cost.
In addition to better pricing, superior reputations are associated both with larger
credit tranches and better terms. A study of 181 deals with a median value of
$408 million showed that the General Partners reputation is significantly
related to leverage and deal structure.19 The study found that reputable private
equity groups pay narrower bank and institutional loan spreads, have longer
loan maturities, and rely more on institutional loans.20
Conversely, reputational damage can lower credit ratings and increase credit
costs. After its reputational crisis, BP was briefly unable to borrow money at
any price. Two days after Carnival Corps. Costa Concordia cruise ship
capsized, Standard & Poors issued a bulletin saying that costs associated with
the disaster would negatively affect Carnivals 2012 operating performance,
including any investment associated with restoring the reputation of the Costa
brand, which is one of Carnivals largest and most well-known.21 And the
failure of MF Global, the financial derivatives broker, and the ensuing legal,
regulatory, and reputational damage, led Standard & Poors to reduce the
ratings of the parent, CME Group Inc.22
Security: The Johnson & Johnson Case

[Security is] the degree of protection a company offers against events
undertaken by actors intentionally, criminally or maliciously, for purposes
that adversely affect the firm. Because fear is the great disruptor of life and
commerce, it is useful to think of security, the most ethereal of the intangible
assets, as absence of fear. (Table 1-1)
There was nothing Johnson & Johnson could have done to signal more
convincingly its ethical culture than its enterprise-wide behavior during the
1982 Tylenol poisonings. At that time, Tylenol was the undisputed leader in the
painkiller field, accounting for a 37% market share. Had Tylenol been a public
corporation, profits would have placed it in the top half of the Fortune 500.
The recounting of the security crisis the company endured forged a powerful
linkage between the words corporate ethics and Johnson & Johnson. During
the fall of 1982, a malevolent person or persons replaced Tylenol Extra-
Strength capsules with cyanide-laced capsules, resealed the packages, and
deposited them on the shelves of at least a half-dozen pharmacies and food
stores in the Chicago area. By the end of the crisis, seven people had purchased
the tainted capsules, ingested them, and died.
Having learned about the developing crisis from a phone query by a Chicago
reporter, Johnson & Johnson Chairman James Burke charged a seven-member
strategy team with two goals: protecting people and saving the product.23 The
companys first actions were to alert consumers nationwide immediately
through the media not to consume any Tylenol product. After two more
contaminated bottles of Tylenol were found, Mr. Burke ordered a national
withdrawal of every capsule.
The crisis generated unprecedented news coverage. More than 100,000 separate
news stories ran in U.S. newspapers and garnered hundreds of hours of national
and local television coverage. The companys post-crisis study revealed that
more than 90% of the U.S. population had heard of the Chicago deaths within
the first week of the crisis. Two news clipping services found more than
125,000 clips on the Tylenol story, and one of them claimed that the story had
received the widest U.S. news coverage since President John F. Kennedys
assassination.24
Extensive coverage enabled the company to communicate to its stakeholders

what it was doing to mitigate the disaster and restore its reputationactions
proving that ethical behavior was a cultural standard at Johnson & Johnson.
Figure 6-2. Analysis of the 167 articles appearing in the business media during the 12 months
preceding 15 May 2009 concerning Johnson & Johnson and reputation show an overwhelming
positive sentiment, with a positive to negative ratio of 8.38. Source: Newssift.com, a Financial
Times service.
When the dust had settled, the central message stakeholders received was that
the company was moral, revered its customers, and was itself a victim of a
wanton act of terrorism. Its reputation was secured for the next quarter-century.
Surveys consistently ranked the firm at or near the top of almost every
reputational ranking, and press coverage tended to be favorable (Figure 6-2).
The companys low CDS costs reflected the benefits of its long-term superior
reputation and perceived superior creditworthiness (Figure 6-3).
Figure 6-3. Firms with superior reputations tend to face lower credit costs. Shown are the
company and two peers, and their respective costs of credit as measured by the ratio of their CDS
price relative to the average CDS price of the S&P 500. Source: Kossovsky N. J&J, a credo and a
reputation (case study). Intellectual Asset Management. 2010; 39: (January/February): 3034.
Guidance
Creditors are obviously at an informational disadvantage, since there is no way
they can fully comprehend the motives or anticipate the potential behaviors of a
borrower. They are forced to depend upon the body of information beyond
direct knowledge that is encapsulated in the word reputation.
Hypothesizing in 1982 what J. P. Morgan knew empirically in 1912, Milgrom
and Roberts suggested that reputations would play a role in credit
relationships.25 Along this same line of thought, Berger and Udell suggested
that older firms accessed credit more easily than younger firms because enough
time had passed to establish the firms public reputation, thereby mitigating
asymmetric information problems.26
Looking at consistency of repayment alone is inadequate for distinguishing
healthy firms with similar repayment records. Firms may adopt a wide range of
other actions that influence how their creditworthiness is perceived. A firm
may, for example, hire quality managers or take a conservative approach to risk
management, leading it to be perceived as a high-quality firm in terms of its

credit risk. These and other qualitative features are factored into the bond rating
agencies rankings.
While we prefer the term reputation, qualitative features not present on
standard corporate financial statements are also known in financial circles as
non-financial or extra-financial information. In its 1996 Measures that
Matter study, Cap Gemini Ernst & Young, a global accountancy, established
that non-financial performance plays a critical role in how public companies are
valued, accounting for as much as 35% of institutional investors valuation.27 In
2005, PwC, another global accountancy, reported controlled experiments
showing that extra-financial data and intangible asset value calculations swayed
40% of analysts to change their target valuations of public companies. That
same year, Thomson Extel, the publishing group, reported that 6% of buy-side
brokerages devoted material resources to extra-financial data to determine
intangible asset value. A year later, that figure was updated to 32% of buy-side
brokerages.28
More investment managers also seem to be collecting extra-financial
information. In 2007, Vigeo, a provider of extra-financial data, reported that
they had been retained by ABP Fund, which had 200 billion ($280 billion) in
assets under management. Also, in 2007, the Enhanced Analytics Initiative,
international extra-financial investment information cooperative, reported that
its membership had a total of US$2.4 trillion of assets under management.
Today, that increased attention to extra-financial information has grown to
encompass, among others, groups with investment strategies informed by
corporate environmental, social, and governance practices under the rubric of
socially responsible investing.
In 2000, Cap Gemini Ernst & Young declared the market at once demands and
relies on non-financial information in company evaluations and valuation
decisions.29 As seen with the VW case, 12 years later some investors are still
comfortable factoring extra-financial information into the pricing of equities or
debt. Anecdotally, select members of the professional credit
communityregional bankersmay be similarly inclined.
The credit experience of Pittsburgh-based Littlearth Productions, a womens
accessories manufacturer, is illustrative. A licensee of the National Football
League, Littlearths products, sold under the Pro-Fan-ity brand, are made for the
female sports enthusiast. The companys globally distributed operations and
supply chain call for levels of working capital augmented through lines of
credit. Robert J. Brandegee, CEO, attributes the strength of his banking
relationships to the intangible value of his license. The bank is willing to work
with us when we are not quite in formula because they know how much we
will sell this upcoming NFL season, he says. His bank manager, like many
citizens of Pittsburgha drinking town with a football problem29is an
enthusiast of the local professional team, the Steelers. Rob adds, His
understanding of the emotional power of our brand is a benefit that makes all of
the difference for us in terms of our ability to grow through conventional
financing!
But other members of the stakeholder community of creditors, even if they are
sports fans, are often not moved this way. The fact that such different comfort
levels exist for something as fundamental as credit risk explains, in part, why
the Nobel Committee has awarded two separate prizes in 1996 and 2001 for
work in the field of markets with asymmetric information.
Economists as far back as Adam Smith30 observed that, as interest rates rise, the
best borrowers drop out of the market. However, it was the work of Michael
Spence, who along with George Akerlof and Joseph Stiglitz was awarded the
Nobel Prize in Economics, that explained how credit rating agencies and
insurers helped translate extra-financial informationreputationinto
information that can be appreciated and valued by all stakeholders.31
Because reputation is difficult to value, commercial insurances can be unusually
valuable in signaling information about credit risk related to reputation risk
arising from operational risk. The art is in the detail. The strongest signals on
creditworthiness come from insurances that indemnify policyholders against
reputational value loss and that incentivize better reputation risk management.
In 2011, both AIG and Zurich Financial Services, in cooperation with Aon,
introduced reputation insurances that primarily provide indemnifications for
crisis communications expenses. In 2012, Kiln Group in cooperation with Steel
City Re introduced a different type of productReputational Value Insurance.
Reputational Value Insurance protects against first-party loss to a companys
reputation arising from a failed business process and consequential adverse
media attention. Evidence of reputation risk control is a condition of
underwriting the insurance, and loss limits are indexed to reputational value
metrics.32 Insurances are discussed further in Chapter 8.
Consider This
Reputation is an umbrella term for the extra-financial
information on intangible assets that lenders can factor into
their assessment of the creditworthiness of a borrower.
Among the largest companies, a better reputation can
enhance the creditworthiness of a borrower and the benefits
can persist for years.
Insurances are among the most cost-effective instruments
for signaling reputation-driven enhanced creditworthiness.
Properly designed reputation insurances can help
stakeholders appreciate and value a companys state of
reputation risk control.
By the Numbers
Table 6-1. Effects of Reputation on Credit Costs
VW Group Corporate bond yield dropped to 85% 3 yr ROE compared to

record low of 1.3%. 33% for world markets, 20%
for DAX
Funding advantage of at least 400 bps
over its main European rivals.33
Johnson & Johnson Post-crisis CDS prices lower by 510 Equity price resilience
basis points than peers and as low as
5% of the average for all S&P 500
companies.
Multiple studies Credit spreads for the Worlds Most Increase

Admired Companies are ~0.75%
lower than the prices for those with
the worst reputations.
CDS prices for the Worlds Most
Respected (Largest) Companies are
~0.60% lower than the prices for
those with the worst reputations.
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http://www.newyorker.com/talk/financial/2008/10/20/081020ta_talk_surowiecki. Accessed 2
August 2012.
2 Authers J. A return to vision of J. P. Morgan. Financial Times. 29 July 2012. Available at:
http://www.ft.com/intl/cms/s/0/e6e6a57c-d7d2-11e1-80a8-00144feabdc0.html#axzz22O9ypWmI.
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of Finance. 2001; 56:21772207.

4 Duffee GR. Estimating the price of default risk. Review of Financial Studies. 1999; 12:197266.
5 Amato J, Remolona E. The credit spread puzzle, BIS Quarterly Review. 2003; 5163.
6Elton EJ, Gruber MJ, Agrawal D, Mann C. Explaining the rate spread on corporate bonds.
Journal of Finance. 2001; 56:247277.
7Goodman PS. Taking hard new look at a Greenspan legacy. The New York Times. 8 October
2008. http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html?pagewanted=all.
8 Fitch affirms Volkswagen at 'A' on Porsche acquisition. Press Release. Reuters. 5 July 2012.
Available at: http://in.reuters.com/article/2012/07/05/idINWNA042820120705. Accessed 3

August 2012.
9 Benjamin H. Porsche joins Bugatti to spur VW bonds record: corporate finance. Bloomberg. 9
July 2012. Available at: http://www.businessweek.com/news/2012-07-08/porsche-joins-bugatti-

to-spur-vw-bonds-record-corporate-finance. Accessed 3 August 2012.
10 Hulten C. Agnostic blessings: how to count intangibles. Mission Intangible Monthly Briefing. 3
December 2010. Audio recordings available from the Intangible Asset Finance Society:
http://iafinance.org/monthly-briefings. Accessed 15 September 2012.
11Bauer R, Hann D. Corporate environmental management and credit risk. Working paper,
European Centre for Corporate Engagement, June 30, 2010. Available at:
http://ssrn.com/abstract=1660470 or http://dx.doi.org/10.2139/ssrn.1660470. Accessed 3 August
2012
12 Mitchell SL. How reputation drives principled performance. Mission Intangible Monthly
Briefing, 1 April 2011. Audio recordings available from the Intangible Asset Finance Society:
http://iafinance.org/monthly-briefings.
13Dassen S. Sin companies and credit risk. Masters Thesis. Maastricht University, Faculty of
Economics and Business Administration, Maastricht, 24 May 2011.
14 Chapelle T. S&P emphasizes safety as factor in credit scores. Agenda. 24 October 2011.
15 Davies G. Corporate reputation and competitiveness. New York: Psychology Press, 2003.
16Fombrun, CJ, Gardberg NA, Sever JM. The reputation quotient: a multi-stakeholder measure of
corporate reputation. Journal of Brand Management. 1999; 7: 241255.
17 Anginer D, Warburton AJ, Yildizhan C. Corporate reputation and cost of debt. Available at:
SSRN: http://ssrn.com/abstract=1873803 or http://dx.doi.org/10.2139/ssrn.1873803. Accessed 3

August 2012
18Lucier M. Quantifying the financial impact of reputation. In Building and enforcing intellectual
property value 2010. IP Media Group, 2010; 1520.
19 James C. Buyout financing: the changing role of banks in deal financing. Available at:
www.frbsf.org/csip/research/200710_Chris_James.pdf. Accessed 3 August 2012.

20Demiroglu C, James CM. The role of private equity group reputation in LBO financing.
Journal of Financial Economics. 2010; 96(2):306330
Reputation risk in focus at credit rating agencies. Business Insurance. 26 February 2012.
21
Available at: http://www.businessinsurance.com/article/20120226/NEWS06/302269975.

22Polansek T. S&P cuts CME Group rating due to MF Global risk. Reuters. 10 February 2012.
Available at: http://www.porknetwork.com/pork-news/SP-cuts-CME-Group-rating-due-to-MF-

Global-risk-139044309.html?view=all. Accessed 2 August 2012.
23Crisis communications case study: Tylenol. BCMpedia. Available at:
http://www.bcmpedia.org/wiki/Crisis_Communications_Case_Study_Tylenol. Accessed 12
August 2012.
24 Case study: the Johnson & Johnson Tylenol crisis. Crisis Communication Strategies. DoD Joint
Course in Communication. Available at:

http://www.ou.edu/deptcomm/dodjcc/groups/02C2/Johnson%20&%20Johnson.htm. Accessed 12
August 2012.
25 Milgrom P, Roberts J. Predation, reputation, and entry deterrence. Journal of Economic Theory.
1982; 27:280312.
26Berger AN, Udell GF. Relationship lending and lines of credit in small firm finance. Journal of
Business. 1995; 68:351382. Available at: http://dx.doi.org/10.1086/296668. Accessed 3 August
2012
27Measuring the future: the value creation index. Cap Gemini Ernst & Young Center for Business
Innovation, 2000; 3.
28Kossovsky N. Accounting for intangibles: from IP to CEO. Patent Strategy & Management.
2007; 8(7):34.
29Pittsburgh. Urban dictionary. Available at:
http://www.urbandictionary.com/define.php?term=pittsburgh&page=2. Accessed 1 September
2012.
30Smith A. An inquiry into the nature and causes of the wealth of nations. London: Strahan &
Cadell, 1776.
31Spence AM. Consumer misperceptions, product failure and producer liability. Review of
Economic Studies. 1977; 44:561572.
32 Steel City Re. Protecting reputation value. Available at:
http://www.steelcityre.com/protecting_value.shtml. Accessed 1 September 2012.

33Tait N, Kirk S. Lex in depth: Volkswagen. Financial Times. 5 September 2012.

http://www.ft.com/intl/cms/s/0/8723e25e-f761-11e1-8c9d-00144feabdc0.html#axzz25h3VSeTG.
Accessed 6 September 2012.
CHAPTER
Equity Investors
Given the recent reputational, legal and regulatory risks we believe the
board is in need of independent leadership.
Class A Equity Investors of News Corporation1
Equity investors express their expectations mostly by buying or selling shares.

Through these direct behaviors, they establish stock prices and earnings
multiples. Firms with superior reputations benefit from higher multiples on
earnings. Poor reputations tend to result in higher stock price volatility and
greater vulnerability to headline risks. In a reputational crisis, any firm may
experience a collapse in stock price.
Recently, investors have begun voicing their expectations with increasing

frequency through their proxies. Some of their expectations may reflect social
values; many others are reactions to financial performance alone. In very recent
years, investors have become far more active in their expression of
disappointment, through voting against board members and against
management plans, with increasing attention to Nay on pay.2 Also, increased
numbers of these shareholders are taking their displeasure to the courts.
2 Chapter 7 | Equity Investors
Individual corporate executives and board members may also suffer personal
reputation damage when their companies endure an adverse reputational event.
Investors are not yet storming the Bastille, but their concerns about the
reputations of their companies are being taken very seriously. The following
studies illustrate some of the widely varied examples of growing shareholder
influence on corporate behaviors and their reputations.
Facebook Inc.
Most equity investors buy stocks that they expect to be able to sell at a higher
price within a reasonable period. Before Facebooks initial public offering
(IPO), Reuters reported that it was already oversubscribed with one week left.
For the IPO of the Decade, analysts expected that the upper end of the
projected price range of $28 to $35 would be raised. In turn, Facebook would
raise more than the expected $10.6 billion, and shares could be expected to rise
once the IPO was complete.3 Expectations were high. Just ten weeks later, the
shorts were high.
This historic 18 May 2012 Facebook Inc. IPO did not go as many had expected.
Facebook shares, which opened up 11%, closed just above their $38 IPO price.
More than 576 million shares changed hands, setting a trading volume record
for U.S. market debuts.4 Most investors had expected a first-day pop, but five
days later, Facebook equity was hemorrhaging value (Figure 7-1).
Figure 7-1. Time series chart showing Facebooks stock price from its May launch through early
August. Within 10 weeks, Facebook equity had shed 47% of its IPO value. Source: Yahoo
Finance.5
The company had priced its IPO at the top end of its target range and increased
the size of the offering, becoming the first U.S. company to go public with a
valuation greater than $100 billion. On 2 August, after less than three months,
that valuation dipped briefly to $42.8 billion. At a valuation of 122 times
historic earnings, those expectations arguably still could be irrationally
exuberant.
When the stock was still above $30, long before the magnitude of the mismatch
between equity investor expectations and broad market behavior became
apparent, Vanity Fair published a tongue-in-cheek indictment of all potentially
culpable parties, namely, everyone6:
The Underwriters
for lowering their expectations of earnings just before the IPO, and
informing only a select number of larger clients.
Your Stupid Cell Phone

for enabling mobile advertising that is less lucrative to Facebook and
worrying the underwriters.
The Media
for propping up Facebook and confusing a terrific social-media service
with a hot stock. The journalists should have been savvy enough to see
through Wall Streets foolish promises.
General Motors
for yanking its advertising from the site just before the IPO.
Barack Hussein Obama

Why not?
NASDAQ
when on IPO, day, a glitch delayed Facebooks market debut by roughly
half an hour, and later delayed order confirmations.
Facebook.com
for alleged registration and prospectus (that) were materially false.
Not everyone was disappointed in Facebook Inc.s huge drop. Some European
investors bought structured products benefiting from the stocks decline.7 A put
warrant that predicted Facebook would be at $22 by March 2013 cost 6 euro
cents ($0.07) to buy in the week after Facebook went public. On 6 August, the
warrant was worth 36 euro cents, a return of more than 500%.
Reputation and Information Processing

Equity investors have the luxury of assessing the expected benefits of the
drivers of value on customers, employees, vendors, and creditors and then
determining if the current stock price is reasonable, too high, or too low. Major
macroeconomic events, regional microeconomic events, and specific corporate
events can all reset current expectations.
The Facebook IPO illustrates a confusion between reputation and brand that can
impact stakeholder behavior. Reputation, which is an expectation of behavior
held by stakeholders, should not be conflated with brand, which is an emotional
construct. Corporate reputation creates a powerful aggregation of information
that draws from an enormous and diverse array of sources. In general, the
process of its formation is cognitive and provides a framework through which
investors process current events. Brands, on the other hand, can create an
emotional attachment that obscures reality and undermines rational choice.
Consider how investors processed news about Facebook just before its IPO.
James Gorman, CEO of Morgan Stanley, the lead underwriter, disclosed that he
had unprecedented retail demand and people calling in from every part of
the country. Gorman confirmed that 26% of the shares were placed in the
hands of individual investors.8 Individual investors who were users of the
product were often passionate supporters. Retail investors had always been key
to Facebooks IPO strategy, in part because it had more than 900 million users
globally. We want to dump a lot of money into Facebook, said one aspiring
investor, citing peers activity on the site as evidence of its longevity. Youre
on Facebook half your day, if not more. Its a necessity. Its water, its death,
and now its Facebook.9 Such passion drove extraordinary expectations and
created a company brand that acted as a powerful news filter. The demand is
insane, said one retail broker to the Financial Times. You could write that
Facebook was the worst company in the world, and retail would still want the
stock.10
Writing about the rush for shares at the IPO of Arsenal, an English football
club, the Financial Times observed in 2010 that investors willingness to pay an
ego premium can add roughly 25% to a companys sale price.11 That would
put the fair value of Facebook at $32 per share, all other things being equal.
While only a few were overtly disparaging the firm, there was ample
information to properly determine more factually grounded, business-oriented
expectations about Facebooks advertising-linked revenue model. Two weeks
before the IPO, Marin Software, a digital marketing platform that processed
more than $100 million worth of spending on Facebook, found the cost per
click for Facebooks standard ads, which made up an estimated three-quarters
of the social networks advertising revenues, had fallen 26% over the prior year.12
A full month before the IPO, Facebook published quarterly numbers that
showed the rate of revenue growth was slowing, seasonality factors were
kicking in, and costs were soaring. The net effect for the first quarter of 2012
was a 36% slump in the companys operating profit margin, down from 53%
the year before.13
Ignoring reality is never a good strategy for investors. But when adverse events
obscure reality, a good reputation can provide visibility to investors and dispel
fear, uncertainty, and doubt.
Recall that Johnson & Johnson emerged in 1982 from its crisis with an
unimpeachable reputation for ethics. Not often appreciated is that a second
Johnson & Johnson Tylenol poisoning had also occurred. While the first attack
in 1982 caused significant financial damage, the second in 1986 didnt. The
primary differences between the two events were that by 1986, Johnson &
Johnson had strengthened its control over the security processes that ensured
safety in its products, and it had established a stellar reputation for ethical
behavior.
With its ethical reputation, Johnson & Johnsons contentions were credible: that
it was in control of its supply chain, that the poisoning was a rogue criminal act,
and that all other products were safe. Equity investors took the cue.
After the initial event in 1982, the companys market value fell by $1 billion, or
30% of its equity value, and took 2.5 years to equilibrate; during the course of
the 1986 event, the company recovered its lost reputational value as equity
investors boosted its stock price by 30% (Figure 7-2).
Figure 7-2. Time series chart of return on equity. A: Johnson & Johnson (JNJ), June 1982
through June 1985. The stock took 2.5 years to recover value from the fall 1982 Tylenol crisis.
Following the incident, J&J invested time and effort into strengthening its reputation resilience by
improving the underlying business processes that previously had allowed the product tampering
to occur. B: Johnson & Johnson June 1985 through June 1988. There was no meaningful adverse
impact of a second Tylenol crisis in 1986. In fact, the stock price actually rose and outperformed
the S&P 500 by 30%. Source: Kossovsky N. Mission Intangible: Managing risk and reputation to
create enterprise value. Intangible Asset Finance Society/Trafford, 2010. Reproduced with
permission.
The companys diligence in ensuring the safety and security of all its business
processes was communicated so effectively that it bolstered J&Js reputation
among consumers, and the company recovered 70% of its market share within
five months of the crisis. Investors concerns receded in less than two months,
and the company outperformed the S&P 500 index over the course of the year.
Subsequent research revealed that many consumers were so reassured by the
steps that J&J had taken that, instead of deserting Tylenol, they actually
switched to it from other painkillers.
Conversely, a bad reputation can exacerbate bad news. So it was for Knight
Capital Group. In the summer of 2012, the entire financial services sector was at
a reputational low point with customers and regulators, as well as other
stakeholders. For a financial services company, it was a bad time to have a
reputational crisis arising from an operational failure.
On 1 August 2012, Knight, a major market maker in global equities, watched

briefly as its electronic systems began trading for themselves. According to The
New York Times, technical problems led the firms computers to rapidly buy
and sell millions of shares in over a hundred stocks for about 45 minutes after
the markets opened. Those trades pushed the value of many stocks up, and the
companys losses appear to have occurred when it had to sell the overvalued
shares back into the market at a lower price.14 Knight Capitals tab for the bad
trades: $440 million.
Knights safety system, like BPs blowout protector on the Deepwater Horizon,
failed. Two days later, with its stock price down from $10.50 to below $3 at the
start of trading, Knights reputation as a safe platform for U.S. equity trades was
in tatters. Customers, employees, and regulators all wondered why it took the
firm so long to stop trades that were losing $10 million per minute. Even just a
minute or two would have been surprising to me. On these time scales, that is an
eternity, said David Lauer, a one-time trader at a high-speed firm. To have
something going on for 30 minutes is shocking.15 The losses threatened the
stability of the firm, and Knight Capital acknowledged that its capital base, the
money it used to conduct its business, had been severely impacted by the
event and that it was actively pursuing its strategic and financing
alternatives.14
Meanwhile, the regulatorssoon to be followed by the litigatorswere joining

the bloggers in outrage. Existing rules make it clear that when broker-dealers
with access to our markets use computers to trade, trade fast, or trade
frequently, they must check those systems to ensure they are operating
properly, SEC Chairman Mary Schapiro said two days after the event. And,
naturally, we will consider whether such compliance measures were followed in
this case.16
Five days after the business process failure at Knight, and with adverse
publicity mushrooming, Wall Street bailed out one of its own. A group of
investors led by Jefferies, the investment bank that structured the deal;
Blackstone; Getco; Stephens; Stifel Financial; and TD Ameritrade acquired
control and about 70% of Knight for around $1.50 a share.17
Operational failures from computer system malfunctions are risks that

companies like Knight Capital Group routinely disclose in their annual reports.
Capacity constraints, systems failures and delays may occur in the future and
could cause, among other things, unanticipated problems with our trading or
operating systemsdecreased levels of client service and client satisfaction,
and harm to our reputation. If any of these events were to occur, we could
suffer substantial financial losses, a loss of clientslitigation or other client
claims, and regulatory sanctions or additional regulatory burdens.18
It is not clear what, if any, systems Knight Capital had in place to mitigate those
risks. Nor is it clear that the company contemplated a precipitous failure. But
the data show that controls that mitigate reputational risks arising from
operational values do more than protect against losses. When companies make
operational improvements in reputational risk management in a way that can be
appreciated and valued by equity investors, value is added.
Constituent members of the S&P 500 index were scanned in the winter of each
year for firms that appeared to have latent reputation value as suggested by their
Steel City Re Corporate Reputation Rankings. The algorithm underpinning the
RepuStars Variety Corporate Reputation Index, calculated by Dow Jones
indexes, was used to accomplish this. Portfolios of up to 57 companies were
k
structured each year and the one-year returns were compared with the baseline
S&P 500 index returns (Figure 7-3). On average, those companies filtered for
latent reputation value outperformed the broader market by 6.5% annually over
the 10-year study period. 19
Figure 7-3. Re-based one-year returns on equity among S&P 500 index constituent members
identified by the RepuStars Variety algorithm (RepuSPX) as having as-yet unrealized reputation
value. The average value is 6.5%. The baseline levels of return are the S&P 500 index. Source:
Mission: Intangible blog of the Intangible Asset Finance Society. Reproduced with permission.20
Consider This
From the perspective of equity investors:
Reputation, a cognitive expectation of behavior held by

stakeholders, should not be conflated with brand, an
emotional construct.
Superior reputations can mitigate the reputational

consequences of adverse events.
When a corporation operates in an industry sector held in

low esteem, it is even more vulnerable to a reputational
stumble.
Unexpected gains (or losses) in reputational value among

major companies can be expected on average to add (or
subtract) 6%7% to (from) the market capitalization.
WPP plc
In May 2011, WPP plc, the worlds largest marketing services group, teamed up
with both Aon, one of the worlds largest insurance brokers, and Zurich
Financial Services, a leading insurer, to create a supersized reputation
restoration insurance product: $100 million for advertising, lobbying, and public
relations.21 WPPs role in the product is to act as a kind of loss adjuster for the
policy, advising on and directing spending for a crisis-hit company. In a vividly
ironic twist, one year later, the CEO of WPP, Sir Martin Sorrell, was facing his
own reputational crisis.
A proposed 56% pay boost for Sorrel on top of a prior years substantial turn
toward global retrenchment was inconsistent with shareholders evolving
expectations of meeting certain economic responsibilities. One evolving notion
is that a CEO cannot lose a lot of money for shareholders and expect to be
rewarded. WPP was not unaware of this expectation. Adding insult to injury, in
January 2012, a consortium of the conglomerates communications companies
announced at Davos that major global brands have more work to close the gap
between their performance in the marketplace and their citizenship.22
As is almost always the case, a failure of a business process was at the bottom
of the WPP reputational crisis. Board governance failed thrice. The first was not
processing shareholder concerns effectively. A second was failing to understand
that the politics of pay in the United Kingdom had changed. Last, according to
The Telegraph, they were relying too heavily on compensation consultants.23
All of this may be true, but the simple answer is that the reputation of the firm
had been deteriorating. If you look at the long-term performance in general in
the media industry, it has been dismal, said Sanford C. Bernstein analyst
Claudio Aspesi. When investors are disappointed with the performance of their
companies, they look to the CEO. So scrutiny over what management teams
have done to justify their pay packages is entirely appropriate, added Aspesi.23
The reputations of companies and CEOs are often conflated. Serial studies over
10 years by Weber Shandwicks Chief Reputation Strategist, Dr. Leslie Gaines-
Ross, suggest that executives believe that 50% of a companys reputation is
attributable to the CEO. In a May 2012 update, 66% of the general public said
that their perceptions of top leadership also affected their opinions of company
reputations from a great deal to a moderate degree. Only 7% said that there is
no link between the two.24
On 13 June 2012, 60% of WPP investors voted against the remuneration

packages of directors, including Sorrell. The nay vote came on the heels of a
protest vote from 40% of investors in 2011. Were disappointed by the result
of the vote, Sorrell said in an e-mail. But the shareowners have spoken.25
Jeffrey Rosen, head of WPPs remuneration committee, said: If we take

anything away from this, it is that we should have a more continuous program
of dialogue with shareholders. Twenty-two percent of shareholders thought the
time for dialogue had passed and voted against Rosens reappointment. Two
other directors had even higher votes against.25 Only 2% voted against Sorrells
reappointmentit was his pay level that they rejected.
Given the linkage between CEO and the company reputation, scrutiny does not
reveal a pretty picture of the reputations of CEOs. Gaines-Ross reported in 2009
that in the wake of the global financial meltdown of 2008, only 14% of
American executives held a positive view of chief executives,26 and among the
general public, probably an even lower percentage. Added Gaines-Ross:
Companies and leaders fall, often trip a second time as they institute
change but, on the third try, you definitely lose investor and customer patience.
After a third attempt or three sequential mishaps, your reputation gets a scarlet
R.27
The investor rebellion at WPP was one of the biggest since 2009, when 90% of
Royal Bank of Scotland Group plc shareholders turned down the pension plan
for the lenders former chief, Fred Goodwin. Goodwin, who had built the Royal
Bank of Scotland into one of the worlds largest banks, also led the bank to ruin
within four years, posting the biggest loss in U.K. corporate history24
billion ($38 billion). The British government had to spend 45 billion ($71
billion) bailing out and nationalizing RBS for an 82% stake.
Leading the bank to near-collapse and then walking away with a fat pension so
infuriated the British public that Goodwin was stripped of his knighthood in
January 2012. Having brought the honors system into disrepute, in the words
of the Huffington Post, he found himself in the company of British spy
Anthony Blunt, Zimbabwean President Robert Mugabe, and Romanian dictator
Nicolae Ceausescu.28
Say-on-Pay and Other Vocalizations

Evolving legislation in the United States and United Kingdom has given
shareholders a greater voice in corporate governance, but like many politically
initiated shifts in power, the instigators are voters. Shareholders who have
regularly rubber-stamped management-inspired proposals on governance and
pay are increasingly becoming voters and taking issue with executive pay
programs.
Sir Francis Bacon, a liberal-minded reformer of his day, famously wrote that
knowledge is power.29 Because of social media, shareholder/voters today are
more aware than ever, and they are exercising their newly found powers to
some effect. Even at historically docile Japanese companies, shareholder
meetings the summer of 2012 were marked by a flurry of proposals from
investors challenging management by opposing board appointments, for
example, or simply expressing anger at executives.30
WPPs dissenting shareholders had ample company. In 2012, more than 30% of
investors in the Pru, the UKs largest insurer, opted to vote against the
companys pay plan. Sixteen percent of shareholders voted against the CEO pay
package at Aberdeen Asset Management. At Aviva, chief executive Andrew
Moss resigned from the company after shareholders rejected the insurance
groups pay policies. Nearly 50% of shareholders of William Hill, the United
Kingdoms biggest bookmaker, voted against the firms remuneration report.
Shareholders at Trinity Mirror, the newspaper company, prompted the
resignation of CEO Sly Bailey after a quarter of the firms shareholders
pressured the board to reduce her pay.
Angry over domestic energy prices, nearly 12% of shareholders voted against
remuneration packages at Centrica, the owner of British Gas. Cookson, the U.K.
materials technology company, took a beating at the annual general meeting
after 32% of its shareholders voted against the re-election of the entire board
following its decision to award 20 million ($32 million) in shares to directors.
According to the Daily Telegraph, dissenters included Lord Myners, the Labour
peer and chairman of Cevian, a 14% investor in the firm. Nearly 32% of votes
cast at the annual general meeting opposed the directors remuneration report.
Financial institutions are favored targets of shareholder rage. After dismal

returns, around 15% of shareholders rejected the remuneration report of Man
Group, the U.K. hedge fund firm, piling more pressure on chief executive Peter
Clarke to resign. At Barclays, even before the LIBOR (London Interbank
Offered Rate) scandal became public, anger at Bob Diamond's pay package
spilled out into open mutiny at the banks annual general meeting when 27% of
investors voted against it. UBS was hit with a 36.84% rejection of its
compensation report and Credit Suisse with a 31.6% rejection. Across the pond,
in an almost unprecedented revolt, 55% of the Citibanks shareholders rejected
a $49 million pay package for its chief executive, Vikram Pandit.31 The only
surprise about this vote was that so many shareholders still voted in favor.
Citigroups stock has declined more than 90 percent in the last five years, and
the company has been a prime example of mismanagement in the years leading
up to the financial crisis.32
Rage and anger here are being driven by a perception that the bankers have
skewed values. The majority of people feel its just a culture of greed,
explained one executive coach.33 Or perhaps not sharing the benefits of that
greed. Proxy advisory groups such as Institutional Shareholder Services and
Glass Lewis have been credited with influencing many of the successful nay
campaigns of 2012. But they have not been successful when a banks reputation
among shareholders, economic returns, and executive pay has been generally
aligned.
Shareholders in the United States who are not themselves activists actually have
little in common with Occupy Wall Street protesters. Except in fairly
extraordinary circumstances, it appears they dont much care about how much
people get paid, as long as earnings and share prices keep rising.34 The banks
have deservedly received outsized attention because of persistent headline risk
brought on by pockets of truly bad behavior in the financial sector, but
compensation has otherwise not been a major battleground.
Correlating Respect and Pay

Using the Barrons Respect data introduced earlier as a proxy for a firms
reputation among its shareholding professional investors, the data show that
greater respect goes hand in hand with greater CEO salary in the financial
sector. Barrons Respect scores explained 27% of the variance in salary levels
among CEOs of the worlds largest financial institutions, and each additional
full notch of additional Barrons Respect translated to an additional $800,000 in
salary (Figure 7-4).
Three companies stood apart from the model. Berkshire Hathaway had the
second highest mean Barrons Respect score among the largest financial
institutions, just behind Visa. Visas CEOs nominal salary was $4.23 million
and was low relative to the respect earned from investors. Berkshires CEO, one
of the five wealthiest men in the world, took home only $490,000 in salary, an
exceptionally low salary nominal salary that is heavily supplemented with
contingent compensation. At the other end of the spectrum, Citigroup had the
second lowest mean Barrons Respect score, just above AIG. While AIGs
CEOs salary was $3.02 million, and his compensation package was approved
by 99.19% of the votes cast, Citigroups CEOs nominal salary was
significantly above the trend line at $7.02 million; his compensation package
was approved by only 45% of the votes cast.
Figure 7-4. Correlation between CEO base pay level ($ millions) and Barrons Respect score. In
financial services, being respected by investors translates into better pay, and when within reason,
into harmonious annual general meetings. Source: Salary data drawn from most recent annual
reports as published by Yahoo Finance. Available at: http://finance.yahoo.com/.
Again using the Barrons Respect data as a proxy for a firms reputation, the
data show that greater respect does not explain CEO salary in the Consumer
Non-Durables sector (Figure 7-5). Exemplary companies are Altria Group,
Procter & Gamble, PepsiCo, Diageo, LOreal, SAB Miller, LVMH Mot
Hennessy, Kraft Foods, and Coca-Cola. Barrons Respect scores explained
none of the variance in salary levels among CEOs of the worlds largest food,
beverage, and related products companies.
Figure 7-5. Correlation between CEO base pay level ($ millions) and Barrons Respect score. In
the consumer non-durables section, being respected by investors does not translate into better pay.
Source: Salary data drawn from most recent annual reports as published by Yahoo Finance.
Available at: http://finance.yahoo.com/.
It is the goal of this volume to present the data rather than speculate on the lack
of any correlation. However, this is not to say that investors are completely
indifferent to the pay of executives at non-financial companies. Shareholders
have disapproved executive compensation systems at some U.S. companies
such as Big Lots (31% approval), Cooper Industries (30%), Simon Property
Group (27%), Pitney Bowes (35%), and Chiquita Brands (20%). Outsized pay
for performance is the dominating issue. According to Towers Watson, the
compensation consultancy, companies whose shareholder returns were
consistently in the bottom quartile over five years were about nine times more
likely to fail their say-on-pay votes than neutral performers. 35
Companies that outperform can pretty much do what they want, even when the
CEO is barely known. Benefitting from Apples stellar reputation, CEO Tim
Cooks $378 million 10-year package was approved with 83% of the votes cast.
If a company is doing well, said Doug Friske, a Towers Watsons consultant,
w
shareholders have no problem with pay that recognizes that.35 But not always.
Proxy advisor ISS recommended against the compensation package at the Walt
Disney Company, a firm with a good reputation among all stakeholders. The
company protested that it had (reported a) record financial performance in
Fiscal Year 2011(with) total shareholder return more than four times greater
than that of the S&P 500 during Mr. Igers more than six years of leadership.
But with Disney, a company widely respected, the issue for the powerful proxy
advisor wasnt pay or performanceit was governance. ISS recommended
against voting for the members of Disneys Governance and Nominating
Committee as a result of appointing its CEO as Chairman of the Board as part
of a reasoned CEO succession strategy. ISS is generally opposed to CEOs
serving jointly as their own boss as chairpersons. ISS has also recommended
against Disneys position on say-on-pay.36 The package squeezed by with 57%
of the votes cast.
ISS had recommended a vote against pay packages at 14% of the companies it
assessed in 2012, up from 12% last year. Shareholder support was 30% lower at
companies with a negative say-on-pay assessment from ISS.37
Even if we havent seen widespread shareholder revolt, Friske said, theres

definitely been a change in boardroom attitudes. Maybe its not a shareholder
spring, but perhaps we can call it a shareholder thaw.35
Nevertheless, executive compensation systems put to a say-on-pay vote

continue to be approved by shareholders of most companies, often by large
majorities. Semler Brossy, a compensation advisor, reported in June 2012 that
at midyear say-on-pay votes in the Russell 3000 found only 40 of 1,594
corporations, or 2.5%, had failed. Ninety percent of the large companies won at
least 70% approval from shareholders in such votes, according to another
consultancy, Davis Polk.37 Though the press talked up a shareholder spring,
the failure rate of approximately 2% for the first half of 2012 was comparable to
the rates for 2011.38
Then there is litigation. Shareholders who express their feelings through their
proxies and are ignored by their companies can sell their equity, of course, but
they have recourse to that more explicit communication channel as well.
When, over shareholder protests, the board at Cincinnati Bell Inc. bumped up
the compensation of the top executives by up to 80% despite a 68% drop in
2010 net earnings, they were sued, becoming the first company to garner a no
vote for executive compensation under Dodd-Franka distinction of sorts.39
The lawsuit was brought by Illinois-based NECA-IBEW Pension Fund, a Bell
shareholder, and accused Cincinnati Bell Inc.s outside directors of breaching
their duty to investors and the companys top executives of unjust enrichment
over pay raises. The suit sought return or impoundment of the pay increases and
implementation of internal controls preventing excessive compensation to the

companys top executives.
Companies may not have to abide by shareholder advisory say-on-pay votes

mandated under the Dodd-Frank Act, the Wall Street Journal noted in June
2011, but lawyers specialized in securities class action suits have already
brought a half dozen suits against directors and executives for ignoring their
results.40 A number of firms have tried to settle the claims quickly. Among
those that have settled are KeyCorp and Occidental Petroleum. Others that have
faced suits were Beazer Homes, Hercules Offshore, and Umpqua Holdings, and
law firms had pending investigations at Dex One, Masco Corp., and Stanley
Black & Decker, among others. In addition to legal fees, the Journal stated,
the suits could impact companies more widely in areas like the cost of director
and officers liability insurance, and how much compensation consultants
charge.
Guidance
Many Facebook investors, enthralled with the company and its brand, took the
plunge and bought high, only to sell low. Professional investors with less
emotional engagement, and wary of the markets reputation for disappointing
investors caught up in the new, new thing, were more prudent. Innovation may
make for good companies; it may not necessarily make for good investments.
Investors in Johnson & Johnson in the late 1980s invested in a good company.
The companys culture had been tested by fire in 1983. Its security systems
were tested in 1986 and proven to be better than anyone had imagined.
Shareholders found a company in which risks previously felt to be inherent in
the sector had been eliminated through superior processes. Appreciation of that
reduction in risk helped shareholders better value the firm and discover an
additional 30% in enterprise value.
Paul Liebman, a compliance attorney who notably has worked for both the
largest public and private companies in the United States, ExxonMobil
Corporation and Koch Industries, recounted a story of Charles Kochs
investment philosophy. Koch, he said, only wanted to own businesses that
operated legally, ethically, safely, and profitably. Liebman, who was at the
time Chief Compliance Counsel at Dell, a technology company, added, If
anyone of those four were missing, then he didnt want to be involved.41 Most
equity investors, at the end of the day, are similarly inclined.
Despite their enhanced influence with management and board composition,

investors message to management remains stable: create value and
shareholders will reward management. Lose value and shareholders will support
management as long as managements reputation for eventually rewarding
shareholders remains intact.
Frederick D. Lipman, head of the Association of Audit Committee Members,

Inc., points out that Warren Buffet takes the contrarian position that stock price
is not really controlled by the executives of his companies, so he sees no reason
to either reward or punish them for its volatility.42
The investors message also comes with a warning. Lose value, signal disregard
for shareholders, and cause shareholders to expect little from management, and
they will fight on pay or seek the removal of management and/or the board. For
lost reputation, even Buffet will be ruthless.43
Consider This
Because the reputations of CEOs and the companies they
lead are often conflated, investor behaviors toward one are
shaped by the other.
Empowered by recent legislation, shareholders are using

conversations on CEO pay as one behavior to express their
beliefs.
When either a company or a CEO has a good reputation,

shareholders will support most strategies.
By the Numbers
These discussions illustrate how reputation can affect shareholder behavior, and
how those behaviors affect the executive teams freedom to operate, set
compensation, and execute their business strategies (Table 7-1).
Table 7-1. Effect of Reputation on Investor-Associated Behaviors
Operations Effect Stock Price Effect
Facebook Inc. Irrational exuberance conflating brand 50% loss on equity

with reputation
500% gain on equity
derivatives
Johnson & Johnson Market share growth from unexpected 30% boost in projected market
reputational boost even in the face of cap
an adverse event
S&P500 Unexpected reputational boost Average annual market cap

boost of 6.5% over 10-year
study period
Financial institutions Correlation of investor respect metric N/A

with CEO salary: $800,000 per full
notch up
All companies Consistent bottom quartile ROE are N/A

nine times more likely to fail say-on-
pay
1Rushton K. Rupert Murdoch faces shareholder revolt at News Corporation AGM. The
Telegraph. 18 July 2012. Available at:
http://www.telegraph.co.uk/finance/newsbysector/mediatechnologyandtelecoms/media/9410035/
Rupert-Murdoch-faces-shareholder-revolt-at-News-Corporation-AGM.html. Accessed 6 August
2012.
2Myles D. Stronger say-on-pay means shareholder spring to stay. IFLR. 26 July 2012. Available
at: http://www.iflr.com/Article/3066760/Corporate/Stronger-say-on-pay-means-Shareholder-
Spring-to-stay.html. Accessed 4 August 2012.
3Facebook IPO demand above expectations. 24/7 Wall Street. 11 May 2012. Available at:
http://247wallst.com/2012/05/11/facebook-ipo-demand-above-expectations/. Accessed 7 August
2012.
4Oreskovic A. Historic Facebook debut falls short of expectations. Reuters. 18 May 2012.
Available at: http://news.yahoo.com/facebook-prices-top-range-landmark-ipo-005337198--
sector.html. Accessed 7 August 2012.
5 http://finance.yahoo.com/q/hp?s=FB+Historical+Prices
6Weiner J. Whos to blame for the Facebook I.P.O. disaster? Blame must be assigned! Vanity
Fair. 23 May 2012. Available at: http://www.vanityfair.com/online/daily/2012/05/Whos-to-
Blame-for-the-Facebook-IPO-Disaster-Blame-Must-Be-Assigned. Accessed 7 August 2012.
7Marsh A. Facebook bears garner 500% profit from structured product bets. Bloomberg. 6
August 2012. Available at: http://www.bloomberg.com/news/2012-08-06/facebook-bears-garner-
500-profit-from-structured-product-bets.html. Accessed 7 August 2012.
8Demos T. Gorman calls Facebook investors naive. Financial Times. 31 May 2012. Available
at: http://www.ft.com/intl/cms/s/0/d84a2ab0-ab64-11e1-b675-
00144feabdc0.html#axzz22rXUquye. Accessed 7 August 2012.
9Demos T. Retail demand for Facebook risks inflating IPO. Financial Times. 16 May 2012.
Available at: http://www.ft.com/intl/cms/s/0/1f8d58f0-9ed8-11e1-a767-
10 Darila M, Santa M. Retail brokers stop accepting orders on Facebook shares. World Business
Press. 17 May 2012. Available at: http://wbponline.com/Articles/View/5026. Accessed 7 August

2012.
11 Lex. Psychic income. Financial Times. 20 August 2010.
12Bradshaw T, Dembosky A. Facebooks premium ad prices still rising. Financial Times. 6 May
2012. Available at: http://www.ft.com/intl/cms/s/0/77a89c04-9774-11e1-83f3-
13Waters R. Facebook gives the bulls pause for thought. Financial Times. 24 April 2012.
Available at: http://blogs.ft.com/tech-blog/2012/04/facebook-gives-the-bulls-pause-for-
thought/#axzz22sWPhcYk. Accessed 7 August 2012.
Popper N. Knight Capital says trading glitch cost it $440 million. The New York Times. 2
14
August 2012. Available at: http://dealbook.nytimes.com/2012/08/02/knight-capital-says-trading-

mishap-cost-it-440-million/. Accessed 7 August 2012.
15Silver-Greenberg J, Popper N, de la Merced MJ. Trading program ran amok, with no off
switch. The New York Times. 3 August 2012. Available at:
http://dealbook.nytimes.com/2012/08/03/trading-program-ran-amok-with-no-off-switch/.
16Chairman Schapiro statement on Knight Capital Group trading issue. Press Release. US
Securities and Exchange Commission, 3 August 2012. Available at:
http://www.sec.gov/news/press/2012/2012-151.htm. Accessed 4 October 2012.
17Mackenzie M, Alloway T. Outside investors take control of Knight. Financial Times. 6 August
2012. Available at: http://www.ft.com/intl/cms/s/0/616e6ea6-dff8-11e1-a96a-
00144feab49a.html#axzz22rXUquye. Accessed 7 August 2012.
18 Knight Capital Group Annual Report, 2011, pp. 1920.
Greenberg MD. On breaking the log jam: the how and why of corporate reputation leadership.
19
20 Huygens, C. Reputational value symmetry. Mission: Intangible, 4 February 2012. Available at:
http://www.iafinance.org/_blog/MISSION_INTANGIBLE/post/Reputational_Value_Symmetry/.
Accessed 13 October 2012.
21 Davies PJ. Insurance for groups to restore reputations. Financial Times. 8 May 2011. Available
at: http://www.ft.com/intl/cms/s/0/8a61e98a-79a3-11e0-86bd-
Global corporate reputation index finds major brands lag citizenship qualities. Press Release.
22
WPP. 27 January 2012.
23 Reece D. Sir Martin Sorrell's pay in dock but its WPP board who should take the blame. The
http://www.telegraph.co.uk/finance/comment/damianreece/9330589/Sir-Martin-Sorrells-pay-in-
dock-but-its-WPP-board-who-should-take-the-blame.html. Accessed 8 August 2012.
24 Gaines-Ross L. CEO reputation still going strong. CEO.com. 3 May 2012. Available at:
www.ceo.com/flink/?lnk=http%3A%2F%2Freputationxchange.com%2F2012%2F05%2F03%2Fc
eo-reputation-still-going-strong%2F. Accessed 8 August 2012.
25WPP investors vote against pay package of CEO Martin Sorrell. Bloomberg. 13 June 2012.
Available at: http://www.bloomberg.com/news/2012-06-13/wpp-investors-vote-against-pay-
package-of-chief-martin-sorrell.html\. Accessed 8 August 2012.
26 Gaines-Ross L. Resetting CEO reputation. Huffington Post. 11 November 2009. Available at:
www.huffingtonpost.com/dr-leslie-gainesross/resetting-ceo-reputation_b_354147.html. Accessed
8 August 2012.
Gaines-Ross L. Timing is everything in reputation. reputationXchange. 8 August 2012.

27
Available at: reputationxchange.com. Accessed 8 August 2012.
28 Lawless J. Ex-RBS CEO Fred Goodwin stripped of knighthood. Huffington Post. 31 January
2012. Available at: http://www.huffingtonpost.com/huff-wires/20120131/eu-britain-rbs/.

29Knowledge is power. Sir Francis Bacon, Religious Meditations, Of Heresies, 1597. Cited in
The Quotations Page. Available at: http://www.quotationspage.com/quote/2060.html. Accessed
10 August 2012.
30 Tabuchi H. Japanese shareholders starting to show their teeth. The New York Times.27 June
2012. Available at: http://www.nytimes.com/2012/06/28/business/global/japanese-shareholders-
starting-to-show-their-teeth.html?pagewanted=all. Accessed 10 August 2012.
31 The shareholder spring: investor revolts in 2012. Financial News. 8 August 2012. Available at:
http://www.efinancialnews.com/gallery/in-pictures-shareholder-revolts/3. Accessed 8 August

2012.
32Davidoff SM. Furor over executive pay is not the revolt it appears to be. New York Times. 1
May 2012. Available at: http://dealbook.nytimes.com/2012/05/01/furor-over-executive-pay-is-
not-the-revolt-it-appears-to-be/. Accessed 3 September 2012.
33Schuffham M, Bart K. Credit Suisse and Barclays investors revolt over pay. Reuters. 27 April
2012. Available at: http://www.reuters.com/article/2012/04/27/us-barclays-creditsuisse-agm-
idUSBRE83Q0VP20120427. Accessed 10 August 2012.
34Gongloff M. Bank shareholders' executive pay revolt no match for big returns. Huffington Post.
7 May 2012. Available at: http://www.huffingtonpost.com/2012/05/07/say-on-banker-
pay_n_1496133.html. Accessed 10 August 2012.
35Brady D. Say on pay: boards listen when shareholders speak. Bloomberg Businessweek. 7 June
2012. Available at: http://www.businessweek.com/articles/2012-06-07/say-on-pay-boards-listen-
when-shareholders-speak. Accessed 10 August 2012.
Quinlivan S. Disney at odds with ISS again: Making sense of Dodd-Frank. 1 March 2012.
36
Available at: http://dodd-frank.com/disney-at-odds-with-iss-again/. Accessed 10 August 2012.
37 Frankel A. Shareholder spring? Not so much, new study says. Reuters. 8 June 2012. Available
at: http://blogs.reuters.com/alison-frankel/2012/06/08/shareholder-spring-not-so-much-new-
study-says/. Accessed 10 August 2012.
38Sandler RJ. Mid-season update on the 2012 proxy season. Harvard Law School Forum on
Corporate Governance and Financial Regulation. 7 June 2012. Available at:
http://blogs.law.harvard.edu/corpgov/2012/06/07/mid-season-update-on-the-2012-proxy-season/.
39Cincinnati Bell settles 'say on pay' shareholder suit. Business Courier. 21 December 2011.
Available at: http://www.bizjournals.com/cincinnati/news/2011/12/21/cincinnati-bell-settles-say-
on-pay.html. Accessed 10 August 2012.
40Chasan E. Say-on-pay turns into sue-on-pay. Wall Street Journal. 30 June 2011. Available at:
http://blogs.wsj.com/cfo/2011/06/30/say-on-pay-turns-into-sue-on-pay/. Accessed 10 August
2012.
41Liebman P. How reputation drives principled performance. Mission Intangible Monthly

Briefing, 1 April 2011. Audio recordings available from the Intangible Asset Finance Society.
Available at: http://iafinance.org/monthly-briefings. Accessed 5 October 2012.
42 Lipman FD. Intangible incentives: compensation and corporate performance. Mission

Intangible Monthly Briefing. 13 January 2012. Audio recordings available from the Intangible
Asset Finance Society, http://iafinance.org/monthly-briefings. Accessed 5 October 2012.
43Russell D. Be ruthless with reputation. PR Week. 3 November 2011. Available at:

http://www.prweek.com/uk/league_tables/1100806/dean-russell-fleishman-hillard-ruthless-
reputation/. Accessed 3 July 2012.
CHAPTER
Boards of
Directors
This has now turned into a reputation matter, a financial squeeze for BP, and
a political matter, and that is why you will now see more of me. As this is
now turning to a different type of crisis, that is where I come in.
Carl-Henric Svanberg, Chairman BP1
Elected by shareholders, the board of directors in a stock corporation is the

highest management authority. Its most critical duties are to select and
compensate senior management, protect the assets of the corporation, and
approve strategythe companys approach to marshaling and deploying
resources to meet corporate objectives. Each of these duties leads to corporate
actions that establish a companys reputation among its various stakeholders.
Governance is the umbrella term for process that boards use to execute their
duties. Culture, an expression of corporate values, gives tone to
governanceoften called the tone at the topand is ultimately reflected in
2 Chapter 8 | Boards of Directors
reputation.2 Bob Diamond, Barclays former chief executive, directly referred to

culture 50 times as he testified for three hours before a House of Commons
committee about the U.K. banks role in the industry-wide rigging of
benchmark interest rates.
Writing tongue-in-cheek for the Financial Times, Andrew Hill observed:
There is a lot of it about. Culture was the secret sauce at Goldman Sachs,
of which there is now virtually no trace, according to Greg Smith, a
disgruntled former employee of the US investment bank. The ingrained
conventions of Japanese culture were behind the crisis at the tsunami-hit
Fukushima nuclear plant, says the man chairing the probe into the disaster.
British pharmaceutical group GlaxoSmithKline has made a culture of
putting patients first a priority, having clamped down on aggressive selling
and marketing of blockbuster drugs that this month resulted in a $3 billion
settlement with the US government.3
Today, governance needs to demand a culture sensitive to corporate reputation.

As shown earlier, the ability of a company to bring products and services to
market and generate greater revenues and lower costs is directly linked to a
companys reputation. An executive teams understanding of this aspect of
business is central to their stewardship of the companys assets, observed Aron
Cramer, President and CEO of BSR, a corporate social responsibility
consultancy.4
Ultimately, the board is where the buck stops with regard to corporate culture.
Eternal vigilance must be a watchword, since even the top performers can fall
from grace. In fact, they are often the most at risk, since their behaviors tend to
become unconscious and automatic and may reduce the ability of the
organization to adapt to changes in the business environment.
Oversight is a board-level responsibility, but it is undeniably a managerial

process. This chapter shows how sensitivity to whats at stake in reputation risk
can inform board-level actions. To both remain informed and enable
stakeholders to appreciate and value their efforts, boards will find the tools
introduced in this chapter particularly helpful as they select and compensate
senior management, protect the assets of the corporation, and approve strategy
in the context of corporate reputation.
Say-on-Pay: Compensation Committee

Heading the list of the top 10 compensation committee agenda items for 2012
published by Pearl Meyer & Partners, the executive compensation firm, is the
charge to understand your companys pay-for-performance linkage.5 The
starting point is to really understand company strategy and the key metrics that
drive it, advises Simon Patterson, Managing Director.6 Use industry-relevant
performance metrics that support the short- and long-term business objectives
of the company and creation of shareholder value, adds John L. Anderson, lead
senior executive compensation consultant at Meridian Compensation Partners.6
Ann Murray, partner at McKenna Long & Aldridge LLP, a law firm, warns that
boards need to act defensively and anticipate shareholder reaction. Failed say-
on-pay votes triggered derivative litigation against directors in about 20% of the
cases in 2011.7
The case studies that follow show how sensitivity to reputation evolved to
become a central pillar of corporate strategy; it represents 11% of the CEOs
bonus compensation at UBS and is factored into compensation at both JP
Morgan Chase and Goldman Sachs. Metrics that report on
reputationespecially reputational value metricshave a clear role in
supporting the boards execution of its duties of compensating key executives
and driving shareholder value.
There are also compelling personal reasons. Personal reputation risk, being
sued, being challenged by regulators, being challenged by shareholders are just
a few of the risks faced by compensation committee members, said Dennis
Whalen, executive director of KPMGs audit committee institute.8 Reputational
value metrics can help boards explain their compensation packages to
stakeholders, and they can help protect the directors personal reputations and
wealth.
UBS
Formed in 1998 from the merger of two Swiss giants, SBC and Union Bank of
Switzerland, UBS in 2012 celebrated 150 years of banking services. It is today a
world-class wealth manager, the biggest universal bank in Switzerland, and the
second largest institutional asset manager globally.
2011 was a challenging year for the industry as a whole. Markets had ongoing
concerns surrounding eurozone sovereign debt, the European banking system,
the U.S. federal budget deficit, and economic growth issuesall of which
affected client confidence. Activity levels were subdued as investors sought out
safe-haven investments and remained on the sidelines of markets for most of the
second half of the year.9
At UBS, although profits were depressed, they were present until a surprise $2.3
billion loss was acknowledged in September 2011. Thats when UBS revealed
that a rogue trader had lost a quantity of money so large that it potentially wiped
out profits for the entire quarter.10 The trader, Kweku M. Adoboli, made
speculative bets with the companys own money on various benchmarks.
Concealed through fictitious trades, those positions violated the firms risk
limits. The firm was surprised once more by a loss it had not anticipated, and
throughout the financial community, there was an exasperated cry, as Douglas
Adams, the science fiction humorist, might have written, Oh no, not again.
In 1998, UBS had an inauspicious start as Europes biggest bank, losing in the
year of its formation CHF750 million ($520 million) and heading the league
table for the largest single loser in the collapse of Long-Term Capital
Management, the infamous U.S. hedge fund.11 Among the casualties was
Chairman Mathis Cabiallavetta, who, after a tenure of only 4 months, fell on
his sword and resigned.12
The 21st century brought more drama. While the go-go years of the early aughts
were good for USB, it was UBSs announcement disclosing that it was the first
Wall Street firm to suffer heavy losses that marked the end of that period of
irrational exuberance and the beginning of the 2007 subprime mortgage crisis.
By December, UBS reported writedowns for the year of CHF21.6 billion ($18
billion).13 UBS turned to the Government of Singapore Investment Corporation

(GIC) and an unnamed investor from the Middle East for SFr19.4 billion ($17.2
billion) to shore up its balance sheet.14 By March 2008, the writedown had
grown to $37 billion, the biggest single-year loss of any company in Swiss
history, and Chairman Marcel Ospel reluctantly stepped down.15
Before a full year had passed, UBS was expensing $780 million more in
disgorgement of profits, interest, penalties, and restitution of unpaid taxes to the
U.S. government.16 The payments were part of a deferred prosecution
agreement on charges of conspiring to defraud the United States by impeding
the Internal Revenue Service and for failing to register with the Securities and
Exchange Commission (SEC) as a broker/dealer and investment adviser for
U.S. citizens. The UBS case became a centerpiece in a U.S. crackdown on
offshore tax evasion.17 With less than 1 year on the job, Chairman Peter Kurer
agreed to step down.18
On 26 February 2009, UBS lured Oscar Grubel, a Board member at Winterthur

Group, out of retirement to take over as CEO. Having spent his entire career in
the banking sector, he understood the ramifications of the reputational crisis at
UBS. Speaking to the companys 65,000 staff 30 months later, From my first
day on the job, I placed the reputation of the bank above all else.19 A few
months later, at the 2009 Annual General Meeting of UBS, Kaspar Villiger was
elected to the Board of Directors and was soon after appointed Chairman of the
Board. He served as Finance Minister and Head of the Swiss Federal
Department of Finance for 8 years, until he stepped down at the end of 2003.
After leaving government, he was elected to the boards of Nestl, Swiss Re, and
the Neue Zrcher Zeitung, from which he resigned in 2009 when he took on the
UBS chairmanship.20 Gruber and Villiger embarked on a major effort to
transform UBSs culture into one that recognized and mitigated reputational
risk.
At the same time, leaders of the G20 were holding their second summit for the
year in Pittsburgh, where they endorsed the Financial Stability Boards (FSB)
Principles for Sound Compensation Practices and their Implementation
Standards.21 The FSB, established in London after the 2008 global banking
crisis and successor to the Financial Stability Forum formed after the 1998
global banking crisis, includes members of most key groups of finance

ministries, central bankers, and international financial bodies.
FSB concluded that the banking behaviors triggering the two major crises were
promoted by incentives that centralized reward but socialized risk. Convinced
that a short-term bonus culture had triggered excessive risk taking before the
financial crisis, they have pushed banks to align their payment structures better
with risks and institutional performance.22 The FSB proposed that compensation
structures be adjusted to account for all types of risk, including difficult to
measure risks such as liquidity risk and reputation risk.21 Another suggestion,
being implemented in the United States, is to link banks pay plans to payments
made into governments deposit insurance schemes.23
Grubel and Villiger recognized they had to strengthen UBSs risk culture. They
used the FSB standards for making the cultural changes stick by linking
reputation risk to compensation. The language and emphasis on reputational
factors in the companys annual reports reflects these changes. One indicator is
that the number of citations of the word reputation doubled to 42 mentions
between the 2008 and 2009 annual reports (Figure 8-1).
Figure 8-1. Number of mentions of the word reputation in UBS annual reports, 20082011.
More substantive are the changes in the language of the risk disclosures, risk
management principles, and compensation-linked incentives. With each passing
year after the crisis of 20072008, the prominence of reputation risk grew as the
drivers of the risk became better defined. At the same time, reputation risk
increasingly became a driver for the compensation of most senior executives.
The clearest insight into board values and thinking is the corporate annual
report. The following table details the subtle but definite shift in language over
recent years toward a reputational focus (Table 8-1).
Table 8-1a. Evolving Prominence of Reputation as a Disclosed Strategic Risk Factor in UBSs
Annual Reports
Order in List Nature of Risk

of Risk
Factors
2008 Last of 11 UBSs reputation is critical in maintaining its relationships

with clients, investors, regulators and the general public.
2011 Second of 17 Damage to our reputation can have fundamental negative

effects on our business and prospects. Our reputation is
critical to the success of our strategic plans. We recognize(d)
that restoring our reputation (is) essential to maintaining
our relationships with clients, investors, regulators and the
general public, as well as with our employees.
Table 8-1b. Evolving Prominence of Reputation Protection in Discussions of Risk Management

and Control Principles in the Companys Annual Reports
Five pillars/key principles support our efforts to achieve

an appropriate balance between risk and return
2008 #5- Protection of UBSs reputation depends, among other things, on the
effective management and control of the risks incurred in the course of its
business. All employees should make the protection of UBSs reputation
an overriding concern.
2011 #2-Reputation protection through a sound risk culture characterized by a

holistic and integrated view of risk, performance and reward, and by full
compliance with our standards and principles, particularly our Code of
Business Conduct and Ethics.
Table 8-1c. Evolving Prominence of Reputation in the Letter from the Chair of the Human
Resources and Compensation Committee in the Companys Annual Reports
Reputatio Highlights
n Factor
2008 No The final amount awarded to executives depends on their achievement of

performance targets linked to long-term, risk-adjusted value creation.
Three year claw-back structure for all cash bonus awards to alter the
UBS corporate culture.
2011 Yes While a number of improvements were made to strengthen how we

identify key risk-takers and measure their performance, no specific
changes were made to the overall framework in 2011. It thus offers
stability and continuity, as well as the necessary features.
Group Executive Board compensation factors:
Group and divisional performance information, including risk-adjusted
profitability and other financial and non-financial factors such as

leadership effectiveness, strategy execution, and reputational impact.
Risk Committees involvement in compensation matters:
to ensure that compensation plans are aligned with our business
strategy, and that policies are designed to enhance risk awareness
andthe possibility of reputational risk.
Within 4 months of disclosing the September 2011 losses, Chairman Kaspar

Villiger announced his decision to step down a year early, leaving UBS to face
its fifth chairman in 14 years.24 His work, however, was not done. Over the next
few months, he would take two more opportunities to impact UBSs evolving
culture of reputation risk awareness and management that would propel UBS
ahead of the 2009 FSB standards. And he would do so with the new head of
UBSs Human Resources and Compensation Committee, Ann Godbehere.
A financial sector veteran, Godbehere had been on the board with Villiger since
2009, and was known to him before then when she was CFO at Swiss Re. She
had done significant repair work as interim chief financial officer and executive
director of Northern Rock post-nationalization prior to joining the board at
UBS. She has been a non-executive director of British American Tobacco plc
since 2011, non-executive director of Atrium Underwriting Group Limited and
Ariel Group Limited since 2007, non-executive director of Prudential plc since
2007, and chairman of its audit committee since 2009.25
On 15 November 2011, UBS appointed a new CEO who affirmed the

importance of reputation management. Chatting with the media on his first
official day on the job, Sergio Ermotti, the former UniCredit Deputy Chief
Executive Officer who just joined UBS in April, said, No profit is worth more
than our reputation as a bank.26 With only 1 week before his end of tenure, on
23 April 2012, UBS Chairman Kaspar Villiger pushed both the benefits and
costs of reputation right to the top. The idea behind this is that you try to
evaluate the CEO according to whats necessary for executing the companys
strategy in the long term. There are nine criteria in total, of which some shall be
qualitative. Reputation is one of them. It will count more than one ninth.27
The existing framework allows UBS on one hand, to motivate our employees
by rewarding strong performance, and on the other hand, to withdraw or reduce
incentives where performance has been weak or where employees act against
the interests of the firmWe will keep our framework under review to ensure
that it continues to meet our key goal of aligning employee and shareholder
interests, Ann Godbehere said in the lenders annual compensation report for
2011.27 The CEO is very much in agreement with this, Villiger said. I would
find it important that this would be done by more people.
At Barclays Bank, the new chairman, David Walker, said in August 2012 that
he was undertaking a top-to-bottom review of the embattled business, telling a
British newspaper that he wasnt wedded to any of his predecessor's policies.28
Charged with rebuilding Barclays reputation in the wake of the LIBOR
(London Interbank Offered Rate) scandal, Walker said finding a new chief
executive was his number one priority, though a rewrite of the banks pay
policy was also in the cards. Walker, who led a review of banking culture for
the Labour government in the aftermath of the 2008 banking crisis, framed the
governance priorities: The board absolutely does not need a clearout, but it
does need to be supplemented. Three significant roles have gone the
chairman, the chief executive, and the chairman of the remuneration
committee.29
Linking Compensation to Reputation

Linking CEO compensation to corporate reputation is a natural extension of the
FSB recommendations. While it is not clear all CEOs are taking as kindly to it
as UBSs Ermotti, most are resigned to it. When questioned by Representative
Barney Frank at a House hearing on the JP Morgan Chase losses of 2012, CEO
Jamie Dimon said he did not know if he would be the subject of potential
clawbacks by the board of directors that determines his compensation. I can't
tell my board what to do, Dimon told Frank.30
Although the CEOs compensation at JP Morgan Chase is not tied to reputation

explicitly, reputation is a factor in the companys compensation plan. Its worth
considering, since in the opinion of many, JP Morgan Chase is still having a
reputational crisis as this volume goes to press. The onslaught of regulators,

litigators, and bloggers triggered by a $2 billion hedging loss in the spring of
2012 suggests that something went wrong.
Consider the conflicting interests of regulators, shareholders, management,

corporate directors, and employees on the matter of incentive pay clawbacks.
Similar to the UBS model and others conforming to the FSB recommendations,
according to Bloomberg, JP Morgan Chase can cancel stock awards or demand
they be repaid if an employee engages in conduct that causes material financial
or reputational harm, JPMorgan said in its annual proxy statement.
The same goes for Goldman Sachs. Equity awards should be subject to vesting
and other restrictions over an extended period of time. A clawback should also
exist for cause, including any individual misconduct that results in legal or
reputational harm.31 JP Morgan Chase adds the teaser, The company will
claw back pay if its appropriate. . .32
Appropriate is a squishy word. The market wants to know what formula will
be used to convert the magnitude of the alleged damage into the magnitude of
clawbacks, and when, after the alleged damage was precipitated, the magnitude
of the damage will be assessed. Remember that millions of dollars of
compensation and bonus pay are at risk. Bloomberg reported that New York
City Comptroller John Liu said that JP Morgan should tell shareholders it will
aggressively claw back every single dollar possible from the executives
responsible for the $2 billion loss. Employees subject to the clawback will
probably have other opinions.
JP Morgan Chases corporate directors will find little comfort in subjective

measures of reputation, caught as they are between regulators on one hand and
litigators on the otheremployees and investors tend to speak through
litigators. This means that the companys directors and officers insurance
carriers are no doubt wishing that the directors would turn to objective measures
and establish standards before they effect a clawback. More generally, every
corporate board of directors that has identified reputation to be material to their
companys business should be seeking a solution to their need for objective
reputation metrics, if only to preempt future issues.
Fund managers and financial advisers, given the prevalence of concern about
reputation risk, would also like objective measures. Auditors would no doubt
appreciate objective measures as well, not only in the context of controls, but
also because reputation has now been identified as a driver of liquidity. Even
communications professionals would likely find better ways to shape the stories
surrounding JP Morgan Chaseand every other publicly traded client
companyif they had objective measures of reputation.
Reputational value metrics today are essential managerial and oversight tools.
They objectify what would otherwise be subjective decisions at risk for being
second-guessed. Moreover, they apprise the market of the status of an asset
increasingly felt to be a vital part of a companys value.
Many different stakeholders today need quantitative reputational value metrics

for a wide range of core business activities. Since companies have already
disclosed the materiality of reputation risks, they have opened the door to
reputational management. In our culture, we tend to manage that which we can
measure. As the JP Morgan Chase clawback issue shows, the need to adopt
quantitative measures of reputation is a time-sensitive matter for many
stakeholders.
Consider This
Linking reputation and compensation at the highest levels
of a corporation is at the top of todays best practices for
driving a reputation-focused risk culture throughout the
organization.
Linking compensation and clawbacks to a companys

reputation requires reputational value metric systems to
monitor, measure, and report reputation.
Asset Protection
Accountants may struggle with the valuation of reputation, but most corporate
directors have long accepted that it is a vital corporate asset. Leslie Gaines
Ross, chief reputation strategist for Weber Shandwick, a public relations
agency, explained to Forbes: In certain industries, it's 90% trust and
reputation, like in the financial services industryIts like health care
companies, or pharmaceutical companies, airlines. If you dont trust an airline,
youre not going to fly it.33 In other words, in certain industries, a lost
reputation is tantamount to a fatal enterprise-level wound.
Unlike other corporate assets, however, reputation is damaged through the

interplay of a failed business process, adverse publicity, and stakeholder
expectations. Above and beyond implementing business process controls,
protecting corporate reputation value may include waging an active battle with
activists for the hearts and minds of stakeholders.
In the Harvard Business Review article, Reputation Warfare, Gaines Ross

wrote: Companies trying to protect their good names are increasingly coming
under assault from small-scale antagonists: dissatisfied customers, disgruntled
employeesvirtually anyone with a personal computer and an ax to grind.34 It
is a battle well known to the Walt Disney Company, whose brand asset is
valued at $29 billion. 35
Modern communication strategiesempower your team, respond promptly, and

embrace social mediaare all fine and good, but as shown in the study below,
asymmetric warfare demands additional strategies. They are, according to
Gaines-Ross, stockpiling credentials for future use, avoiding disproportionate
show-of-force, and finding sympathetic third parties to serve as force
multipliers.
To stockpile credentials, companies need to establish an authentic reputationa

goal whose value has been demonstrated throughout this volume. To show
forcemarketing and legal muscleproportionately, companies need a
scorecard to measure the reputational impact of an attack. Reputational value
metrics, discussed at length in Chapters 9 and 12 and earlier in this chapter, can
inform show-of-force strategies.
Theres much to be said about the value of sympathetic third parties, but in the
court of public opinion, the opinions of such third parties are discounted
because they are known to be, well, sympathetic. Theres more to be said about
the value of dispassionate third parties. In the next section, the value of
insurances, a staple of markets with asymmetric information, is explored in the
context of a dispassionate communications strategy. After all, as an editorial in
Corporate Board Member helpfully reminded its readers, The most important
insurance is sleep insuranceknowing that your personal and corporate assets
are covered in the event of a crisis.36
The Walt Disney Company

Robert A. Iger was celebrating his 14th month as CEO of The Walt Disney
Company when he received a fax from Hong Kong just in time for Christmas
2006. The cover memo concluded ominously, We look forward to discussing
with you the improvement of labor conditions in Disney supplier factories in
China and elsewhere on or before December 22.37 Attached to the five-page
memo was a 31-page report entitled, A Second Attempt at Looking for Mickey
Mouses Conscience: A Survey of the Working Conditions of Disneys Supplier
Factories in China.
Iger had risen through Disneys ranks on the Capital Cities/ABC Television side
of the company and previously had served as President and COO. Since January
2000, he had been deeply aware of the ethical labor challenge in China, and, in
December of that year, CBC Marketplace received reports from human rights
activists documenting the unethical practices in Disney factories in China.
CBCs broadcast that month described a report called The Secret Life of Toys
alleging sweatshop conditions. Although the major toy distributors employed
inspectors to monitor labor conditions, the monitoring was felt to be flawed.
According to Jenny Chan, In a recent report on child labour, UNICEF revealed
that young factory workers in developing countries are often hidden in closets
or stuffed into boxes when monitors arrive to inspect the premises.38
The letters author had launched the Hong Kongbased labor watchdog group,
Students & Scholars Against Corporate Misbehavior (SACOM), in 2005.
SACOMs inaugural report, the 32-page Looking for Mickey Mouses
Conscience: A Survey of the Working Conditions of Disneys Supplier Factories
in China, called attention to 10 international labor standards violations:
High occurrence of occupational injuries and accidents
Violations of women workers rights
Wages well below the local legal minimum
Nontransparent and problematic wage calculations
Long working hours
Terrible work environment on the shop floor
Poor living environment
Horrible food
False trails of factory inspection
Restrictions on resignation with 45 days of wages held in

security
During the first year of Igers tenure as CEO, SACOM went on a media
offensive. It made an 11-minute documentary film, Those with JusticeA
Disney Factory in China, jointly produced with Sweatshop Watch, to visualize
the collective struggles of the workers based in Shenzhen, released through
press conferences in Hong Kong and New York in coordination with the
National Labor Committee, currently known as the Institute for Global Labour
and Human Rights headquartered in Pittsburgh. It had earned its stripes by
exposing alleged Disney-associated labor violations in Bangladesh in 2004.39
In January 2006, SACOM successfully nominated The Walt Disney Company

for the Public Eye Award 2006 in the category social rights (human and labor
rights). The Public Eye Awards, according to the groups promotional materials,
mark a critical counterpoint to the annual meeting of the World Economic
Forum (WEF) in Davos. Organized since 2000 by Berne Declaration and
Friends of the Earth (in 2009 replaced by Greenpeace), Public Eye reminds the
corporate world that social and environmental misdeeds have
consequencesfor the affected people and territory, but also for the reputation
of the offender.40 The 2006 Award, which Disney shared with Citigroup, the
banking conglomerate, stated:
Serious labor and human rights violations by Walt Disney subcontractors

tarnish the carefree image that the entertainment giant tries to present to us
through its films and cartoon figures. However the company does not publish
the names of its suppliers in China and therefore prevents the verification of
working conditions through independent inspectors. SACOM calls on Walt
Disney to publish the names of its suppliers and to allow independent NGOs
to make regular inspections of their operations.
SACOM organized a coalition of the committed. The growing list of strategic

partners of SACOM included the National Labor Committee, United Students
Against Sweatshops, Writers Guild of AmericaWest and East, Sweatshops
Watch, Clean Clothes CampaignAustria, and Rseau-SolidaritFrance. In
August 2005, the media campaign against Disney broke into the mainstream.
One of the videos produced by SACOM landed at the Cable News Network
(CNN). Disney said in a statement that its officials have conducted
approximately 20 ILS audits at these factories since 1998.41
In fact, by August 2005, The Walt Disney Companys labor standards

department was liaising with some 6,000 licensees and vendors and had
conducted more than 40,000 audits since 1996. Jim Leung, Walt Disney
Company Regional Director of International Labour Standards, met with
SACOM and other Hong Kongbased labor coalitions, followed by three more
meetings by early January 2006. Nevertheless, the December 2006 SACOM
report revealed gross violations of Chinese labour laws and international codes
of conduct relating to work safety and compensation at seven factories that
manufactured Disney merchandise in southern China,42 and closed with a
demand that Disney order its factory representatives to:
Consult with SACOM and concerned labor groups to

provide workers with training programs
Work out a detailed timetable for participatory training
Support democratic elections run by workers for the

establishment of Workers Committees
Collaborate with workers in factory monitoring for the long

term
Frustrated with the results of its efforts to effect changes at factories producing
its goods, Disney pulled its business. Disney released a statement that it had
been working with both the licensee and the factory for many months and that
notwithstanding multiple offers by Disney to help the licensee and factory to
improve standards, the licensee has chosen to walk away.42 Because Disney
represented 80% of the factorys business, 5 weeks after SACOMs deadline for
action, the 800 workers at Huang Xing Light Manufacturing factory in
Shenzhen in southern China were dismissed and the factory closed. SACOM
criticized Disneys actions as cut and run. Said Chan: This is the worst
response to workers rights violations. Disney must take responsibility for the
labour rights violations carried out by its suppliers.
Wal-Mart, with well publicized labor issues at around the same time, was losing
an estimated 6% top-line sales from potential customers who refused to shop at
the retailer out of ethical considerations. It is not clear what economic effects
conscience-consumerism and the SACOM campaign had at that time on The
Walt Disney Company. But Disney clearly recognized that it was going to be
criticized for supporting exploitative factories, and also for abandoning
exploitative factories. That criticism targeted the authenticity of the Disney
brand, and placed the companys reputation at risk.
Reputation Protection
The strong consumer brand that underpins Disneys value is based on a
reputation for child-friendly family valuebased entertainment. Disneys board
of directors has long appreciated that Disneys reputation confers pricing power,
enhances sales volume, helps control employee- and supplier-related expenses,
and helps reduce the cost of capital.
Matthew Ryan, Disney Senior Vice President, Brand, Franchise, & Customer
Relationship Management, explained in 2001, a strong consumer brand like
Disney is invaluable in attracting the right kind of people to the company:
people come to Disney because they love the brand and want to contribute to its
legacyEveryone who works here knows the high standards the Disney brand
requires, and that compels our employees whether they are front-line cast
members or senior executives, to think through all decisions from the
perspective of brand impact. We have a culture that encourages creativity and
wise risk-taking, but the cardinal rule we have is to never do anything that will
harm the brand.35
By late 2005, Disneys kind of leadership in corporate reputation protection was

becoming widespread. Enterprise risk managers from multiple companies were
increasingly responding to the dark sidereputation riskas a threat to
survival. The Economist Intelligence Unit (EUI) produced a report entitled
Reputation: Risk of Risks based on surveys of 269 risk managers in
companies of varied size.43 The following were the key findings:
Corporate reputation is a prized and highly vulnerable corporate

asset.
Reputation risk is the single most significant threat to global
business operations.
Companies struggle to categorizelet alone quantifyreputational
risk.
In 2007, the Conference Board, the business membership, and research

association recommended that boards of directors should:44
Reach a common understanding of the concept of corporate

reputation and tie its discussion to a comprehensive analysis of the
firms stakeholder base.
Become familiar with managements rationale for prioritizing

stakeholder relations and be persuaded that the selected relations
are instrumental to achieving the firms long-term objectives.
Discuss and understand the nature of reputation risk as an effect of
certain business operational incidents, not a separate and distinct
category of uncertainties.
Oversee the design and implementation of a strategic, top-down,
and holistic risk management program where all business events
with potential consequences on the firms reputation capital are
identified and measured.
Consider adhering to The Conference Board Road Map to Risk
Governance to embed reputation risk oversight into a
comprehensive risk management program.
In 2009, the Conference Board returned to the subject of reputation risk,45

reporting on a survey of 148 executives from companies around the world.
Fifty-nine percent indicated that assessing the perceptions and concerns of
stakeholders was an extremely or very significant issue, making it the highest-
ranked challenge. McKinsey & Company, a management consultancy, asserted
that companies had to step up their reputation management efforts: A
companys reputation has begun to matter more now than it has in decades.
Companies and industries with reputation problems are more likely to incur the
wrath of legislators, regulators, and the public.46 Its not just talk. Reputations
are built on a foundation not only of communications but also of deeds:
stakeholders can see through PR that isnt supported by real and consistent
business activity.
A 2009 Blue Ribbon Report on Risk Governance from the National Association
of Corporate Directors (NACD) issued a regulatory conversation on
requirements for a board-level risk committee with the conclusion that
delegating to a committee is part of the problem, and recommended that the
whole board should take ownership of risk oversight.47 The Committee of
Sponsoring Organizations of the Treadway Commission (COSO), a joint
initiative of five accounting societies, produced its own rather audit-centric
template.48 In November 2009, the International Standards Organization (ISO)
released ISO 31000:2009Risk managementPrinciples and guidelines
(US/EU/Other). This standard provides principles, framework, and a process for

managing any form of risk in a transparent, systematic, and credible manner
within any scope or context.49 Also in 2009, Standard & Poors began
integrating enterprise risk management issues into credit ratings.50
With reputation risk slowly being appreciated as a consequence of operational

risk, more corporate boards began to understand its materiality. A brief surge
after the Sarbanes-Oxley legislation showed that 99 (20%) of the S&P 500
constituent members disclosed the materiality of reputation risk, but the annual
count tapered to a low of 32 (6%) in 2007, and by 2009, the number had risen
only slightly to 11%. That year, new rules by the U.S. SEC on required
disclosures about corporate risk management shifted responsibility for
enterprise risk to the level of the board.51,52 By the next year, the fraction was up
to 32%; and, as of June 2012, 71% of the S&P 500 index constituent members
disclosed that reputation risk was material to their business (Figure 8-2).
Figure 8-2. Proportion of S&P 500 companies disclosing reputation risks in section 1A of their
annual 10K SEC filing.
For members of corporate boards, reputation risk is personal. Under

longstanding precepts of corporate law, the business and affairs of a corporation
are managed by its board of directors. The board has authority to appoint
officers who assume day-to-day management functions under the direction of
the board. Directors and officers, in turn, are bound by fiduciary duties to
shareholders, generally entailing affirmative, open-ended obligations to act in
the best interest of the corporation and its shareholders.
There are two categories of fiduciary duties: the duty of care and the duty of
loyalty. As Cathy Reese explains in Corporate Finance Review53:
The duty of care requires that directors and officers exercise disinterested
due care in decision making, and act on an informed basisFurther,
corporations can indemnify officers and directors against personal liability
for losses that the corporation incurs resulting from decisions made in
breach of the duty of care.
The duty of loyalty requires that directors and officers serve the interests of
the corporation and its shareholders with undivided allegiance. Unlike the
duty of care, corporations are not permitted to indemnify officers and
directors against personal liability for breaches of the duty of loyalty.
Provided a director did not breach the duty of loyalty by standing on both
sides of a transaction in order to benefit personally, Delawares Business
Judgment Rule provided assurance that courts would not second-guess the
wisdom or the propriety of their decisions, even if they turn out in retrospect to
have been improvident. That safe harbor has been offering directors and officers
increasingly less shelter as the implications of two decisions separated by a
decade have been appreciated by the market.
The Delaware courts review of In re Caremark International Inc. Derivative

Litigation in 1996 established the duty of oversight as one expression of the
duty of care and ruled that directors should be held liable for directorial
indecision as well as the directorial decision.54 Specifically, the court said that
the board, including officers, could be held liable for unconscionable failures
of the board to act in circumstances in which due attention would arguably have
prevented the lossso that's a failure of the board to actor in circumstances
in which loss eventuates not from a decision but from unconsidered in action.55
This duty of oversight applies to all corporate assets, including reputation. Ten
years later, the Delaware Supreme Court upped the ante by formally approving
the directors duty of oversight but upgrading its importance to an expression of
the duty of loyalty. The court is essentially saying in these oversight liability
cases that you can't avail yourself of the Business Judgment Rule if you exercise
no judgment, added Reese.
To underscore that point, in December 2010, a shareholder group filed suit

against the board as well as managers of Johnson & Johnson, the once-
venerated health care conglomerate, for an unspecified amount alleging failure
to uphold their duty of oversight, breaching their duty of loyalty, and allowing
adverse events to proceed that inevitably destroyed the companys hard earned
reputation.
The suit followed nearly 2 years of adverse publicity arising from the failure of
one business process or another: ethical breaches, quality failures, and safety
recalls by the bucketful. The depth and breadth of the failures affirms a certain
this-is-not-your-fathers-Buick sensibility about Johnson & Johnson today.
According to Tony Chapelle, who reports for the Financial Times' Agenda
Week: Governance experts say that J&Js board should step in and more
closely oversee the companys business processes in three vital areas: quality,
safety and ethics. In the spring of 2012, Warren Buffets Berkshire Hathaway
joined in the conversation by cutting its investments in Johnson & Johnson by
almost two-thirds to $700 million.56
A 2012 review compiled 18 case studies of companies that suffered various

crises between 1999 and 2009.57 The high-profile companies were selected so
that there was full maturity in the consequences, explained Professor Alan
Punter, one of the authors. The companies included AIG, Arthur Andersen, BP,
Cadbury Schweppes, Enron, Firestone, Northern Rock, and Socit Gnrale.
Said Punter, The consequences were fairly severe, and thats just the
measurable ones58:
In 7 cases out of the 18 cases studies, the company

collapsed and/or faced a government rescue (AIG, Arthur
Andersen, Enron, Independent Insurance, Land of Leather,
Northern Rock, and Network rail).
In 11 cases, the chairman or CEO lost his job.
In 16 cases, the company and/or senior executives were

fined.
In 4 cases, senior management or board members were

jailed.
Corporate directors, when asked, readily disclose their personal concerns about
reputation risk. A 2012 survey by the accounting and audit firm Eisner and
Amper reported that around 70% of corporate directors identified reputational
risk as the most important risk to their boards, noting that reputational risk had
overtaken compliance risk as the number one concern. The study observed that
this percentage skyrockets with the addition of their concerns about the
elements of reputational risk which include IT risk, product risk, outsourcing
risk, privacy and data security, and risk due to fraud.59 Similarly, a 2011
Lloyds Risk Index review of 500 C-suite board level executives showed that
reputational risk had risen to the 3rd ranking, up from 9th in 2009.60
Managing reputation risk is first an operational concern. By direction of the

board, several companies have created operational units focused on reputational

risk. Goldman Sachs firm-wide business practice committee (and subordinate
regional and divisional committees) monitor and oversee reputational and
operational risk events affecting the firm. Scenario analysis is one of the tools
they use, employing operational risk expertise within its broader risk
management framework. According to its global co-heads of operational risk
management, Mark DArcy and Spyro Karetsos, now Principal, Enterprise Risk
and Control, Vanguard: While it is not our responsibility to quantify
reputational risk, there is an internal process that measures our exposure to
those risks that are difficult to quantify, one of which is reputational risk. 61
Capital One Financial established a department of corporate reputation and

governance almost a decade ago. Led by the companys general counsel (who
reports directly to CEO Richard Fairbank), the department includes the legal,
corporate affairs, regulatory affairs, audit, and government affairs functions of
the firm. We built a discipline for including reputation risk assessments into
business decision-making across the enterprise, said Richard Woods, Capital
Ones senior vice president of corporate affairs.62
According to Willis, the insurance brokerage and intermediary, 95% of major

corporations in the last 20 years have suffered at least one serious reputation-
damaging event based on a survey of 600 publicly held companies. The
research used precipitous and sustained loss of market capitalization as a proxy
for reputation loss, and showed that these companies had faced 1,853 crisis
events, of which 50% were due to a failure of the companys strategy or

business model.63
For risks to asset value that cannot be otherwise mitigated, there are insurances.
Starting in 2011, a number of companies began offering insurance products for
reputation risk. Two principal types of coverage are available, all in the $100
million limit range. First are communications solutions, offered by underwriters
in cooperation with PR/Communications groups, which provide outsized
indemnifications for crisis communications expenses. Underwriters include
AIG, Zurich/Aon, and Willis. Second is a reputation value loss policy, offered
solely by underwriters in cooperation with Steel City Re, the parent firm of the
author. This provides indemnifications for losses due to business process
failures that generate adverse publicity. Losses are indexed to an independent
measurable parameterchanges in the companies reputational value metrics.
Under a parametric system, claim payments are triggered by the occurrence of a

specific event that can be objectively verified, such as a hurricane reaching a
certain wind speed or an earthquake reaching a certain ground shaking
threshold. Underwriting and claims management are greatly simplified.64
Losses under Reputational Value Insurance are capped at the lesser of policy
limits or fractions of the policy limits depending on the value of the
parameterthe magnitude of change of the insureds reputational value
metrics.
Insurance is available only to companies that demonstrate they are in control of

the business processes whose failures are likely to generate adverse media
coverage and reputational events. A useful analogy for the constraint is in fire
insurance, a common property insurance product, where measures such as
sprinklers and fire extinguishers are required as a condition of underwriting the
policy.
Three examples illustrate companies that should consider insurance for

reputational value risk:
When a company has achieved iconic status or is a brand

leader, its stakeholders possess elevated expectations. On
the downside, its detractors have a more vulnerable target.
Iconic firms are preferred targets for activists whose claims,
even if libelous, attract significant media attention.
Reputational Value Insurance provides a means of
independently and credibly refuting false claims, because
the insurance fosters reputation-enhancing behaviors and
actually protects against losses caused by rogue activities.
A company may be in a commercial sector that has

overarching reputational challenges, where management
wishes to differentiate the business from its peers. In a
reputationally challenged sector, qualifying for
Reputational Value Insurance provides an independent and
credible means for signaling exceptional status.
When a company is recovering from a reputational event,

management wishes to signal rehabilitation. The three-step
process that is required by the insurance enables
stakeholders to recognize that risks going forward are
greatly reduced. Qualifying for Reputational Value
Insurance informs stakeholders that the business is
rehabilitated.
Reputational Value Insurance can be a visible part of the management of

reputation risk because it can be readily observed, understood, and valued by all
stakeholders.
Since the 2006 letter, SACOM has expanded its range of corporate targets.
According to Chan, Our objective hasnt changed. We still want Disney and
other corporations to bear their social responsibility and fulfill their obligations
to ensure that workers are properly treated and labour laws are followed.42
SACOMs Disney Project promises to persist in monitoring and disclosing any
violations of labor laws in Disneys supplier factories in China, [and hopes]
to awaken the conscience of Disney.65
John R. Lund, senior vice president of Disney Parks Supply Chain Management
for Disney Destinations LLC, epitomizes the companys conscience. Before
2008, when Lund took the top supply chain job at Disney Destinations, the
Disney arm that oversees theme parks, resorts, and cruise lines around the
globe, the companys supply chain operations focused on cost containment.
Now, supply chain operations focus on all six reputational pillars. The company
works with suppliers it considers to be of high integrity, and has formed
stronger relationships with fewer suppliers. We have reduced the number of
vendors by over 50 percent in the last four years, Lund said. He believes that
supply chains can drive shareholder value by improving operating income, asset
utilization, and the companys reputation. The reputation of a company is
fundamentally affected by the choices you make in running a supply chain, he
said.66
Consider This
Reputation is a valuable corporate asset that takes years to
build and could take only moments to destroy.
An authentic corporate culture of reputation protection

engages employees with all the associated financial
benefits; it helps build reputational resilience.
An authentic corporate culture of reputation protection

expresses itself in every aspect of the companys
operations; reputational metric scorecards help guide the
show of force (the deployment of marketing and legal
muscle).
Insurances can help stakeholders better appreciate and

value the otherwise opaque state of the operational controls
for reputation risk protection.
Business Strategy
The boards duties and responsibilities, for which they are accountable, include
reviewing, approving, and guiding corporate strategy.67 Operational surprises
can play havoc with business strategy and they occur with alarming frequency.
They can draw managements attention and resources away from core
objectives. When they involve reputational risks, they can draw board attention,
reduce revenues, and raise expenses as various stakeholders are adversely
impacted.
More than two thirds of the 618 companies surveyed by Willis admitted they
were caught off guard by an operational surprise somewhat to extensively
in the last 5 years, and an even higher percentage for large organizations and
public companies.68 Yet when asked whether they saw proprietary advantages
in integrating risk management with strategy, only 15% felt mostly or
extensively while more than half replied minimally or not at all.
Because the reputation of a business is a critical factor in determining its value,

it is at the board level where risk management must be integrated with strategy,
and where a culture for reputation risk awareness must reside.69 Brand-centered
firms such as Disney, McDonalds or Apple brought the founders innate sense
for the value of reputation into the boardroom, where it is integrated into
business strategy. Rolls-Royce and Goldman Sachs have evolved this sense of
reputational risk awareness. The studies below describe in greater detail how
three companiesStandard Chartered plc, a financial services firm; Diageo plc,
a beverage firm; and Anglo American plc, a mining concernhave integrated
reputation risk management into board-level strategic oversight.
Standard Chartered plc

Although the British Empire isnt as global as it used to be, that hasnt stopped
Standard Chartered, a company that traces its roots back more than 150 years, to
the heyday of the Empire.70 This U.K.-based banking group, familiarly known
as Stanchart, operates primarily in Asia, the Middle East, and Africa, within
some of the world's fastest-growing economies, as well as in Europe and the
Americas. With more than 1,700 offices in more than 70 countries, the company
operates through two business segments: consumer banking (deposit accounts,
loans, cards, and investment products) and wholesale banking (capital markets,
cash management, international trade, custody, and clearing services).
Differentiating Standard Chartered from the many banks that had experienced
reputational crises in the past 5 years, non-executive Chairman Sir John Peace
wrote: We are different because we have a cohesive and distinctive global
culture with a strong emphasis on values and leadership. Here for good, our
brand promise powerfully sums up who we are and what we stand for.71
Standard Chartered has two dedicated board-level committees addressing

reputation risk: the Board Risk Committee (BRC) and the Brand and Values
Committee (BVC).
The Board Risk Committee, whose membership consists exclusively of non-

executive directors of the Group, is responsible for oversight and review of
prudential risks including but not limited to credit, market, capital, liquidity,
operational, and reputational factors. These are the traditional hard factors of
finance. The groups Chief Risk Officer reports to this committee.
Added in 2010, the Brand and Value Committee addresses the softer factors.
Summarizing the committees second year of operations, Chairman Paul
Skinner wrote: The Committee continues to make good progress on its key
priorities including, but not limited to, the main themes of brand,
customer/client focus, reputational risk, sustainability and culture and values.
According to Standard Chartereds 2011 annual report:71
At each Committee meeting, the most significant and forward-looking

reputational risks facing the Group are considered and reviewed. A heat
map is presented that sets out the forward-looking reputational risk from the
lenses of multiple external stakeholders such as Socially Responsible
Investors (SRIs) and Non Governmental Organisations (NGOs). The
Committee has sought and received assurance from management that the
mechanisms in place for monitoring reputational risk remain robust and
reporting to the Committee remains fit for purpose.
The board oversees layers of operational controls where reputation risk

management is defined at both the strategic and tactical level.
The GRC provides Group-wide oversight on reputational risk, sets policy

and monitors material risks. The Group Head of Corporate Affairs is the
overall Risk Control Owner for reputational risk. The BRC and BVC provide
additional oversight of reputational risk on behalf of the Board.
At the business level, the Wholesale Banking Responsibility and Reputational
Risk Committee and the Consumer Banking Reputational Risk Committee
have responsibility for managing reputational risk in their respective
businesses.
At country level, the Country Head of Corporate Affairs is the Risk Control
Owner of reputational risk. It is their responsibility to protect our reputation
in that market with the support of the country management team. The Head
of Corporate Affairs and Country Chief Executive Officer must actively:
Promote awareness and application of our policies and procedures

regarding reputational risk
Encourage business and functions to take account of our reputation in all

decision-making, including dealings with customers and suppliers
Diageo plc
Diageo plc is the leading premium spirits business in the world by volume, net
sales, and operating profit. The company produces and sells 8 of the worlds top
20 spirits brands and is one of the few international drinks companies that span
the entire alcohol beverage market, offering beer, wine, and spirits. Diageos
well-known brands include Smirnoff vodka, Baileys cream liqueur, Johnnie
Walker Scotch whisky, Jos Cuervo tequila, Tanqueray gin, Captain Morgan
rum, Guinness beer, and wines from Sterling Vineyards and Beaulieu Vineyard.72
Diageos products are sold in more than 180 markets around the world. In many
countries, there are cultural stigmas associated with its products, and in most
countries antisocial behavior is associated with socially irresponsible
consumption of its products. Protecting its reputation is central to its ability to

enjoy the active support of customers, consumers and suppliers, together with
the confidence of their other stakeholders, wrote its non-executive Chairman
Dr. Franz B. Hume. There can be no compromise on our values and standards
of integrity. In the last three years we have devoted much time and energy to
ensure that all our employees understand that Diageo must have complete
compliance with the high standards of behaviour laid out in our Code of
Conduct.73
The companys corporate governance report shows reputational risk awareness

and the importance of internal controls and risk management in engineering
resilience into the system:
Diageos aim is to manage risk and to control its business and financial
activities cost-effectively and in a manner that enables it to: exploit
profitable business opportunities in a disciplined way; avoid or reduce risks
that can cause loss, reputational damage or business failure; support
operational effectiveness; and enhance resilience to external events. Risk
management and internal control processes encompass activity to mitigate
financial, operational, compliance and reputational risk.
Enterprise-level reputational concerns map into its supply chain management

strategies:
Responsible sourcing is critical to maintaining Diageos positive reputation

and meeting customers and consumers demands. To this end, Diageo
manages social and ethical risk, ranging from labour and human rights to
commercial integrity, through a four-stage screening and auditing process.
Diageos expectations of business ethics and sustainability are made clear to
suppliers. Minimum compliance and ethics standards as well as aspirational
goals are set out in Diageos Partnering with Suppliers Standards.
Additionally, Diageo plays a leading role in AIM-PROGRESS, the
collaborative consumer goods sector forum working to improve processes
and standards in a more effective way through member organisations supply
chains.
In the year ended 30 June 2011, Diageo launched its Sustainable Agriculture
Sourcing Guidelines and subsequently worked to determine how the

guidelines could help support broader sustainable development, focusing
first on cream. As a part of this initiative, Diageo helped its main cream
supplier in Ireland create their sustainability programme, including an
advisory committee, on which Diageo sits along with members of the private,
independent and public sectors, to help drive sustainability performance in
the Irish dairy farming industry.
Anglo American plc

Anglo American's name might be a little misleadingit has never been
American.74 Founded in 1917, the U.K.-based company owns significant stakes
in global producers of platinum (75% of Anglo Platinum) and diamonds (45%
of De Beers S.A.). Anglo American also has interests in ferrous and base metals
and industrial minerals. It ranks among the worlds largest iron ore producers
and is also a leading copper producer. It is one of the worlds largest coal
miners and exporters of metallurgical coal, a key raw material in steel
production, and also produces thermal coal, used to generate electricity. The
founding Oppenheimer family no longer controls Anglo American.
Good governance, writes non-executive chairman Sir John Parker, is not

merely following a set of rules, but ensuring that the highest standards of
behaviour begin at board level and flow throughout the organisation.75
The management of risk is critical to the success of Anglo American, writes

David Challen, Chairman of the Audit Committee. The Group is exposed to a
variety of risks which can have a financial, operational, or reputational impact.
Effective management of risk supports the delivery of the Groups objectives
and achievement of sustainable growth.Understanding our key risks and
developing appropriate responses is critical to our future success. We are
committed to a robust system of risk identification and an effective response to
such risks.75
The company in their annual report of 2011 recognizes the direct link between
employee behavior and reputation among various stakeholders.
We are committed to our people, who determine how effectively we

operate and build our reputation with our investors, partners, and
fellow employees every day, and whom we require to uphold our
values.
Effective management of occupational health protects our people,
enhances productivity, and helps maintain our license to operate
and our global reputation.
Anglo American pays significant attention to the reputational impact of nearly

every operational risk.
Operational performance and project delivery impact. Failure to

meet project delivery timetables and budgets may affect operational
performance, delay cash inflows, increase capital costs and reduce
profitability, as well as have a negative impact on the Groups
reputation.
Infrastructure impact. Failure to obtain supporting facilities may
affect the sustainability and growth of the business, leading to loss
of competitiveness, market share and reputation.
Failure of rail or port facilities may result in delays and increased
costs as well as lost revenue and reputation with customers. Failure
to procure shipping costs at competitive market rates may reduce
profit margins.
Business Integrity impact: Potential impacts include prosecution,
fines, penalties and reputation damage.
Failure to achieve expected standards of health, safety and
environment performance in joint ventures impact: higher costs or
lower production may result and have a bearing on operational
results, asset values or the Groups reputation.
Culture and Strategy

Family-owned enterprises are the clearest examples of organizations with
inbuilt cultural strength. Partnerships are also, historically, fierce guardians of
strong cultures.3 Critics of Goldman Sachs have pinned some of the blame for
the perceived decline in its old-fashioned values on its 1999 transformation

from a partnership to a publicly listed company.
But while creating a culturesay, at a startupis relatively easy, sustaining a

healthy one as the company grows is more of a challenge. An exemplary
company whose culture survived for years after transforming from a family
business to a public company is Johnson & Johnson. The Johnson & Johnson
Credo protected its culture and its intense focus on the pillars of its reputation,
and guided management during its security crisis of 1983.
Penned by then CEO Robert Wood Johnson shortly before the companys initial
public offering in 1944, the Credo represents Johnsons philosophy about
running a business. The Credo is an active part of the corporate culture and is
referenced repeatedly in the Companys major operating and reporting
documents. It is a statement of corporate social responsibility that was crafted
some 40 years before the concept was popularized.
The Credo is written in the first-person plural and recognizes the companys
obligations to its stakeholders. The first paragraph sets an unambiguous ethical
tone from the top:76
We believe our first responsibility is to the doctors, nurses, and patients, to

mothers and fathers and all others who use our products and services. In
meeting their needs, everything we do must be of high quality.
The Credo calls for the need to reduce our costs in order to maintain
reasonable prices and to give suppliers and distributors an opportunity to
make a fair profit. Employees must be respected and treated with dignity,
fairly compensated, and we must provide competent management, and their
actions must be just and ethical.
The Credo also acknowledges issues of sustainability and corporate citizenship:

Our final responsibility is to our stockholders. Business must make a sound
profit. We must experiment with new ideas. Research must be carried on,
innovative programs developed, and mistakes paid for. And, in its last line, the
Credo modestly addresses what many have argued is the primary obligation of
business, When we operate according to these principles, the stockholders

should realize a fair return.
The Credo and the companys positive reputation obviously served it well at
that time. But the companys current saga suggests it may have mislaid the
powerful Credo of its founder. The current challenges illustrate a dictum that no
corporate leader can afford to neglect. Sustaining an excellent corporate
reputation is a never-ending responsibility. It requires unrelenting vigilance and
attention to all the processes that create reputation. Resting on laurels is not an
option.
Consider This
A mission statement can reveal much about a companys
culture.
The structures and processes of governance are the board-

level signs of a companys culture.
A culture that incorporates reputation into its governance

increases the likelihood that the operational benefits can be
realized.
Reputational metrics and reputational insurances are

indications that a company embraces a culture for
reputation risk management and overall business strategy.
Guidance
Corporate governance that demonstrates authentic oversight of the pillars of
reputationethics, quality, innovation, safety, sustainability, and
securitycreates value. A recent study by Mercer Investment Consulting found
that 46% of institutional asset owners now take environmental, social, and
corporate governance analysis into consideration when making investment
decisions. And institutional investors demonstrate a willingness to pay a
premium of 12%14% for the shares of well-governed companies in North

America and Western Europe, and even higher premiums for the shares of well-
governed companies in emerging markets, a McKinsey & Company study
reports.77
The economic performances of Diageo and Anglo American over the trailing 12
months illustrate the rationale. Diageo returned 46% while the S&P 500
Beverage Index returned 17.25% (Figure 8-3a);78 and Anglo American lost 12%
while the S&P/TSX Global Mining Index lost 20% (Figure 8-3b).79
Figure 8-3a. Trailing 12-month returns for Diageo plc and the S&P 500 Beverage Index.
Figure 8-3b. Trailing 12-month returns for Anglo American plc and the iShares S&P/TSX Global
Mining Fund.
Three out of four business leaders believe corporate reputation is substantially

driven by internal corporate culture, yet only 5% think their organizations
culture is strong enough to preclude reputational crisis, according to a recent
survey of 100 business leaders and HR professionals conducted by MWW
Group.80 Standard Chartered found itself in a reputational crisis in August 2012.
The matter came to a head on 14 August when the British bank agreed to pay
New Yorks top banking regulator $340 million to settle claims that it laundered
hundreds of billions of dollars in tainted money for Iran and lied to regulators.81
Until the moment of the crisis, Standard Chartered was returning 20% for the
trailing 12 months while the S&P Global Financials Sector Index as returning
9.35% (Figure 8-4).82 Within a few weeks, the major loss of market cap was
significantly restored and the trailing 12-month returns were greater than the
reference group by the time of the settlement. As discussed more generally in
Chapter 10, Standard Chartereds good fortune with regulators can be
attributed to its boards good faith response and management of the crisis.
Effectively the banks decision to opt for a fast settlement of the charges
allowed it to escape from sinking sand.83 By the numbers, as this book is fond
of noting, the banks quick actions reduced the magnitude of the potential fine.
The banks payment of $340 million was less than the mid-2012 payment of
$619 million by ING, the Dutch bank, for sanctions breaches, while HSBC has
set aside $700 million to cover expected fines for money laundering failures.84
But if an institutions reputation is sullied, those responsible must go. A big
issue is the failure of oversight, which means Standard Chartered needs to act
over the make-up of the board, said one top-20 shareholder. They may need
to act quickly over this to prevent a loss of credibility.85
The good news for companies assailed by allegations of bad behavior is that,
while it may take as long to create a good culture as it does to establish a good
reputation, a strong set of values is usually harder to destroy. Standard
Chartered plc, a case in point, is an example of rapid action informed by an
appreciation of the value of reputation. All bets are off, however, should the
company itself be dismantled or taken over.3
Figure 8-4. Trailing 12-month returns for Standard Chartered plc and the iShares S&P Global
Financials Sector Fund.
UBS is rebuilding a culture that is part of the companys heritage. It has taken a
leadership role in its sector by being the first to publicly and specifically link its
CEOs compensation to the firms reputation.
Disney has a very strong brand-centric culture and a reputation for family
values that it is protecting through operational changes in areas many would not
consider important to a brandback office and supply chain operations.
Johnson & Johnson, a reputational bellwether for more than a quarter century,
shows the magnitude of reputational resilience a strong culture can create. In the
past few years, the culture of Robert Wood Johnson has been diluted by more
modern notions that have tolerated, well, greater ethical flexibility. And the
chickens have come home to roost as the company faces up to $2 billion in
costs to settle hip implant claims86 and another $2.2 billion for aggressive
product marketing that triggered three False Claims Act lawsuits.87
In their 1982 book, In Search of Excellenceone of the first attempts to

identify and explain the correlation between a positive corporate culture and
strong performanceTom Peters and Robert Waterman pointed out that
poorer-performing companies often have strong cultures, too, but
dysfunctional ones.3 The present chapter illustrates practical steps boards can
take to build strong, positive, and reputationally sensitive cultures through
oversight of executive compensation, asset protection, and business strategy.
By the Numbers
Table 8-2. Enterprise-Level Reputation Risks, Board Actions, and Value Created
Risk, Board Action, or Result Measure
Average change in the number of mentions of the word reputation in 52% increase
UBS annual report after the 2009 reforms
Fraction of CEO bonus at UBS linked to measures of reputation 11%
Most recent annual rate of disclosure of corporate reputational risk 50% per year increase
Fraction of board members who rank reputation as their firms topmost 70%
concern
Fraction of major corporations that have had at least one major 95%
reputational event over the past 20 years
Average trailing 12-month economic returns of Anglo American, 18% superior returns
Diageo and Standard Chartered relative to their benchmark indexes
(prior to the 1 August crisis)
CHAPTER
Analysts
Budd Beach, an analyst at Raymond James, asked what [Wal-Mart]
executives thought the effect [of allegations of corruption in its Mexican
operations] on the companys reputation was. We will be a better company
because of this, Mr. Duke, the CEO, responded.
The New York Times, 1 June 20121
Reputation is a consequence of corporate behavior that motivates stakeholders

to behave in ways that either reward or punish the corporation. Reputation value
is the measure of reward or punishment. This chapter compares and contrasts
measures of both the impression and the expression of reputation value that may
be useful to financial analysts. Featured are the methods of Transparent Value,
Fortune, Barrons, Harris Interactive, Reputation Institute, and Steel City Re,
the authors employer. Consistent with Bernsteins maximthe plural of
anecdote is not datathese measures are useful alternatives to scattershot
extra-financial reputation information.2
4
2 Chapter 9 | Analysts
Reputation Value
Congratulations, Mr. Carnegie, you are now the richest man in the world.3
Thus in 1901, banker J. P. Morgan sealed his purchase of Carnegies steel
company and memorialized for eternity proof that Andrew Carnegie knew how
to create value. Not that anyone had doubts. At the time Morgan bought
Carnegies assets to create U.S. Steel, the company produced more of the metal
than all of Great Britain.
Carnegies formula was transparent. I think Carnegies genius was first of all,
an ability to foresee how things were going to change, says historian John
Ingram. Once he saw that something was of potential benefit to him, he was
willing to invest enormously in it.4
Heres the catch. He knew both where to look and how to develop winning
strategies. On knowing where to look, he said, As I grow older, I pay less
attention to what men say, I just watch what they do. As to strategy, Carnegie
was a believer in the wisdom of crowdsstakeholders, actually. He called it a
mastermind group.
Carnegie elaborated on this in 1908 to newspaper columnist Napoleon Hill:

Well, if you want to know how I got my money, I will refer you to these men
here on my staff; they got it for me. We have here in this business a master
mind. It is not my mind, and it is not the mind of any other man on my staff, but
the sum total of all these minds that I have gathered around me that constitute a
master mind in the steel business.5
Steel City Res approach to measuring reputational value and establishing a

reputational value ranking rests on combining these two principles. Steel City
Re watches what stakeholders are expected to do by watching Carnegies
mastermind watch stakeholders. Before one can determine what stakeholders
are expected to do, one has to channel Carnegie and know where the
mastermind would watch what they do.
In August 2012, Bloomberg reported that there were two thoughts as to whether
Boeing would or would not stick to its scheduled development of its 787
airframe.
The development of a stretch version of the Dreamliner, called the 787-10X,

continues as well, Boeing Commercial Airplanes President Ray Conner
wrote in a message to employees. The Seattle Times reported, citing
unidentified people familiar with the matter, that Boeing had slowed down
the development process.6
Boeings statements and the conflicting comments of insiders present two

alternate realities that will impact each of its major stakeholders. For example,
customers who may have been expecting the availability of the modified 787 by
a certain date may choose to move to a different platform or upgrade existing
platforms to extend their life spans a bit longer. Employee pools may shift in
number, skill set, and geographic location based on Boeings production
schedules. Supply chains, and the vendors that feed them, will be activated,
accelerated, or deactivated depending on the actual changes being implemented
by Boeing. Watching the stakeholders and what they do can provide
indications of Boeings actual intentions.
As Carnegie proved, there is value in watching what they are doing. A company
established in 2003 was based on that premise.
Transparent Value, LLC articulated its dedicated goal: seeking to deliver

sustainable investment returns across global equity markets by introducing a
new way to measure the equity value of publicly traded companies. Transparent
Value, LLC provides a range of financial market services based on an analysis
of what stakeholders are doing. Using patent-pending processes, their
investment methodology fused the insights of fundamental analysis with the
transparency of a disciplined, rules-based stock selection and portfolio
construction process.
In May 2009, Guggenheim Partners, LLC, a diversified financial services firm,

acquired a controlling interest in Transparent Value and its subsidiaries.
Guggenheim, with $125 billion in assets under management, made substantial
investments in infrastructure and to seed the funds that replicated Transparent

Value indexes, according to Julian Koski, their founder.7 Today, Transparent
Values analysis of what they are doing feeds a proprietary algorithm that
calculates the probability that what is being done will enable management to
deliver the business performance expected by shareholders as reflected in
current stock price. Transparent Value calls its proprietary measure the
Required Business Performance Probability (RBP Probability) metric.8
Their analytical process starts with a companys current stock price and most
recent financial statements from which they determine expected cash flows,
and, from there, the level of sales needed to support the current stock price.
Then they statistically determine, using managements past business
performance and an analysis of supply chain activity, the probability that there
will be sufficient products sold at the expected prices to meet expectations.
Transparent Value observes company behaviors, calculates investor

expectations, and then determines the probability that the former will meet the
latter. When investor expectations are materially ahead of what a company
appears to be capable of delivering, Transparent Value interprets the finding as
risky investor behavior. It reports that behavior with a metric called the
Behavioral Risk Indicator. Investor behavior in advance of the Facebook IPO,
reviewed in Chapter 7, is an example of what Transparent Value would consider
material Behavioral Risk.
RBP tells us the revenue required at the most granular level, such as how many
iPods Apple has to sell, or how many stores Starbucks has to open, or how
many packages FedEx has to ship to support the price of its stock, Koski
explains.9
Beyond analyzing probabilities of meeting investor expectations, Transparent

Value also invests in companies with the highest RBP Probabilities in select
benchmark indexes while avoiding those companies in the benchmark that they
believe have the highest likelihood of disappointing and underperforming
relative to other companies. The logic is mathematically sound: if you can avoid
investing in the worst relative performers, you should outperform the
benchmark index. Avoiding losers isnt a glamorous business, Koski admits,
and companies that fit Transparent Values winner profile tend to be a plain
Jane. I noticed that in my familys portfolio, it had always been the unsexy
names that made money. Unsexy is better than sexy, but only in stock
picking.7
Transparent Value provides investment strategies for a range of mutual funds

generally investing in large capitalization companies. Two exemplary funds, the
Market and Value funds Transparent Val DJ RBP US LC Mkt Idx I
(MUTF:TVIMX) and Transparent Val DJ RBP US LC Val Idx I
(MUTF:TVVIX) respectively, both underperformed the S&P 500 Composite
Equity Index over the trailing 12 months from 4 October 2012 with mean
monthly returns of 1.80% and 2.05% compared to the S&P 500s mean monthly
return of 2.09% (Table 9-1).
Table 9-1. As of 4 October 2012, Trailing 12-Month Portfolio Characteristics of Exemplary

Strategies Informed by Required Business Performance Probability Metrics (Risk-Free Rate
[RFR] = 1.17%)
S&P 500 TVIMX TVVIX
Mean monthly return 2.09% 1.80% 2.05%
Standard deviation 5.61% 4.76% 5.99%
Compound monthly 1.94% 1.70% 1.88%

return
Annualized return 25.03% 21.63% 24.54%
Annualized standard 19.42% 16.50% 20.75%

deviation
Excess return (RFR) 23.86% 20.46% 23.37%
Sharpe ratio 1.23 1.24 1.13
Sortino ratio (0%) 58.41% 57.69% 53.91%
Portfolio beta 0.69 0.93

(relative to S&P 500)
Portfolio alpha 0.35% 0.11%

Portfolio correlation 0.82 0.87

to S&P 500
Coefficient of 0.48 0.86

determination
Transparent Value watches what people do and then uses its proprietary models
to estimate the probability that those actions will meet the expectations of
investors implied by the stock price. Steel City Re also watches what people do.
However, it relies on the other Carnegie tool, the mastermind, to watch what
people do in the expectation of what other people are going to do. For this, Steel
City Re looks to decision markets.
Decision markets (also known as predictive markets, information markets,

prediction markets, idea futures, event derivatives, virtual markets, or
Carnegies mastermind) are markets created for the purpose of making
predictions.10 They have two key features: each participant makes a prediction
independent of influences from any other participant, and the market rewards
the participant who made the prediction that most closely approximates the
future outcome. Markets may reward participants in two ways: indirectly,
through accolades and other external acknowledgments that eventually
favorably impact employment and compensation, or through an immediate prize
or award. In decision markets that trade future contracts whose value is the
reward, current market prices can be interpreted as predictions of the probability
of the event or the expected value of the parameter.10
Participants cannot have conflicted interests wherein they may be motivated to

offer a prediction other than their best guess in order to purposefully distort the
markets outcomean unfortunate condition that existed and distorted the
outcome of LIBOR (London InterBank Offered Rate), the product of a decision
market currently supervised by its sponsor, the British Bankers Association
(BBA).11 Nevertheless, the market behind the BBAs LIBOR provides

meaningful insight into a key decision market in the world of finance.
The BBAs LIBOR is a benchmark giving an indication, or expectation, of the

average rate at which a leading bank can obtain unsecured funding in the
London interbank market for a given period in a given currency. Absent
manipulation, it therefore represents the lowest real-world cost of unsecured
funding in the London market.
Individual LIBOR rates are the end-product of a calculation based upon

submissions from a bank panel, made up of the largest, most active banks in
each currency LIBOR is quoted for. The panel comprises the decision market.
The panel watches what the panelists do in the expectation of what global bank
lending officers are going to do.
Every decision market participant on the panel is asked to base their LIBOR
submissions on the following question:
At what rate could you borrow funds, were you to do so by asking for and
then accepting inter-bank offers in a reasonable market size just prior to 11
am?12
LIBOR is based as much on actual transactions as it is on expectations of future

transactions. Since not all banks will require funds in marketable size each day
in each of the currencies and maturities they quote, it would not be feasible to
create a suite of LIBOR rates if this was a requirement.
However, a bank will know what its credit and liquidity risk profile is from
rates at which it has dealt and can construct a curve to predict accurately the
correct rate for currencies or maturities in which it has not been active.
In markets that trade future contracts, people who buy low and sell high are
rewarded for improving the market prediction, while those who buy high and
sell low are punished for degrading the market prediction. Graefe and
Armstrong reported recently that the simple averages of forecasts, the method
BBA uses to calculate LIBOR, and more structured prediction markets with
futures contracts such as the Iowa Election Markets, The simExchange,
Hollywood Stock Exchange, NewsFutures, and the Popular Science Predictions

Exchange, produce outcomes with similar accuracy.13
Steel City Re draws data from prediction markets that capture the expected
behaviors of stakeholders that impact the profit and loss (P&L) statement. There
are four equally weighted families of data that comprise the pillars of the Steel
City Re Reputational Value Metrics: the CRR, a measure of ranking joined
arithmetically, and the RVM, a non-financial measure of value joined
geometrically. These four families of expectation data report on the various
P&L elements discussed in prior chapters: stakeholder behaviors responsible for
revenue, stakeholder behaviors responsible for expenses, equity investor
behaviors, and a measure of the alignment of the various stakeholders
expectations.
The reputational value metrics comprise purely algorithmic arithmetic and

logarithmic transformations of those data that are purchased by Steel City Re
from a publicly traded commercial vendor. Steel City Re does not create the
markets, nor does it influence the decisions reached by the markets. There is
one integrated algorithm and it transforms the published data in a repeatable
manner. The automated process is monitored to ensure that the outputs are
reliable. Steel City Re neither adds nor subtracts information from the
calculation.
The calculations generate non-financial measures of value that are recorded as

the RVM scaled in a non-financial unit, the Gerken Unit, named after a co-
founder of the company. Steel City Re also calculates values that are ordered by
rank to generate the CRR scaled four significant digits as a percentile unit
(Table 9-2).
Table 9-2. Properties of Steel City Re Reputational Value Metrics
RVM CRR
Unit Gerken Percentile
Component joining Geometric Arithmetic

method
Range Generally 1.0 x 2.5 0.0000 x 1.0000
Median 0.4301 (23 August 2012) 0.5001
Primary use Volatility and risk Relative value
In April 2009, Steel City Re first made available these objective algorithmically
generated reputational value metrics to support a range of executive
management needs.14 The metrics helped corporate boards and senior
management better communicate with stakeholders, quickly assess stakeholder
reactions to major strategic initiatives, enhance oversight including
compensation decisions, and better mitigate and manage crises. Steel City Res
reputation metrics have also inspired an investment strategy called RepuStars.15
The RepuStars Variety Corporate Reputation Index (INDEXDJX: REPUVAR),
a stock selection strategy, is calculated and published by S&P/Dow Jones
Indexes. The RepuSPX, a similar strategy applied only to the constituent
companies of the S&P 500 Composite Index, is privately managed by
Technology Option Capital, a financial modeling advisory company.
The Steel City Re reputational value metrics are calculated through a

proprietary algorithm that quantifies the expectations held by stakeholders that
produce economically relevant behaviors. The behaviors directly impact
company revenues and operating costs. Expectations of these behaviors
therefore impact expectations of company value. Usually captured by stock
price, this value may sometimes deviate.
At times, stakeholders may reasonably disagree and hold different expectations.

When equity stakeholders have low expectations, while other stakeholders have
high expectations, there are value opportunities.
The selection algorithm underpinning the RepuStars strategy is designed to

identify these value opportunities. For REPUVAR, the algorithm selects up to 3
companies from each of 19 commercial sectors companies in which value
opportunities are implied by a high reputation value and a low stock price.
REPUVAR is denominated in U.S. dollars. The components trade on U.S.
exchanges and are screened for price and market cap. The benchmark index is
the S&P 500 Composite Equity Index.
For RepuSPX, the algorithm selects up to 8 companies from members of the

S&P 500 composite equity index from each of 19 commercial sectors where
value opportunities are implied as previously.
REPUVAR underperformed, while RepuSPX outperformed the S&P 500

Composite Equity Index over the trailing 12 months from 4 October 2012, with
mean monthly returns of 2.18% and 3.04% compared to the S&P 500s mean
monthly return of 2.09% (Table 9-3).
Table 9-3. As of 4 October 2012, Trailing 12-Month Portfolio Characteristics of Exemplary

Strategies Informed by Steel City Res Corporate Reputation Metrics (Risk-Free Rate [RFR] =
1.17%)
S&P 500 REPUVAR RepuSPX
Mean monthly return 2.09% 2.18% 3.04%
Standard deviation 5.61% 6.60% 6.35%
Compound monthly 1.94% 1.98% 2.85%

return
Annualized return 25.03% 26.20% 36.48%
Annualized standard 19.42% 22.86% 21.99%

deviation
Excess return (RFR) 23.86% 25.03% 35.31%
Sharpe ratio 1.23 1.09 1.61
Sortino ratio (0%) 58.41% 49.88% 80.64%
Portfolio beta 1.11 1.04

Portfolio alpha -0.13% 0.87%

Portfolio correlation 0.94 0.92

to S&P 500
Coefficient of 1.23 1.11

determination
Other Reputation Metrics

Because reputation has often been conflated with brand, the evolution of
reputation measurement and management has been heavily influenced by the
analytical framework and measurement tools of market research. As Forbes
magazine explains, We live in a world where word of mouth is the No. 1 driver
of sales and competitive advantageand because theres a strong correlation
between a companys reputation and consumers willingness to recommend it,
businesses need to focus on building those strong bonds with stakeholders.16
Most prominent among the tools used to quantify reputation is the market
opinion survey and its product, a reputation score.
Fortune
Fortune magazine, working in cooperation with the Hay Group, has been
producing since 2001 what they believe is the definitive report card on
corporate reputations.17 For the 2012 U.S.-based list of Most Admired
Companies, Hay Group, a global management consultancy, began with the
Fortune 1000, the 1,000 largest companies ranked by revenue. The 10 largest
were selected for each of 58 industries. To create the 58 industry lists in 2012,
Hay asked executives, directors, and analysts to rate companies in their own
industry on nine criteria, from investment value to social responsibility. The
nine axes of ranking are:
Innovation
People management
Use of assets
Social responsibility
Management quality
Financial soundness
Long-term investment
Product quality
Global competitiveness
The participant list is compiled in JulySeptember and the surveys sent out
annually in October. A second reminder mailing goes out toward the end of
November, and all surveys are due back to the Hay Group by mid-December at
the latest. Raters are asked to evaluate each eligible company on each attribute
by assigning a score from 0 (Poor) to 10 (Excellent). For the purposes of
the industry rankings, a companys overall score is determined through a simple
average of the individual attribute scores. Companies that rank in the top half of
their industry are defined as most admired within their industry.18
Discussing the 2012 data, Mel Stark, vice president and regional reward
practice leader at Hay Group, said, Over the past 15 years, we have seen the
composition of the Worlds Most Admired Companies (WMAC) list change,
but the attributes that enable those companies to excel have remained the same.19
According to Hay Groups research, the four critical factors for organizational
success are the things they do:
Executing and enabling strategy
Building structures and processes to sustain long-term

performance
Achieving success through people
Placing a high value on leadership and talent

WMAC companies behave differently from their peers. Hay Group reports that
94% of WMAC feel that their efforts to engage employees have reduced
turnover vs. 67% of peers, and 81% of WMAC use performance measures to
encourage leaders to think short term and into the future vs. 43% of peers.20
Fortune notes, tongue in cheek, The only thing harder than gaining admiration
from peers in the corporate world is maintaining it (Table 9-4). Three of the
Most Admired CompaniesGE, P&G, and Berkshire Hathawayhave stayed
in the top slot of their industry sector every year they were included in the
survey.21 A rather exclusive group we would add.
Table 9-4. 2012 Fortunes Most Admired of the 1000 Largest U.S. Companies: Top 10
2011 Ranking 2012 Ranking Company
1 1 Apple, Inc
2 2 Google
7 3 Amazon.com
6 4 The Coca Cola Company
12 5 IBM
8 6 FedEx
3 7 Berkshire Hathaway
16 8 Starbucks
5 9 Procter & Gamble
4 10 Southwest Airlines
Barrons
Barrons is a member of The Wall Street Journal family of companies owned
by Dow Jones, and in turn, by News Corp. Barrons surveys professional money
managers annually about the respect they accord the worlds 100 largest
companies. A more narrowly defined survey population than that used by
Fortune and Hays Group in their Most Admired list, participants are asked to
select one of four statements reflecting their view of each company: Highly
Respect, Respect, Respect Somewhat, or Dont Respect. A point value is
assigned to each response, with the highest accorded to Highly Respect, and a
mean score is tabulated for each company. In the case of ties, the higher ranking
goes to the company with the most Highly Respect votes (Table 9-5).22
When asked to rank the factors they consider most important in determining
respect for corporations, 24% of the managers this year offered strong
management while 20% said sound business strategy. Both are observable
behaviors that underpin managements reputation and about 50% of a
companys reputation. Eighteen percent felt ethics were foremost in their minds
in terms of respect. Revenue and profit growth was the top concern for only 9%
of respondents.
Barrons notes that while The Most Respected Companies rankings

historically havent been predictive of stock-trading patterns, the collective
opinions of professional investors can serve as one component of evaluating
companies.
Table 9-5. 2012 Barrons Most Respected of the 100 Largest Companies: Top 10
1 1 Apple, Inc
4 2 IBM
5 3 McDonalds
2 4 Amazon.com
NR 5 Caterpillar
7 6 3M
13 7 United Parcel Service
19 9 Nestl
17 10 Intel
Harris Interactive
In contrast to Barrons survey of money managers, Harris Interactive, a leading
global independent research organization, surveys the general public. Formerly
known as the Harris Poll, Harris Interactive has used since 1999 the Harris
Reputation Quotient (RQ) to measure the reputations of the most visible
companies in the United States. The Annual RQ process begins with a
Nominations Phase and is followed by a Ratings Phase, where they measure the
reputation of the most visible companies in the United States.
For the Nominations Phase, which is used to identify the companies with the
most visible reputations according to the general public, respondents are
asked to name companies that stand out as having the best and worst reputations
overall. For the 2012 survey, two open-end questions were asked of about 4,600
people online:
Of all the companies that youre familiar with or that you might have heard
about, which TWO in your opinion stand out as having the BEST
reputations overall?
Of all the companies that youre familiar with or that you might have heard
about, which TWO in your opinion stand out as having the WORST
reputations overall?
Nominations from the surveys were tallied with subsidiaries and brand names
were collapsed within the parent company. The nominations were then summed
to create a total number of nominations for each company, and the final list
comprised the 60 most visible companies in the United States as of October
2011.
The RQ Ratings Phase is also driven by survey of the general public. For two
weeks in December 2011, approximately 13,000 respondents ranked more than
60 companies on 20 different attributes comprising six major reputational
categories and the scores were compressed arithmetically to values where 80 or
greater is excellent, and 50 or lower is critically poor.23 The categories are:
Social Responsibility
Vision and Leadership
Financial Performance
Emotional Appeal
Products and Services
Workplace Environment
The 13th annual Harris RQ survey comprising the survey results of December
2011 were reported in February 2012 (Table 9-6). In summary, wrote the
market research firm, Its a complicated world for corporate America as
consumer perceptions grow increasingly negative. With the erosion of trust in
corporate leadership, consumers have higher expectations and are demanding
more information and transparency from companies with which they plan to
spend their hard-earned dollars. Companies with which the general public is a
stakeholder only indirectly, and therefore likely to be impacted by their
critically poor reputational standing only through shareholder or regulatory
action, included three major financial sector firms.
Over the lifespan of the RQ study, twelve companies have received scores
below 50, and the vast majority of these, like Enron, MCI (formerly
WorldCom), Adelphia, and Global Crossing, are now defunct. The 2012 RQ
survey shows the reputations of Bank of America, Goldman Sachs and AIG in
an equally challenging place. The general public believes that Bank of
America has been more concerned with operational and financial recovery
than with customers and rates the bank low in levels of trust, ethics, and
customer service. In order to rebuild their reputation, Bank of America will
need to engage beyond this functional rebound.24
Table 9-6. 2012 Harris Interactive Reputation RQ Ranking of the 60 Most Visible Companies:
Top 10
5 1 Apple, Inc
1 2 Google
8 4 Amazon.com
7 5 Kraft Foods
10 6 The Walt Disney Company
2 7 Johnson & Johnson
17 8 Whole Foods Market
16 9 Microsoft
Reputation Institute
Similar to the Harris approach, the Reputation Institute, a global management
advisory organization, surveys the general public to generate its branded
corporate reputation rankings, RepTrak (Table 9-7). Founded in 1997, surveys
of the Reputation Institutes RepTrak calculate reputational scores on the basis
of seven drivers of reputation that collectively influence the four brand-like

emotional foundations of reputation: Admiration, Trust, Good Feeling, and
Overall Esteem. The seven key dimensions that drive corporate reputation in the
RepTrak system are: 25
Products/Services
Innovation
Workplace
Governance
Citizenship
Leadership
Financial Performance
The RepTrak System evaluates the degree to which a particular dimension

affects the emotional bond between a particular stakeholder group and a
company, and it determines which dimensions have the highest impact on
support and recommendation. It works across stakeholders providing a
single lens to measure and manage reputation.25
For the 2012 study of U.S. companies, the largest companies based on revenue
data from the Forbes Global 2000 list were filtered for firms that were engaged
in general public-facing commercial activities and/or had a reasonable amount
of familiarity with the general public. Survey results from 10,200 respondents
were then tallied and values normalized to allow for multiyear longitudinal
studies.
Reported in cooperation with Forbes magazine, the 2012 study showed that the
influence of perceptions of the enterprise on its overall reputation has continued
to increase over the years. In the Reputation Institute survey, governance drove
15.6% of a companys reputation with consumers, followed by corporate
citizenship (14.2%). These dimensions were second only to Products &
Services (17.7%).
Table 9-7. 2012 Reputation Institute Reptrak150 Ranking of U.S. Companies: Top 10
15 1 General Mills
2 2 Kraft Foods Inc.
3 3 Johnson & Johnson
5 4 Kelloggs
1 5 Amazon.com
46 8 Apple, Inc.
28 9 Pepsi Co.
20 10 Procter & Gamble
Explaining the data, Kasper Ulf Nielsen, Reputation Institutes executive

partner said, Peoples willingness to buy, recommend, work for, and invest in a
company is driven 60% by their perceptions of the company and only 40% by
their perceptions of their products.16 The data trend, notes the Institute, speaks
to our current environmenta Reputation Economywhere a companys
value is being driven by who they are, not just by what they do.
Although the distinction between who they are and what they do may not be
apparent to survey respondents, they, too, ranked four companies in 2012 in the
poor reputation group with scores below 40 on the RepTrak scales. Those
companies were Halliburton, Goldman Sachs, Fannie Mae, and Freddie Mac.
Table 9-8. Characteristics of the Overlapping RepTrak and RQ Public Survey Measures
2012 RepTrak 150 2012 Harris RQ 60
Mean 67.24 70.79
Standard error 1.57 1.39
Median 71.26 73.19
Standard deviation 10.88 9.66
Sample variance 118.28 93.27
Kurtosis 0.07 0.19
Skewness 0.89 -0.91
Minimum 36.95 46.18
Maximum 83.30 85.62
Guidance
There is a hunger for reputation metrics. Evidence is accumulating to show
that reputation is (emphasis in the original) directly associated with superior
corporate performance over time, in ways that likely yield benefit both to
investors and executives.26 In a culture that manages what it can measure, and
invests according to modern portfolio theory, metrics are essential.
None of the providers of survey data, or Steel City Re with its algorithmic
metrics, suggests that reputational metrics alone are good stock picking tools.
Surveys tend to be backward-looking, says Charles Bobrinskoy, research
director at Ariel Investments in Chicago. People look at who has accomplished
a lot and rank them highly. As investors, we have to say, Is all of it in the stock
today? Conversely, he says, it is important to ask whether a widely hated stock
just might be an opportunity.22 That question is explicit in both the RepuStars
and Required Business Performance investment strategies that are informed by

the Steel City Re and reputation metrics.
The Fortune Most Admired survey data and Barrons Most Respected survey
data appear to capture the perceptions of investor and business professional
stakeholderspeerswhile both Harris Interactive and the Reputation Institute
reputation scores capture the perception of the general public comprising a mix
of customers, vendors, employees, or simply interested parties that vote and
may influence regulators. The Steel City Re metrics capture the integrated
views of all stakeholders.
Figure 9-1. Plot of the RQ (y-axis) scores and RepTrak (x-axis) scores for the 2012 metrics.
There is a 94% correlation between the RepTrak and RQ public survey measures, while the
coefficient of determination (R2) is 88%.
There is a 94% correlation between the scores for the 48 companies found both
on the 2012 RepTrak150 list and the 2012 Harris Interactive RQ 60 list (Figure
9-1). This not surprising in light of some common history between the two
measures. In 2006, Harris Interactive Inc.; Charles J. Fombrun, founder of the
Reputation Institute; and Reputation Institute, Inc. entered into an agreement

whereby Harris Interactive acquired all of Fombruns right, title, and interest in
(1) the trademarks Harris/Fombrun Reputation Quotient, Reputation
Quotient, and RQ, (2) every corporate measurement tool to which those
trademarks refer or have referred, and (3) all data generated from application of
such measurement tools. The agreement also contains certain restrictions on the
ability of the parties to provide future specified reputation-related services for a
period of 24 months, and also contains mutual releases of prior claims. The
Harris Interactive paid Fombrun $525,000 as consideration for the trademark
rights transferred and the exclusive right to use the standardized methodology
dating back to 1999 developed by Harris Interactive and Fombrun to measure
corporate reputation.27
On the other hand, among the 128 companies for which there are overlapping
metrics, there is only a 21% correlation between the Reputation Institutes
RepTrak metrics reflecting public opinion and the companies most admired by
their peers as reported to Fortune (Figure 9-2). The most notable outliers:
Goldman Sachs and Halliburton, which both scored above 7 among their
peers/Most Admired and below 40 among the general public/RepTrak. Among
the 43 companies for which there are overlapping metrics, there is a 67%
correlation between the Barrons Most Respected rankings provided by
professional money managers and Fortunes Most Admired rankings from a
wider cut and larger group of business professionals.
Figure 9-2. Plot of the WMAC scores (y-axis) and RepTrak scores (x-axis) for the 2012 metrics.
There is a 21% correlation between the Reputation Institute RepTrak public survey and the
Fortune Most Admired professional survey measures while the coefficient of determination (R2)
is only 5%.
Studies on corporate reputations dating back more than a decade have

emphasized the plurality of perceptions and representations around a company,
referring to corporate reputations as a multifaceted rather than as a monolithic
concept.28 The poor correlation between two distinct communities of
stakeholders, the general public as captured by the RepTrak metrics and the
business community as captured by the Most Admired metrics, show that this
remains true in 2012.
Theoretical work argues that stakeholders tend to pay attention to actions that
are perceived as salient to their specific interests and values, and make
inferences about corporate dispositions (their trustworthiness, reliability, social
responsibility, etc.) based on observed actions that are interpreted as reflections
of the former.29 Empirical research exploring the drivers of reputation among
specific categories of stakeholders, however, is relatively scarce,
notwithstanding the recent emergence of multi-stakeholder investment

strategies.
A relatively recent study looked at the dimensions that affect the judgment of
securities analysts, key influencers whose evaluations and behavior affect
collective perceptions of critical resource-holders such as institutional as well as
retail investors.30 Results from a survey of 75 analysts operating on the Milan
Stock Exchange by Gabioneta et al. indicate that securities analysts tend to
judge companies mainly on their financial performance, the configuration of
their governance structures, the quality of their financial disclosure, and the
quality of their leadership and of their prospects for the future.31
The Gabioneta study indicated that four dimensions of corporate reputation

namely Financial Performance, Vision & Leadership, Financial Disclosure, and
Corporate Governance following the framework of the Reputation Institute
displayed a high correlation with the overall disposition of securities analysts
toward a company. These four dimensions of corporate reputation, however, as
suggested empirically by the 2012 survey data, did not seem to have a direct
effect on analysts behaviorthat is, on the content of the recommendations
they issue. Instead, their influence appears to be mediated by what we termed a
company's emotional appealin other words, the extent to which a company
is trusted, liked, admired, and respected by the respondent.
Another study suggested that analysts might view reputation in the context of a
corporate financial statement. Under this paradigm, it was suggested, reputation
could be parsed on the balance sheet as both an asset and a liability. On the
asset side is the increased value of the implicit claims sold by the firm now and
in the future, while on the liability side is the present value of honoring these
claims in the future. For example, consider a durable-good producer that has
built a reputation for superior post-sales service. The present value of the price
premiums that the firm receives on sales of its product as a result of the
reputation would be an asset. The liability would be the present value of the cost
of providing superior after-sales service in the future.32
Such a perspective is of academic interest but not necessarily operationally

useful to an analyst. This volume has suggested that reputation is best viewed as
influencing the magnitude of line items on the profit and loss statement, as
reflecting stakeholder impressions of governance, and as will be shown in
Chapter 10, influencing regulatory burden. The data in this chapter indicate that
what companies do creates different observable quantifiable reputations among
different stakeholders. These can be measured through surveys and algorithms,
and the various measures of reputation can inform secondary actions among
stakeholders ranging from selecting stocks to improving marketing strategies
To be sure, these various approaches to measuring and quantifying corporate

reputations vary rather widely. One major point of differentiation among the
measures is timeliness. Surveys done well take time; overnight surveys, the
staple of election season, yield widely disparate outcomes even on narrowly
defined questions.
The two algorithmic measures are more responsive to market timing.

Transparent Values metrics rank discrepancies between equity investor
expectations and the likelihood that operations will meet those expectations.
High probabilities of failure can serve as early warnings of securities to avoid.
Steel City Res metrics report reputation ranking, value, volatility, and direction
of change. Because they reflect the expectations of a broad range of
stakeholders, they can help management and boards get timely early warnings
of adverse public reactions to policy decisions and perceptions of operational
risksone of the most compelling applications of decision markets.33
The greatest consumers of metrics are stakeholders who extract the

informational content therein to produce more metrics: market forecasts. More
than any other market segment, analysts will find leading indicators in these
extra-financial measures of corporate reputational value (Table 9-9).
Consider This
Based on what companies do, quantitative measures of
reputation report stakeholder perceptions that eventually
translate to actions with material economic consequences.
Depending on how the data are captured, from whom they

are captured, and how they are processed, reputation
metrics may be leading indicators of customer behavior,
investor behavior, or multi-stakeholder behavior. In any
case, they represent the wisdom of crowds.
Different stakeholders may assign significantly different

reputational values to the same company, thereby enabling
certain reputation metrics to inform equity selection
strategies.
By the Numbers
Table 9-9. Characteristics of Several Measures of Reputation
Type Description Insight
Expert Transparent Values Required Business RBP: 0 < x < 100%

Performance Probability Metrics
primarily for large cap companies.
Captures equity investor expectations.
Algorithmic Two exemplary large cap funds TTM returns TVIMX: 21.63%
informed by Transparent Value metrics,
Market (TVIMX) and Value (TVVIX). TTM returns TVVIX : 24.54%
TTM returns SPX: 25.03%
Algorithmic Steel City Re Corporate Reputation Ranking: 0 x 1.0000

Ranking and Reputation Value Metrics
for approximately 7,000 public Value: ~1.0 x 2.5
companies. Captures multi-stakeholder
expectations.
Algorithmic Two exemplary equity indexes informed TTM returns REPUVAR: 26.20%
by the Steel City Re metrics, RepuStars
Variety (REPUVAR), and TTM returns RepuSPX: 36.48%
RepuStarsSPX. TTM returns SPX: 25.03%
Survey Fortune/Hay Group Most Admired Admired: 0 x 10

metrics for the 1,000 largest companies.
Captures business and financial
professional stakeholder expectations.
Survey Barrons Most Respected metrics for Respected: 1 x 4

the 100 largest global companies.
Captures financial professional
stakeholder expectations.
Survey Harris Interactive Reputation Quotient RQ: ~40 x 90

metrics. Captures general public
stakeholder expectations.
Survey Reputation Institute RepTrak metrics. RepTrak: ~30 x 90

Captures general public stakeholder
expectations.
Survey Correlation of reputation rankings from 21%

the general public with rankings from
the professional business community
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CHAPTER
10
Regulators
By Michael D. Greenberg, JD,
PhD1
We do want to have regulators who set the rules. For example, there has to
be transparency. One of the things thats clear about JP Morgan Chase and
was true about AIG: they didnt know what their losses were. If the rules that
we had talked about had been in place, and they will be shortly, then they
would not have been surprised by losses that were first a tempest in a
teapot, and then $2 billion, and then $5 to 6 billion. Thats our job: to put
rules in place that govern the way things work.
Barney Frank2
Regulators serve as the long arm of government, acting to set and enforce legal
standards that apply broadly to define the landscape of industry and commerce.
Federal and state regulators serve to monitor corporate behavior in many
different ways. Notable examples range from the regulation of pollution by the
Environmental Protection Agency (EPA), to the oversight of domestic aviation
activity by the Federal Aviation Administration (FAA), to the supervision of
securities markets and the capital formation process by the Securities and
Exchange Commission (SEC).
2 Chapter 10 |
Regulators
InQuestion
each instance,
Title U.S. regulators establish and enforce rules that bound and limit
Question 01
the scope
(must of legitimate corporate behavior. Some aspects of regulation (as in the
be unique)
Question Type
case of the SEC) help Multiple Choice
to structure basic commercial and financial activities,
Instructions Do not
setting a blueprint for how business itselfmodify thebe
will shaded cells. Other aspects of
conducted.
Click here for detailed authoring instructions and examples.
regulation touch on more operational or peripheral elements of business
To add more 'Choices', select the last row and use the Word Menu option Ta
enterprise, but that nevertheless Insert
are closely tied to
-> Rows reputation riskas illustrated
Below.
A score of 0 indicates
by regulations that target product quality, or workplace an incorrect answer.
safety, A positive 'Score' indicates a corre
or corporate
To Shuffle the order of choices, place an X or x next to the desired selectio
ethical culture.3 To specify Bloom's Taxonomy, place an 'X' or 'x' next to the desired selection
Fields in Red are mandatory
In all such instances, government standard-setting and enforcement activity
QuestionaText
imposes Which with
set of obligations agency in thefirms
which federalneglect
bureaucracy established
to comply a color-coded
at their own security system th
the likelihood of another terrorist attack?
peril. More deeply, regulators also help to generate a set of normative social
Choices
expectations Pin Answer and reputable
for what responsible Answer
corporate behaviorScore ought to Feedback
(Mark X where desired) (Numeric value - 0 or
look like. Then too, regulators are themselves consumers of reputational higher. 0 stands for
information: the enforcement decisions that regulators make, in particular, incorrect)can
Department of 0 Incorrect.
easily be influenced by the reputation of firms that fall under regulatory
Defense (DOD) XX.
scrutiny. In sum and for a variety of reasons, regulators are an important
North American 0 Incorrect.
reputational stakeholder group for corporations Aerospace
to consider.Defense XX.
Command (NORAD)
At the outset, its important to recognize that the relationship between
North Atlantic Treaty 0 Incorrect.
regulators and the private sector is complex. Deep questions(NATO)
Organization can be asked about XX.
the appropriate scope of regulation, how regulators can and should carry out
National Aeronautic 0 Incorrect.
their functions, and whether or not particular andareas
Spaceof regulation are truly XX.
enhancing of social welfare. Meanwhile, many narrow silos of regulatory
Administration
(NASA)
activity, such as Nuclear Regulatory Commission (NRC) oversight of the
Department of (FDA) oversight
nuclear power industry, or Food and Drug Administration 1 of Correct. Se
Homeland Security
the new drug development process, are highly technical and detailed in their
(DHS)
own right, and demand close scrutiny simply to understand their intent, much
Shuffle Choices Yes X
less theX or
(Mark specific
x whererequirements (and corresponding risks) actually being imposed
upon industry.
applicable) No
Question ID
More broadly and in a somewhat different vein, the relationship between
Difficulty
regulators and business enterprises is not a one-way street. Businesses can and
doPage Reference
influence regulatory policy and enforcement activity, even as regulators
Topic and shape the behavior
monitor The Bureaucracy
of the private sector. Here again, another set of
normative
Skill questions arises, regarding
Remember the Factswhat sort of influence and access
Objective L.O. XX
Hint 1
Hint 2
Hint 3
Blooms Taxonomy Knowledge Comprehensi Application Analysis Synthesis Ev
(Mark X or x where on
applicable)
X
corporations ought to have, in connection with the regulatory process. It is

notably beyond the scope of this chapter to delve deeply into any of these
questions about regulation, other than by acknowledging that the relationship
between regulators and corporations is complicated and reciprocal, and
particularly so when it comes to the influence and impact of corporate
reputation.
For current purposes, the main focus of this chapter is to illustrate three basic
ideas about regulators, corporate reputation risk, and material economic costs.
First, regulators are indeed a major stakeholder group when it comes to
corporate reputation. Regulators are both influenced by reputation in the
decisions that they make and influencers of reputation through their own
enforcement activities. Second, some elements of regulatory policy are
particularly aimed at strengthening the pillars of corporate reputation, and at
driving companies to pursue stronger reputational performance. Finally, some
of the most catastrophic instances of corporate reputational crisis have involved
prominent roles on the part of regulators. Where companies fail to comply with
substantive regulatory requirements, or to engage effectively with regulators,
major reputational damage can sometimes ensue as a result. We reflect on
several examples in the text that follows.
Rewards and Enhanced Reputations

Regulators can reward businesses for behaviors associated with reputation-
building or -sustaining processes. In the cases that follow, Morgan Stanley was
rewarded for behaviors that fostered an ethical environment, notwithstanding
the action of a rogue, and the Centers for Medicare and Medicaid Services was
charged to begin rewarding hospitals for delivering quality services.
Morgan Stanley: Prosecution Declined

Chapter 8 of the Federal Sentencing Guidelines for Organizations (FSGO)
provides a set of standards to deter and punish organizational crime, while
recognizing and encouraging effective compliance programs within firms. The
4 Chapter 10 |
Regulators
FSGO is Title
Question a regulatory Question
enforcement
01 document, in several important ways. It
notably
(must beprovides
unique) benchmarks for federal judges in criminal sentencing, but has
Question Type Multiple Choice
also been influential with regard to Justice Department policy on prosecuting
Instructions
corporate crime, and in deferred Do notprosecution
modify the shaded cells. entered into by
agreements
enforcement authorities. To add more 'Choices', select the last row and use the Word Menu option Ta
Insert -> Rows Below.
Perhaps more important, the AFSGO
score ofhas incentivized
0 indicates a range
an incorrect of Apositive
answer. positive 'Score' indicates a corre
compliance and ethical culture behaviors
To Shuffle the
on order of choices,
the part place an Xsuch
of corporations, or x that
next to the desired selectio
To specify Bloom's Taxonomy, place an 'X' or 'x' next to the desired selection
firms become entitled to more lenient treatment from judges and prosecutors for
having undertaken the behaviors. In this vein, a major amendment to the FSGO
inQuestion
2004 setText Which
out a specific agency inobligation
corporate the federal to
bureaucracy
promoteestablished a color-coded security system th
an organizational
culture that encourages ethical behavior and compliance with law. This is an
Choices of a regulatoryPin
example Answer that ties directly
standard Answer to corporate reputational
Score Feedback
performance, and to efforts by companies to fortify their reputations by for
higher. 0 stands
improving their values, norms, and internal controls. When instances of incorrect)
corporate crime do indeed occur, fulfillment of DefenseFSGO standards
(DOD)
can in principle XX.
help both to protect a firms reputation and to secure more lenient treatment on
the part of enforcement authorities. Aerospace Defense XX.
Command (NORAD)
The prosecution of Garth Peterson, a former managing director for Morgan
Stanley in China who was sentenced in federal court on
Organization 16 August 2012,
(NATO) XX.
showcases the point.4 Peterson, an executive involved in Morgan Stanleys
China-based practice, perpetrated a fraudulent andrealSpace
estate deal in Shanghai that XX.
circumvented the companys internal controls, Administration
and that netted Peterson and his
(NASA)
co-conspirators millions of dollars in illicit gains. Petersons actions were
subsequently found to have violated the U.S.Department of
Foreign Corrupt 1
Practices Act Correct. Se
Homeland Security
(FCPA), which forbids U.S. nationals and corporations from bribing foreign
(DHS)
officials. Under the provisions of FCPA, Morgan Stanley itself could potentially
have
(Mark been subject to criminal
X or x where sanction for Petersons misconduct. Federal
prosecutors,
applicable) No
however, chose not to follow that course, noting instead that
Peterson
Question used
ID a web of deceit to thwart Morgan Stanleys effort to maintain
adequate
Difficulty controls designed to prevent corruption. They concluded that because
Morgan Stanley constructed and maintained a system of internal controls,
Page Reference
which provided reasonable assurances that its employees were not bribing
Topic The Bureaucracy
government officials, the Department of Justice declined to bring any
Skill Remember the Facts
Objective L.O. XX
Hint 1
Hint 2
Hint 3
applicable)
X
enforcement action against Morgan Stanley related to Petersons misconduct.

The company voluntarily disclosed this matter and has cooperated throughout
the Departments investigation.5
How does the Morgan Stanley case relate back to corporate reputational risk?
The answer is that Morgan Stanley was broadly following both FSGO standards
and the requirements of FCPA, through its internal controls designed to prevent
bribery. The Justice Department investigation of Peterson ultimately exonerated
Morgan Stanley of any wrong-doing, and held up Morgan Stanleys internal
controls and cooperation as an example of good conduct on the part of the
company. Thus, Morgan Stanley avoided the potential for significant fines and
penalties under the FCPA, while enhancing its own reputation for honesty with
the Department of Justice, and perhaps with other reputational stakeholder

groups as well. The outcome of the Peterson case represents a potential
reputational crisis that was avoided by the company. It also reflects a series of
management controls and internal investments that were made by Morgan
Stanley, at least in part, in response to regulatory standards for corporate
compliance programs, the latter being embedded in the FSGO, and
subsequently adopted by the Department of Justice in its criminal enforcement
efforts.
The costs avoided by Morgan Stanley were material. Drawing on DOJ

published statistics for all FCPA settlements reached and fines imposed during
19982010, the average associated costs in criminal and other penalties in that
period was $69.4 million. Higher costs were associated with guilty pleas, and
lower with deferred prosecution agreements (Table 10-1).6
Table 10-1. Top Ten Foreign Corrupt Practices Act Settlements, 19982010. DPA=Deferred
Prosecution Agreements.
Company Year Amount of Disposition

Name Settlement (in
Millions)
Siemens 2008 $800 Guilty Plea
KBR/Halliburton 2009 $579 Guilty Plea

6 Chapter 10 |
Regulators
Question Title
BAE 2010 Question 01$400 Guilty Plea
(must be unique)
Question Type
Snamprogetti 2010 Multiple Choice
$365 DPA
Netherlands
Instructions Do not modify the shaded cells.
Technip S.A. 2010 To$338
add more 'Choices',DPAselect the last row and use the Word Menu option Ta
Daimler AG 2010 $185 of 0 indicates an
A score Guilty Plea; DPA
incorrect answer. A positive 'Score' indicates a corre
Panalpina 2010 To$82
specify Bloom's Taxonomy, place
Guilty Plea; an 'X' or 'x' next to the desired selection
DPA
ABB Ltd 2010 $58 Guilty Plea; DPA
Question Text Which agency in the federal bureaucracy established a color-coded security system th
Pride 2010 the likelihood$56of another terroristGuilty
attack?
Plea; DPA
Choices Pin Answer Answer Score Feedback
Shell 2010 $48 desired)
(Mark X where DPA (Numeric value - 0 or
higher. 0 stands for
incorrect)
The willingness of the Department of Justice toDefense
decline(DOD)
prosecution because of XX.
existing controls illustrates how challenging it North
can be to police rogues.
American 0 In part, Incorrect.
the argument goes, this is because everyAerospace individual under the right
Defense XX.
Command (NORAD)
circumstances has his price. The commercialism of the last two decades has
displayed a distinctive kind of boundlessness, North Atlantic of
emblematic Treaty
a world0 in which Incorrect.
Organization (NATO) XX.
everything is for sale, writes political philosopher Michael J. Sandel.7
When he was an Illinois attorney, the story goes,andAbraham
Space Lincoln represented XX.
Administration
a poor widow who was suing the president of the local bank and asking for $5
(NASA)
in damages. Struggling then to earn a living, Lincoln would become the 16th
Department of 1 Correct. Se
president of the United States on the basis of, among other things, his reputation
Homeland Security
for propriety and ethics. (DHS)
The
(Markbank
X or x president,
where a pillar of his community, is alleged to have visited
Lincolns Nopresence of Lincolns partner, offered Abe a bribe to
applicable) office and, in the
throw the ID
Question case. Lincoln is reported to have said, No, the lady deserves her day
inDifficulty
court. The banker responded that it would be humiliating if he lost to this
widow, so he raised his bribe to $25. Lincoln refused. $50, said the banker.
Page Reference
Abe refused again.
Topic The Bureaucracy
Objective L.O. XX
Hint 1
Hint 2
Hint 3
applicable)
X
The banker stood up, started reaching for his wallet and said, Mr. Lincoln, you
drive a hard bargain. Ill give you $100 cash right now. Abe jumped up,
grabbed the banker and threw him out the door, pitching him into the mud
outside. Lincolns partner was astonished. Abe, he tried to bribe you three
times and you didnt mind. Then the fourth time you just seem to blow up, he
said. Abe responded, He was getting too close to my price.8
Hospital Reputation: Quality Encouraged

Responding to the mandates of the Affordable Care Act (ACA), the Centers for
Medicare and Medicaid Services (CMS) enacted regulations in 2011 to
establish a Value-Based Purchasing Plan for hospital services, which ties
hospital reimbursement under Medicare to a series of performance metrics, the
latter notably including patient survey feedback describing the quality of
patients own experiences in hospital.9 In a related vein, CMS issued a 2012
final rule under the ACA designed to reduce 30-day readmission rates at
hospitals, under which Medicare would penalize hospitals through reductions in
their reimbursements of up to 1% during the 2013 program year, based on
hospitals failure to meet specified targets in their own readmission rates.10 It
was anticipated that approximately 2,200 hospitals will be immediately affected
by the new rule on readmission rates, collectively facing financial penalties of
$300 million. In out years under the new CMS regulation, the potential
reimbursement penalties for faulty hospital readmission rates will grow
substantially from the initial $300 million base figure.
CMS rules under the ACA provide another example of the reciprocal
relationship between regulatory action and corporate reputation. On one hand,
the use by CMS of patient feedback in determining hospital reimbursement
rates is fundamentally a reputation-driven process, and one that involves a
regulator drawing on patient survey metrics in order to make basic decisions
about whether to reward or punish specific institutions. Financial penalties
based on high hospital readmission rates, meanwhile, correspond to a different
high-profile regulatory intervention, and one that will likely generate a
reputational impact of its own on targeted institutions (in parallel with the
adverse revenue effect). In sum, new CMS rules for the reimbursement of
8 Chapter 10 |
Regulators
hospitals
Question are
Titleat once influenced
Question by
01 hospital reputations, and at the same time are
likely to unique)
(must be become significant influencers of those reputations. All controversy
concerning the reasonableness of the new CSM rules set aside, there is one
Instructions Do
thing that can be said with confidence not about
modifythe
therules:
shadedThey
cells.seem almost certain
to drive a new reputational focus among hospitals, as the latter seek to protect
their reimbursements by responding Insert -> effectively
Rows Below.to the CMS reimbursement
regime. A score of 0 indicates an incorrect answer. A positive 'Score' indicates a corre
Punishments and Diminished Reputations
Question Text Which agency in the federal bureaucracy established a color-coded security system th
Regulators can punishthebusinesses
likelihood of another terroristinattack?
for failures reputation-building or
Choices
-sustaining processes. Punishments
Pin Answer may come in the form of penalties,
Answer fines, or
Score Feedback
prohibitions from doing business. Punishments may also come in the form
higher. of for
0 stands
denials of requests for relief. In the cases below, BP was penalized for a host of
incorrect)
Department
failures; and, for its business process failures, Knight of was denied
Capital 0 relief. Incorrect.
Defense (DOD) XX.
BP: Failures Punished Aerospace Defense XX.
Command (NORAD)
As weve already discussed at length in Chapters 1 Atlantic
North and 2, Treaty
the BP Deep
0 Water Incorrect.
Organization (NATO)
Horizon drill rig disaster is an example of a highly material reputational crisis XX.
event. The Deep Water catastrophe involvedNational Aeronautic

multiple 0
levels of operational Incorrect.
and Space XX.
problems and challenges in the lead-up to the spill, but one notable dimension
Administration
involved regulatory standards and monitoring, and their relationship to the spill.
(NASA)
Prior to 2011, off-shore oil drilling in the United States was generally1subject to
Department of Correct. Se
the oversight of the Minerals Management Service (MMS),
Homeland an agency within
Security
(DHS) prior to the Deep Water
the U.S. Department of the Interior.11 In the decades
Horizon event, regulatory
Shuffle Choices Yes policy concerning offshore oil drilling X and
(Mark X or x where
transportation
applicable)
had notably
Noseesawed between intervals of intense scrutiny and
stronger regulation (as in the aftermath of the Exxon Valdez event) vs. intervals
Question ID
of deregulation and a more permissive government stance.12
Difficulty
Although the MMS had regulatory responsibility for offshore oil drilling
Page Reference
activities
Topic on the U.S. continental shelf at the time of the disaster, subsequent
The Bureaucracy
reviewers have noted that there was no comprehensive set of regulations
Objective L.O. XX
Hint 1
Hint 2
Hint 3
applicable)
X
specifically addressing deep water technology, drilling, or well design at the

time of the Macando blow out.13 Perhaps for this reason, the MMS notably did
not detect the problems at the Macando well-site through ordinary inspection
processes prior to the event. The post-event investigation nevertheless revealed
a series of regulatory violations associated with the Deep Water Horizon
disaster, including failure to perform operations in a safe and workmanlike
manner, failure to take necessary precautions to keep the well under control at
all times, and failure to use appropriate pressure integrity tests as specified by
regulations.14 Although BP was not directly fined by the regulator for these and
other regulatory violations, the violations themselves arguably set the stage for
the oil spill and for the $20-billion settlement fund that eventually followed it.
The Deep Water Horizon case illustrates an important dimension of regulatory

impact on reputation risk and costs from compliance failures. Particularly where
the focus of a regulator is on safety, security, or product quality issues, then the
risk associated with violating the rules may have less to do with the threat of
investigation and prosecution by the regulator than with injury and harm that
follows from a major industrial accident. In the Deep Water instance, stronger
regulatory monitoring and enforcement in the lead-up to the crisis plausibly
might have helped to prevent the calamity (and the associated reputational
crisis), even though it might also have been perceived by the company as
burdensome and punitive.
So whats the right way to understand the role of the regulator, and of corporate
reputation, in the Deep Water Horizon case? The regulator set broad safety and
operating standards that applied to offshore drilling activity. The regulator did
not discover the violations at the Macando site until after the crisis. Meanwhile,
the regulatory violations of BP and its affiliates were associated with a
catastrophic accident and billions of dollars in damages. Ex post investigation
of the accident spotlighted the regulatory violations and deficiencies.
Among the negative consequences to BP was a serious blow to its reputation,

across all of its major reputational stakeholder groupsincluding, but not
limited to, the federal regulator. Note that major safety and environmental
disasters can always be understood as involving reputational crisis for the firms
involved in them. In this instance, the failure to follow regulatory guidelines
10 Chapter 10 |
Regulators
(and to institute
Question Title effective controls
Question 01 and compliance) was arguably a proximate
cause forunique)
(must be an environmental catastrophe, and for the corporate reputational
hurricane that accompanied it.
Instructions
Do not modify the shaded cells.

Knight Capital Group: Mulligan Denied

A score of 0 indicates an incorrect answer. A positive 'Score' indicates a corre
Knight Capital is a U.S.-based
financial
To Shuffleservices
the orderfirm that engages
of choices, place aninX aorvariety
x next to the desired selectio
of institutional trading and market-making
activities.
To specify Bloom's The firm
Taxonomy, placewas well
an 'X' known
or 'x' next to the desired selection
and reasonably well regarded until August of 2012, when, as recounted in
Chapter
Question7,Text
a glitch in a newly
Which activated automated
agency in the trading program
federal bureaucracy led toa color-coded
established wildly security system th
erratic and unintended securities trading
the likelihood activities.
of another Theattack?
terrorist firm found itself unable
toChoices
shut down the rogue software
Pin Answerquickly, and Answer
trading losses of approximately
Score Feedback
(Mark X where desired)
$440 million resulted within a matter of minutes. The losses threw the (Numeric value - 0 or
firm into
turmoil, led to a collapse in the price of its own common stock, and largely
incorrect)
wiped out the equity position of Knight Capitals Department
existing of 0 forcing
shareholders, Incorrect.
Defense (DOD) XX.
a crisis intervention and recapitalization of the firm by a new group of investors. 15
In the wake of the episode, confidence in the broader North American

stock market (not 0 to speak Incorrect.
Aerospace Defense XX.
of Knight Capital itself) reportedly deteriorated to its lowest point in several
Command (NORAD)
years.16
The automated trading disaster at Knight Capital would have caused a
National
reputational crisis for the company in any event, Aeronautic oversight
but regulatory 0 and Incorrect.
and Space XX.
intervention (or lack thereof) played an important role in both
Administration the lead-up to and
aftermath of, the crisis. (NASA)
Only hours following the frolic and detourHomeland perpetrated by Knights rogue
Security
trading software, the CEO of the company reportedly (DHS) called Mary Schapiro,
chairman of
Shuffle Choicesthe SEC who was
Yes vacationing in Maine, to request that the
X firm be
(Mark X ortox where
allowed unwind its unintentional acquisition of more than $4 billion of
applicable) No
securities positions, in a manner analogous to the cancellation of bogus trades
Question ID
that was permitted following the flash crash of 2010. Knights request for a
Difficulty
professional Mulligan17 was rejected by the SEC, which then forced the
company to seek rapid intervention from new investors in order to recapitalize.
Page Reference
The Wall
Topic Street Journal The
reported: Ms. Schapiro's willingness to stand firm on a
Bureaucracy
decision
Skill that would imperil a largethe
Remember firm was partly a reflection of the changes in
Facts
Objective L.O. XX
Hint 1
Hint 2
Hint 3
applicable)
X
place since the market collapse on May 6, 2010, known as the flash crash.
Exchanges canceled hundreds of trades afterward, angering market participants
who said the decision was arbitrary and hurt market integrity. Under SEC
pressure, exchanges instituted more specific rules governing when trades could
be canceled. Ms. Schapiro stood by those guidelines, say people briefed on the
discussion.18
In a related vein and in the days following the episode, the SEC began to
investigate whether Knight had violated the SECs Market Access Rule,
which promulgated standards to require broker-dealers and market makers to
install new control systems to prevent automated trades that either violate
capital and credit thresholds, or else that appear to be erroneous.19 The Market
Access Rule was itself enacted in the wake of the flash crash of 2010, and was
specifically intended to prevent episodes like the recent Knight Capital trading
debacle.
As of later summer 2012, the SEC investigation of Knight Capital remained

ongoingbut it once again reflects a situation in which the behavior of a firm
arguably violated a regulatory standard pressing for more rigorous compliance
and controls, with disastrous financial and reputational consequences for the
firm. Further regulatory fallout both for Knight Capital, and for the securities
markets more broadly, could easily spin out of this episode downstream.
Guidance
The preceding cases illustrate that regulators are sometimes either strongly
influenced by, or else exert strong influence upon, corporate reputation. The
cases also show that regulators often set standards that can be associated with
tremendous reputational risk to firms, and that that risk often goes beyond the
simple threat of enforcement.
Notably absent from our list of cases in this chapter are the many episodes in
which regulatory enforcement and intervention have themselves been directly
associated with fines and penalties of tens or hundreds of millions of dollars to
corporations (Siemens, Alcatel-Lucent, Daimler-Chrysler, Eli Lilly, Johnson &
12 Chapter 10 |
Regulators
Johnson,
Question etc.).
Title Those episodes
Question are
01 surely important too, but they obscure the
fact that
(must regulation, and the behavior of regulators, can often have a more
be unique)
subtle, but equally important, effect on firms.
Instructions Do not modify the shaded cells.
Whenever regulatory standards Click here for detailed
are violated authoringand
by a corporation instructions
significant and examples.
harm to external stakeholder groups results, then the potential for a reputational
disaster is close at hand. TheA regulator often sets
score of 0 indicates the stage
an incorrect for corporate
answer. A positive 'Score' indicates a corre

reputational risk in these instances, To Shuffle
and the
mayorder of choices,
shine place an X spotlight
the investigative or x next to the desired selectio
after the fact of a crisis episode, even though regulatory enforcement in itself is
not the precipitating factor of the crisis. A similar reputational pattern can be
Question in
observed Text
a wide array Which agency in the
of regulatory federal bureaucracy
examples established
and fact patterns, a color-coded
drawing on security system th
substantive regulators as disparate as the SEC and the Minerals Management
Choices
Service. Pin Answer Answer Score Feedback
In a somewhat different vein, its important to recognize that some key elements
incorrect)
Department of the antecedents
of regulatory policy are particularly aimed at strengthening 0 of Incorrect.
Defense (DOD) XX.
corporate reputation, and driving companies to pursue stronger reputational
performance. The FSGO (with respect to Morgan North Americanand CMS0 examples
Stanley) Incorrect.
Aerospace Defense XX.
described in this chapter are both cases in point.Command (NORAD)
North Atlantic
The FSGO is in one sense a back-handed regulatory document Treaty 0 to drive
seeking Incorrect.
a corporate compliance agenda, at the same time that it also serves as a
blueprint for federal sentencing decisions inNational Aeronautic
corporate 0
criminal cases. The Incorrect.
and Space XX.
FSGO provides a set of detailed instructions toAdministration
companies for how to mitigate
an important precursor to reputational risk, while also establishing incentives to
(NASA)
press companies actually to do so. Department of 1 Correct. Se
Homeland Security
The CMS example, by contrast, spotlights a regulatory
(DHS) effort to
drive stronger
reputational
Shuffle Choicesperformance for
Yes hospitals with another major stakeholder
X group:
(Mark X or In
patients. x where
this case, the regulator is a direct consumer of reputational
applicable) No
information about the institutions, and is using that information to incentivize
Question ID
new hospital-based quality improvement efforts. Here again, regulators play an
Difficulty
important role on both sides of the corporate reputational spectrum. Regulators
set standards
Page Reference that directly influence reputational risk and prophylactic activity
onTopic
the part of firms. The ButBureaucracy
regulators are also consumers of reputational
information,
Skill and can Remember
themselvesthe be
Factsstrongly influenced by it in their
Objective L.O. XX
Hint 1
Hint 2
Hint 3
applicable)
X
enforcement and standard-setting activities. To put it another way, regulators

and firms are like the partners in an elaborate minuet, constantly moving back
and forth in intricate patterns, with a choreography that is partly scripted by
institutional reputations.
Given all of the foregoing, we would be remiss not to remember that there is a
deep and fundamental relationship between what regulators do and what firms
do through their compliance programs. In some sense, compliance efforts
undertaken within companies are a mirror reflection of the standards and
enforcement undertaken by regulators. Compliance in a vacuum would have
little meaning or purpose without regulation to give structure and substance to
related corporate efforts. Again, regulators are one of the basic landscape
features of the business environment, in helping to determine how commerce
and industry will be conducted. Many facets of the relationship between
regulators and the private sector move beyond considerations of corporate
reputation. Nevertheless, corporate reputation and reputational risk are
underlying ghosts in the machine, whenever and wherever the government
becomes involved in the regulation of business enterprise.
What are some practical action items for firms and executives to consider, based
on all of this? First, know your regulator. A firm needs to understand the
substantive regulatory standards that apply to it, and the enforcement posture of
the corresponding regulators, in order to assess and manage its related risks.
Second, engage your regulator. The fact that regulators are themselves a
reputational stakeholder group, and a consumer of reputational information
about business, means that firms have some power to influence them through
the scope of their own behavior. Formulating a plan for how best to do this is
partly a compliance activity, but also an activity with deeper strategic and
cultural significance for firm management.
Finally, firms should appreciate the Socratic maxim: The way to gain a good
reputation is to endeavor to be what you desire to appear.20 Meeting the
demands of regulators is only partly about the technical exercise of fulfilling
outside legal requirements. On a more important level, it is about internalizing
and embodying a set of substantive standards that define product quality,
workplace safety, environmental sustainability, good labor practice, and many
14 Chapter 10 |
Regulators
ofQuestion
the other Titlehallmarks Question
of corporate
01 reputational excellence. To really do this
well
(mustisbetounique)
maximize corporate reputational assets, while reducing reputational
risks, and the financial costs arising, to a minimum (Table 10-2). And that is the
Instructions
fundamental challenge for corporations Do not modify the shaded
in seeking cells.
to deal most effectively with
their regulators. To add more 'Choices', select the last row and use the Word Menu option Ta
Consider This To Shuffle the order of choices, place an X or x next to the desired selectio
Regulators are both influenced by reputation in the decisions that they
make
Question Text and are Which
also agency
influencers of reputation
in the federal bureaucracythrough their
established own
a color-coded security system th
the likelihood
enforcement activities. of another terrorist attack?
Some elements (Mark
of Xregulatory
where desired)policy are particularly (Numeric
aimed valueat - 0 or
strengthening the antecedents of corporate reputation and incorrect)
at driving
companies to pursue stronger reputationalDepartment of
performance. 0 Incorrect.
Defense (DOD) XX.
Some of the most catastrophic corporate reputational crises
North American 0 were Incorrect.
Aerospace
precipitated by corporate failures to comply withDefense
substantive regulatory XX.
Command (NORAD)
requirements, or to engage effectively with regulators.
By the Numbers National Aeronautic 0 Incorrect.
and Space XX.
Administration
Prosecution with imprisonment, fines, and penalties are among the
punishments
(NASA)
regulators use to foster conformance with business practices that are acceptable
Department of
under the law. Conformance as evidenced by intentan 1 authentic
Homeland Security
Correct. Se
reputationeven in the setting of a process failure can mitigate punishment and

(DHS)
avoid costs.
(Mark X or x where
applicable) No
Question ID
Table 10-2. Exemplary Benefits and Costs of Regulatory Compliance or Failure
Difficulty
P&L
PageImpact
Reference Regulator Action Example Value
Topic
Cost avoided TheofBureaucracy
Department Criminal Morgan Stanley $69.4 million
Justice prosecution (est.)
Objective L.O. XX
Hint 1
Hint 2
Hint 3
applicable)
X
averted
Cost avoided CMS Penalties averted Meeting $300 million

Medicare quality (aggregate
standard for anticipated
hospital hospital penalties
readmission for 2013)
Cost incurred Multiple Fines and BP $20 billion

penalties
Cost incurred SEC Relief denied Knight Capital $440 million

1 Michael Greenberg is a Senior Behavioral Scientist with the RAND Corporation and Director of
the RAND Center for Corporate Ethics and Governance. He is a lawyer and a psychologist by
training. He received his PhD in clinical psychology from Duke University and his law degree
from Harvard, and spent several years in corporate law practice at Ropes & Gray in Boston prior
to joining RAND.
2 Representative Barney Frank (D-Mass.) speaking on Bloomberg TV, 2 August 2012. Available
at: http://hereisthecity.com/2012/08/03/rep-barney-frank-congress-cant-write-laws-to-stop-errors-
like-kn/. Accessed 12 August 2012.
3 It is not a coincidence that these examples of regulatory focus correspond directly to several of
the basic pillars of business reputation that we outlined in Chapter 1.
4See discussion in Department of Justice press release dated April 25, 2012, Former Morgan
Stanley managing director pleads guilty for role in evading internal controls Required by FCPA.
Available at: http://www.justice.gov/opa/pr/2012/April/12-crm-534.html. Accessed 2 September
2012.
5 Ibid.
6See Department of Justice, Appendix B Chart 5, Sanctions imposed upon legal persons for
FCPA violations since 1998. Available at:
http://www.justice.gov/criminal/fraud/fcpa/docs/response3-appx-b.pdf. Accessed 2 September
2012.
7Olster S. One nation, ruled by money. Fortune. 20 April 2012. Available at:
http://features.blogs.fortune.cnn.com/tag/ethics/. Accessed 3 September 2012.
8 Tsukerman Y. He was getting close to my price. Available at:

16 Chapter 10 |
Regulators
Question Title Question 01

http://ytspar.tumblr.com/post/458327591/he-was-getting-too-close-to-my-price.
(must be unique) Accessed 3 July
2012.
9 Instructions
See 6,
76 Federal Register 26490 (May Do2011).
not modify the shaded
CMS, hospital cells.value-based purchasing
inpatient
program: final rule.
10 See generally Fiegl C. AMEDNEWS.com, Insert -> Rows Below.
August 27, 2012. 2,200 Hospitals face Medicare pay
penalty for readmissions. Available at: http://www.ama-
assn.org/amednews/2012/08/27/gvsb0827.htm;
andBloom's
To specify Rao J. NPR blog, August
Taxonomy, 13,an2012,
place 'X' or 'x' next to the desired selection
Thousands of Hospitals face penalties
for highin
Fields readmission rates. Available at:
Red are mandatory
http://www.npr.org/blogs/health/2012/08/13/158711121/thousands-of-hospitals-face-penalties-
Question Text Which agency in
for-high-readmission-rates?sc=ipad&f=1001. the federal
Accessed bureaucracy
2 September 2012. established a color-coded security system th
11 Subsequent reorganization within the Department of Interior has replaced the old MMS with
two new administrative entities, the Bureau of Ocean Energy Management and the Bureau of
Safety and Environmental Enforcement. See discussion at http://www.boemre.gov/. Accessed higher. 0 2stands for
September 2012. incorrect)
Defense (DOD)
12 See discussion in King & Johnson. An oil thirsty America divided into dead sea. The Wall
XX.
Street Journal. 8 October 2010.
13 See Bureau of Ocean Energy Management, Regulation and Aerospace Defense XX.
Enforcement. Report regarding the
Command (NORAD)
causes of the April 20, 2010 Macando well blowout, 14 September 2011, at 172.
14 Ibid.
15 National
See Wall Street to bail out Jersey City's Knight Capital with $400Aeronautic
million package.0Bloomberg Incorrect.
and Space XX.
News. August 6, 2012. Available at:
Administration
http://www.nj.com/business/index.ssf/2012/08/wall_street_to_bail_out_jersey.html.
(NASA) Accessed 2
September 2012.
Homeland
16 See Cheng J. The Wall Street Journal. 21 August 2012 Knight Security
Capitals woes chip away at
(DHS)
Wall Street confidence. Available at: http://blogs.wsj.com/marketbeat/2012/08/21/knight-capitals-
woes-chip-away-at-wall-street-confidence/.
Shuffle Choices Yes Accessed 2 September 2012. X
(Mark X or x where
Noat: http://en.wikipedia.org/wiki/Mulligan_%28games%29.
17 Milligan. Wikipedia. Available
applicable)
Question ID
18 Difficulty
Patterson S, Strasburg J, Bunge J. SEC nixed Knight's plea for a do-over. Wall Street Journal. 6
August 2012. Available at:
Page Reference
http://online.wsj.com/article/SB10000872396390444246904577571113923528168.html.
Topic 3 September 2012. The Bureaucracy
Accessed
Objective L.O. XX
Hint 1
Hint 2
Hint 3
applicable)
X
19Rule 15c3-5 under the Securities Exchange Act of 1934, enacted November 15, 2010 (see
Exchange Act Release No. 63241, Nov. 3, 2010, 75 FR 69792). See also discussion in Lynch SN.
Reuters. August 3, 2012, U.S. SEC examining risk controls at Knight Capital. Available at:
http://news.yahoo.com/u-sec-examining-risk-controls-knight-capital-213115172--sector.html.
20 Socrates (470 BC399 BC) quotes. ThinkExist.com. Available at:

http://thinkexist.com/quotations/reputation/2.html. Accessed 2 September 2012.
CHAPTER
11
Cultural Context
By Robert C. Brandegee1
The ability of a company to execute its strategy and bring new products and
services to market, are directly linked to a companys understanding of the
social and environmental context in which this happens.
Aron Cramer2
We have shown how reputation is a consequence of corporate behavior that

motivates stakeholders to behave in ways that either reward or punish the
corporation. Weve argued that reputation crisesinstances in which markets
punish companiesare often consequences of operational failures in one or
more of the six business processes that are the pillars of reputation (Table 1-1).
The factor precipitating market punishment is the magnitude of the markets
disappointment when expectations are not met.
While the behaviors of companies help set those expectations, cultural

normslocal expectations of citizenship behavioralso play a role.3 To
appreciate the complex interplay among cultural norms, corporate values, and
stakeholder expectations, it is helpful to look at cases in which reputational
crises have arisen in the absence of any overt business process failure.
2 Chapter 11 | Cultural Context
This chapter presents only a superficial mention of controversies over some of

the most passionate modern-day social struggles. It is enough for our purpose of
illustrating the cultural context, but it makes no judgment about the issues these
companies encountered in these cases. Although the cases may touch on
readers personal sensitivities, as Chapter 1 indicated, this book observes and
explains in the spirit of American pragmatism and avoids moralizing.
Society, Expectations, and Reputation

Corporate behaviors are shaped by a companys values and reflect its culture.
This is especially the case in companies still led by their founders or closely
held by related family members.
At the time companies are formed, their cultures reflect the values of the time as
well as the strategic and operating processes for meeting market needs. These
are the foundation of corporate cultures. For every company, corporate boards
are stewards of those cultures. As societys expectations evolve, the standards
by which corporate behaviors are judged by a companys stakeholders also
evolve. Corporate cultures, however, are usually slower to evolve, and therein
lies a significant endemic reputational risk: Corporate culture, company values,
and company operations can lose touch with the evolving expectations of both
stakeholders and society at large.
Four casesNews Corp, Chick-fil-A, Susan G. Komen, and Targetillustrate

the diversity of perspectives in society that can transform operational decisions
into reputational crises. Individually, they demonstrate pitfalls to steer clear of
in operating a business so as to minimize market friction. Collectively, they
underscore the many ways that daily debate centers on the question: What
should society expect from businesses that are formed and operate under its
laws?
News Corp: The Great Debate

Elisabeth Murdoch, daughter of News Corp Chief Executive Rupert Murdoch
and chairman of News Corp's U.K. television production firm Shine, declared
on 23 August 2012 that profit without purpose is a recipe for disaster.4

Delivering the annual James MacTaggart Memorial Lecture (the keynote
address at the MediaGuardian Edinburgh International Television Festival),
which both her father and brother had delivered in prior years, Elisabeth said,
It is increasingly apparent that the absence of purposeor of a moral
languagewithin government, media, or business could become one of the
most dangerous own goals for capitalism and for freedom.
Three years and a $4.4-billion reputational crisis earlier (see Chapter 4),
Elisabeths brother Jamesthen heir presumptive to their father Ruperts
Global News Corporation empireexpressed a decidedly different view: The
right path is all about trusting and empowering consumers. It is about
embracing private enterprise and profit as a driver of investment, innovation,
and independence. And the dramatic reduction of the activities of the state in
our sector The only reliable, durable, and perpetual guarantor of
independence is profit.5
James was certainly right about the importance of profit. Without it, a company
cannot survive, no matter how worthy its purpose. Yet that pursuit ended in
precipitous fall. So Elisabeth was right too. Businesses whose aims extend no
further than making a profit can end up destroying themselves.6 Yet, were it not
for its profits then, as well as now, News Corp would not have survived the fall,
and Elisabeth would not have been invited to deliver the keynote.
The debate between the Murdoch siblings is one regal contest in the great
debate on the role of business in society waged by armies of adversaries on
countless fields and issues. It is a debate on which companies speak daily
through their actions as much as their words, as they struggle to address
profitably the common expectations of their markets without antagonizing any
of the various sets of adversaries who compose those markets.
Chick-fil-A: Unnecessary Controversy

In the early 1960s, Truett Cathy founded Chick-fil-A, now the second largest
quick-service chicken restaurant chain in the United States. With more than
1,615 locations in 39 states and Washington, DC, sales topped $4.1 billion in
2011. Large as it is, it remains a family business. Truett is the chairman and
CEO, his son Dan is president and COO, and his son Don (Bubba) is senior vice
president.
Family businesses are built around family values, and nonagenarian Truett
Cathy, author of five motivational books, is a devout Southern Baptist with
strong religion-focused family values. Since 1946, all of his restaurants have
been closed on Sunday.7 One of the missions of the WinShape Foundation, a
charity funded by the family, is supporting marriage enrichment
retreatsbetween a man and a woman. A Foundation spokesperson stated, We
do not accept homosexual couples because of the statement in our contract.8
Marriage, gay rights, and religion are flashpoint issues on which different
groups with strong social convictions passionately disagree. In a June 2012
radio interview, President Dan Cathy elaborated on his companys values and
its support of the traditional family and declared that legalizing same-sex
marriage would invite Gods judgment on our nation. 9,10 In an election year
already seething with politically stoked culture wars, a media firestorm erupted.
US News and World Report described the reactions of several unlikely
stakeholders11:
First the Jim Henson Co., which provided Muppets toys for Chick-fil-A kids
meals, pulled its toys and its partnership with the restaurant. Then the
(Democratic) mayors of Boston and Chicago expressed opposition to new
Chick-fil-A outlets opening in their citiesOn the other side, Republican
politicians such as presidential candidate Rick Santorum and former
Arkansas Gov. Mike Huckabee defended the restaurant chain and its
policies....
Same-sex marriage activists called a boycott and Governor Huckabee countered

by calling a national Chick-fil-A Appreciation Day that increased the chains
business that day by 30%countered in turn 2 days later by a nationwide Same
Sex Kiss Day at the restaurants.12
Truett Cathy is proud of his inherently uncontroversial chicken sandwich, a

food product that his marketcustomers, employees, suppliers, and
creditorsunderstands. It is not clear how Dan Cathys radio pronouncements

improved that products reputation beyond a limited portion of these
stakeholders. The sons ill-considered remarks ignited a potentially damaging
controversy that had nothing to do with the core business his father had built.13
Susan G. Komen: Lurking Controversy

Chick-fil-A was not the only battle in the culture wars of 2012. In January, the
Susan G. Komen for the Cure Foundation announced the elimination of its
funding of breast cancer education and screening by Planned Parenthood
pursuant to a new internal rule that organizations under Congressional
investigation, as Planned Parenthood was at the time, were ineligible for Komen
funding. This decision outraged womens health advocacy groups and triggered
an immediate surge in donations and grants to Planned Parenthood. Three days
later, Komen restored the funding and the senior anti-abortion Komen
executives behind the decision to defund Planned Parenthood resigned, but the
damage had been done. Attendance and revenues at Komen events across the
nation fell by a third. In August, Komen founder Nancy G. Brinker, having
presided over an organization that had raised more than $740 million for breast
cancer research since 1982, stepped down as CEO in the hope that it would
help Komen get past the bad publicity.14,15
Womens health is not uncontroversial.16 Few will find fault with improving the
health of women in general, and curing breast cancer is a noble cause. But the
potentially explosive issue of abortion has always lurked beneath the surface.17
It is to Nancy Brinkers credit that for three decades she succeeded in sidelining
the abortion issue from the benefits of the foundation to womens health.18
Through a few decisions, a handful of Komen executives unleashed a latent
debate that grew in intensity and severely damaged the foundations core
business.19
Target Corp: Stumbling into Controversy

In 2010, Target Corp. angered gay-marriage supporters with a $150,000
political donation that benefited a gay-marriage opponent running for
Minnesota governor, setting off protests and calls for a boycott from a
constituency that had previously seen Target as an ally. Two years later, the
retailer drew the ire of opponents of same-sex marriage by supporting a
promotion organized by a group of gay Target employees.20
In the spring of 2012, Target introduced several Pride-themed shirts, with

proceeds to benefit the Family Equality Council, a group fighting a proposed
amendment to the Minnesota constitution to ban gay marriage.21 In response,
the American Family Association mobilized its supporters to urge Target to pull
the shirts. Andy Parrish of Minnesota for Marriage, a pro-family group leading
the fight for traditional marriage in Minnesota, said, Target has alienated the
strong majority of Minnesotans who support traditional marriage. They also risk
alienating the overwhelming majority of their customers in the 32 states in this
country that have voted to support traditional marriage.22
As a retailer of general merchandise, Target sells products and services that are
hardly controversial. For fifty years, social justice and community service have
been planks of its business platform.23 The companys consistent socially
responsible behavior created market expectations for which it has been widely
acknowledged. It is a company Elisabeth Murdoch could appreciate. In 2010,
the business sidethinking like James Murdochsupported a candidate who
called for lower business taxes, but who also had strong social views
inconsistent with the expectations of Targets market. Through one ill-
considered decision, the company stumbled into a social controversy that could
leave observers with the impression that its 48-year track record of social
responsibility never existed.
Guidance
The Chick-fil-A, Komen, and Target social controversies illustrate how
contending social-issue groups and individuals express their values and direct
their capitalwhether by purchase decisions, by direct donation to social-issue

advocacy groups, or by investment decisions in the equity markets. The lesson
in these three cases is that no corporate action goes unobserved, and that it is
foolish to neglect societys expectations. The lesson in the News Corp. case of
the debate between siblings underscores the diversity of emotional issues
related to these expectations.
Doing the right thing is the right thing to do, advises Paul Liebman, formerly
Chief Compliance Counsel for Dell, Inc.24 Knowing there is a diversity of
opinions as to what constitutes the right thing is the first step toward
understanding the social context for business operations. Finding the least
controversial path through a shifting minefield of socially volatile issues is the
second. Making a misstep along that path is an operational failure that does not
necessarily have to mature into a reputational crisis if the market accepts the
companys authenticity. Building the business case for doing that, with a few
how-tos, is what the first 10 chapters of this book are all about.
Consider This
The culture of the times and the companys founders shape
its initial culture. The steward of corporate culture, the
board, tends to want to protect and preserve that culturea
posture that can actually prevent it from evolving to
respond to changes in societys expectations.
Many social value perspectives expressed by key corporate

figures may cut two ways, strengthening positive reputation
among those stakeholders who agree, and vice versa.
Making key business decisions that are mindful of societys

expectations can reduce the likelihood of inadvertently
triggering a reputational crisis.
1 Robert C. Brandegee is a management consultant, retired, with Brandegee Incorporated.

2 Aron Cramer President and CEO, BSR (a CSR consultancy)_as quoted in Klein P. Can say on
pay increase social responsibility? Forbes. 3 July 2012.
http://www.forbes.com/sites/csr/2012/07/03/can-say-on-pay-increase-social-
responsibility/?goback=.gde_2955795_member_130388605 Accessed 11 August 2012.
3 Gardberg NA, Fombrun CJ. Corporate citizenship: creating intangible assets across institutional
environments. Academy of Management Review. 2006; 31:329346.
4Jannarone J. Elisabeth Murdoch slams profit without purpose. The Wall Street Journal. 23
August 2012. Available at:
http://online.wsj.com/article/SB10000872396390444812704577607642320827980.html.
5 Murdoch J. 2009 Edinburgh International Television Festival MacTaggart Lecture. 28 August
2009.
6Skapinker M. Murdochs schism has lessons for companies. Financial Times. 29 August 2012.
Available at: http://www.ft.com/intl/cms/s/0/be886812-ee2b-11e1-b0e4-
00144feab49a.html#axzz259xfuRiL. Accessed 31 August 2012.
7 Chick-fil-A. Why were closed on Sunday. Available at: http://www.chick-fil-

a.com/Company/Highlights-Sunday. Accessed 9 August 2012.
8 Yes, Chick-fil-A says, we Explicitly do not like same-sex couples. Available at: Change.org, 26
January 2011. Jones M. http://news.change.org/stories/yes-chick-fil-a-says-we-explicitly-do-not-
like-same-sex-couples. Accessed 9 August 2012.
9Dan Cathy, Chick-Fil-A president, on anti-gay stance: guilty as charged. Huffington Post. 17
July 2012.
10 Zimmerman N. Ed Helms takes high-profile stand against Chick-fil-A for anti-same-sex-
marriage stance [UPDATE: Chick-fil-A Relents?]. Gawker. 19 July 2012. Available at:
http://gawker.com/5927438/ed-helms-takes-high+profile-stand-against-chick+fil+a-for-
anti+same+sex+marriage-stance. Accessed 9 October 2012.
11Cline S. Chick-fil-A's controversial gay marriage beef. US News and World Report. 27 July
2012. Available at: http://www.usnews.com/news/articles/2012/07/27/chick-fil-as-controversial-
gay-marriage-beef. Accessed 9 August 2012.
12 Gay rights activists hold kiss day at Chick-fil-A restaurants. CNN. 4 August 2012. Available
at: http://www.cnn.com/2012/08/03/us/chick-fil-a-kiss-day/index.html. Accessed 10 October

2012.
13White MC. Chick-fil-A waffles on gay marriage rights, fries brand image. NBC News,. 21
September 2012. Available at: http://bottomline.nbcnews.com/_news/2012/09/21/14009108-
chick-fil-a-waffles-on-gay-marriage-rights-fries-brand-image?lite. Accessed 10 October 2012.
14Schwirtz M. Breast cancer group changes leaders. The New York Times. 8 August 2012.
Available at: http://www.nytimes.com/2012/08/09/us/susan-g-komen-for-the-cure-changes-
leadership.html. Accessed 9 August 2012.
15Will Nancy Brinkers resignation help Komen Race for the Cure? Palm Beach Post. 10 August
2012. Available at: http://blogs.palmbeachpost.com/opinionzone/2012/08/10/will-nancy-
brinker%E2%80%99s-resignation-help-komen-race-for-the-cure/. Accessed 1 September 2012.
16Papuga C. Why have women's health issues become a leading issue in this election? Huffington
Post. 11 September 2012. Available at: http://www.huffingtonpost.com/casey-papuga/womens-
health-leading-issue_b_1875463.html?utm_hp_ref=elections-2012. Accessed 10 October 2012.
17Melnick M. Why a Christian group pulled pink bibles for breast cancer awareness. Time. 16
December 2011. Available at: http://healthland.time.com/2011/12/16/why-a-christian-group-
pulled-pink-bibles-for-breast-cancer-awareness/. Accessed 10 October 2012.
18 Moyers R. Komen needs a strong board that can Stand up to its founder. Philanthropy. 11
September 2012. Available at: http://philanthropy.com/blogs/against-the-grain/komen-needs-a-
strong-board-that-can-stand-up-to-its-founder/28254. Accessed 10 October 2012.
19 Feder JL. Can Susan G. Komen recover from Planned Parenthood funding fiasco? Politico. 3
February 2012. Available at: http://www.politico.com/news/stories/0212/72435.html. Accessed

10 October 2012.
20 Corporate decision renews Target gay rights controversy. Fox8 News. 15 June 2012. Available
at: http://www.fox8live.com/story/18680499/target. Accessed 1 September 2012.
21 Waldron M. Targets 'Pride T-shirts stir controversy. KTNV Action News. 1 June 2012.
Available at: http://www.ktnv.com/news/national/156531285.html. Accessed 1 September 2012.
22 Bohon D. Target Corp. announces t-shirt campaign for homosexual marriage. The New
American. 28 May 2012. Available at: http://thenewamerican.com/culture/family/item/11525-
target-corp-announces-t-shirt-campaign-for-homosexual-marriage. Accessed 1 September 2012.
23Target Corporation. Culture. Available at: http://corporate.target.com/careers/culture. Accessed

10 October 2012.
24Liebman P. Is ethics a valuable intangible asset? Mission Intangible Monthly Briefing. 9 April
2010. Audio recordings available from the Intangible Asset Finance Society:
http://iafinance.org/monthly-briefings. Accessed 8 October 2012.

CHAPTER
12
Metrics
There are two possible outcomes: If the result confirms the hypothesis, then
youve made a measurement. If the result is contrary to the hypothesis, then
youve made a discovery.
Enrico Fermi1
If your stock price is sensitive to your companys reputation, then managing the
business processes that are the pillars of reputation is a managerial imperative
and board oversight duty. Reputation scores and reputational value metrics can
help. Clearly, senior management needs more detailed measurements than the
board does. But, as Chapter 8 shows, there are three board-level dutiesCEO
compensation, asset protection, and business strategywhose fulfillment could
be enhanced with measures of reputation.
Reputation scores and reputational value metrics are covered in Chapter 9 at a

level of granularity interesting to quantitatively inclined readers, and this
chapter begins where Chapter 9 ended. A qualitative discussion frames the
picture for all readers and proceeds to a quantitative presentation via charts and
graphs.
2 Chapter 12 | Metrics
Metrics: Qualitative Edition

There are two kinds of measures of reputation, and they differ from one another
in the same way that a companys book value differs from its market
capitalization. The first is based on surveys and resembles a companys book
value as determined by a standard transparent accounting procedure. Surveys
have been done for decades, reflect the marketing mindset from which they
arose, and provide a measurement of reputation at the time the survey is
conducted. They are historic snapshots of mindshare and appear to be good
predictors of brand awareness and related consumer behaviors. This book cites
reputation scores from four different surveys. The Worlds Most Admired
Companies (WMAC) survey from Fortune magazine and Worlds Most
Respected Large Companies (MRC) from Barrons magazine capture the
mindshare of a business-oriented survey population. The Reputation Quotient
(RQ) survey from Harris Interactive and the RepTrak survey from the
Reputation Institute capture the mindshare of a broader general population.
The second kind of measure, resembling market values, involves dynamic

processes algorithmically driven by measurements of business performance.
Algorithmic processes have been developed over the past decade, reflect the
analyst mindset from which they arose, and provide a near real-time
measurement of reputation. They are current calculations of expected business
performance, harness the wisdom of crowds, and can be good predictors of
stock price behavior. Hence, these can be useful as early warning signals that
might guide managers in responding to problems and opportunities.
This book introduces measures from two algorithmic sources. Relative Business
Performance probability scores from Transparent Value capture the
probabilities that companies will achieve the business performance expected by
investors as implied by current stock price. Reputational Value Metrics from
Steel City Re (the authors employer) capture reflect the expected economically
relevant behavior of the diverse stakeholders who have been covered in the
earlier chapters of this book.
The distinction boils down to this:

Survey-based reputation scores quantify what a company has done to create stakeholder
opinions; algorithmic-based reputational value metrics quantify what the aggregate of
company stakeholders can be expected to do.
Survey-based reputation scores, not unlike book value, benefit from transparent
methodologies. Based on relatively large samples, they draw statistically valid
inferences from questions as simple as, Rank your respect for this company on
a scale of 15. They may also delve deeper into psychological aspects of
reputation to elicit opinions on matters such as vision and leadership, social
responsibility, financial performance, emotional appeal, products and services,
and workplace environment. The survey-based measures are disadvantaged, like
book values, by their lack of timeliness, inherent backwards view, and inability
to capture the economic value of the opinions. Empirically, they have not
correlated well with going-forward equity performance.
Algorithmic-based reputational value metrics benefit from high-frequency

volumes of timely data that enable the measures to report both spot and
dynamic time-series data on reputational value ranking, volatility (risk), and
projected rate and direction of change. They capture forward-looking
expectations related to economic value that are useful measures for financial
instruments. Today, Transparent Values metrics appear publicly only in
investable mutual funds such as the two described in Chapter 9 (tickers:
TVIMX, TVVIX). Insurers and hedge funds use Steel City Res reputational
value metrics to underwrite reputation risk and to direct reputation-focused
investment strategies. Reputational Value Insurance, underwritten by syndicates
at Lloyds and various insurance companies led by Kiln Group, and the
RepuStars Variety composite equity index calculated by S&P/Dow Jones
indices (ticker: REPUVAR), are examples. Because of their use in financial
instruments, the algorithmic-based metricsnot unlike market valuesare
disadvantaged by their lack of transparent methodology.
Algorithmic data avoid potential systematic biases in survey data that can
unduly shape the reputation scores.2 Whereas the data underpinning the
algorithmic measures of reputation are captured passively, survey data are
captured from volunteers who are aware of their contributions. These biases can
exacerbate biases already evident in the different populations being surveyed
and help explain why the reputation metrics do not necessarily correlate well
between and among the different instruments.
Following nearly identical methodologies, the two general public-oriented

surveys, RQ and RepTrak, showed a 94% correlation among the 48 companies
that were ranked by both reputation scoring systems. But, whereas the
correlation between the general public and business-focused survey populations
in the 128 companies common to both the RepTrak and WMAC measurement
systems was a meager 21%, the correlation between the algorithmic measures
and the business-focused survey populations in the 126 companies common to
both the Steel City Re and the WMAC measurements was 58% (Table 12-1).
Table 12-1. Stepwise Paired Correlations among Five Reputation Measures
WMAC 100% 68% 36% 21% 58%

(118)
MRC (100) 68% 100% 72% 67% 65%
RQ (60) 36% 72% 100% 94% 46%
RepTrak 21% 67% 94% 100% 32%

(150)
Ranking 58% 65% 46% 32% 100%
(142)
WMAC MRC RQ RepTrak Ranking
Fortune Barron Harris Reputation Steel City
Magazi s Interacti Institute Re
ne Magazi ve
ne
These different properties suggest that the algorithmic measures of reputational

value may be more useful for day-to-day managerial and oversight functions,
while the survey-based reputation scores may be more useful for reviews of
historical performance and the types of managerial reviews for which historical
financials are most useful. Whichever objective is to be served, for executives

who must manage reputation, measurement is a must.
Case discussions of Steel City Res algorithmic measures of reputation covering nearly four
years of observations can be found on the blog of the Intangible Asset Finance Society,
Mission: Intangible, at http://www.iafinance.org/BlogRetrieve.aspx?BlogID=419.
Survey-based reputation scores from all four of the aforementioned providers

and algorithmic reputational value metrics from Steel City Re are available
publicly and are compared and contrasted in the text that follows. Some of the
graphics draw upon actuarially and mathematically advanced techniques and
may require significant time for inspection and dissection. Such attention will
ensure a level of comfort for operational and oversight decision-making.
However, if youre already saturated or prefer to look at case studies published
in color online,3 this would be a good time to jump to the Consider This
section at the end of this chapter.
Metrics: Quantitative Edition

Of the approximately 35 public companies discussed in this volume, there are 7
for which there exist 2012 public reputation scores from all 4 providers of
survey-based measures and Steel City Res algorithmic reputational value
metrics. Transparent Values metrics today are shown publicly only through the
mutual funds they drive.
Each of the measurement systems uses a different scale. To simplify the

comparison of values, the measurements from all five systems were converted
to rank-order percentile values whose denominator is reported in the row
labeled Percentile rank denominator. Although they are refreshed weekly,
Steel City Res algorithmic reputational value metrics for the one date of 5
January 2012 are presented to enable tabular comparison with the survey groups
(Table 12-2).
7
Table 12-2. Reputation Scores for Seven Companies Converted to Rank-Order Percentile Values
and Ordered by Their WMAC Ranking
Source Fortune Barrons Harris Reputati Steel

Magazin Magazin Interacti on City Re
e e ve Institute
Name TCK Worlds Most Reputati RepTrak Reputati
R Most Respect on on
Admired ed Quotient Ranking
Compani Compan 5
es y January
12
Percentile 118 100 60 150 142

rank
denominator
American AIG 6% 4% 0% 4% 18%

International
Group
Johnson & JNJ 40% 68% 89% 98% 90%

Johnson
The Coca- KO 65% 92% 96% 95% 96%

Cola
Company
PepsiCo PEP 71% 69% 72% 94% 92%
JP Morgan JPM 81% 51% 6% 10% 19%

Chase
The Walt DIS 98% 89% 91% 89% 59%

Disney
Company
Apple Inc. AAP 100% 100% 100% 95% 98%

L
While current reputation rankings are familiar concepts, the Steel City Re
reputational value metrics introduce additional measures that are explained here
and illustrated in the labeled schematic, which, like a map, will help navigation
through the detailed charts that follow (Figure 12-1). First, labeled AE, is a
five-bar chart called Vital Signs comprising the reputational metrics for a
company as benchmarked against peers in the same standard industry group.
The chart provides a snapshot of the company relative to its peers. Historic
Volatility, A, reports on the 1-year average standard deviation of the
reputational value metric. The Current Volatility, B, reports the exponentially
weighted average of the same parameter over only the trailing 12 weeks. It is
meaningful when the Current Volatility is significantly different than the
Historic Volatility. Current Ranking and return on equity (ROE), C and D,
report in the charts below the Reputation Ranking as of 23 August 2012 (the
tabular values are from 5 January 2012 corresponding to the date of the survey
measures) and the trailing 12-month return on equity as of that same date. Last,
the Forecast Stability, E, reports on the volatility trend. Higher values suggest
less change going forward.
Figure 12-1. Guide to the understanding of representative algorithmically derived reputational

value metrics from Steel City Re and are provided here for educational purposes only. TTM =
trailing twelve months.
The Time Series chart, H, also reports benchmarked data. It gives the
companys reputational value ranking over time relative to peers. The terminal
value corresponds to the value shown in Vital SignsC. Also shown on the time
series graph are the ROE of the company, the median of its peer group, and the
S&P 500 Composite Index serving as a proxy for the broad market. The
terminal value for ROE corresponds to the value shown in Vital SignsD.
The four additional bar charts, FJ, report the same values shown in the vital
signs, but with greater detail. Also, rather than benchmarking to peers, the
percentile values reflect the companys standing relative to approximately 7,300
companies in the Steel City Re database. The values for the peer group quartiles
are also reported. The metrics include Current Reputation Ranking, F; Trailing
Twelve Month (Historic) Reputation Volatility, G; Current Reputation

Volatility, J; and an indicator of reputational stability, the Ranking Vector, I.
Last, a flag chart, K, displays the indication of reputational ranking stability and
the expected direction of change.
Flag graphs L and M are two of four graphs introduced in the Guidance section
of this chapter. They illustrate how rapid changes in reputational value standing
and value can be discovered, and potentially spur management to take action.
American International Group (AIG)

Worlds Most Most Reputation RepTrak Reputation
Admired Respected Quotient Ranking
Companies Company 5 January
2012
6% 4% 0% 4% 18%
Parameter Metric Description

Sector & Count 1312 Finance
Industry & Count 43 Multi-Line Insurance
SubIndustry & Count 179 Insurance Companies

Johnson & Johnson (JNJ)

2012
40% 68% 89% 98% 90%

Sector & Count 557 Health Technology
Industry & Count 32 Pharmaceuticals: Major
SubIndustry & Count 33 Diversified Health Care

The Coca-Cola Company (KO)

2012
65% 92% 96% 95% 96%

Sector & Count 345 Consumer Non-Durables
Industry & Count 20 Beverages: Non-Alcoholic
SubIndustry & Count 20 Soft Drink Producers & Bottlers

PepsiCo (PEP)
2012
71% 69% 72% 94% 92%

Sector & Count 345 Consumer Non-Durables
Industry & Count 20 Beverages: Non-Alcoholic
SubIndustry & Count 20 Soft Drink Producers & Bottlers

JP Morgan Chase (JPM)

2012
81% 51% 6% 10% 19%

Sector & Count 1307 Finance
Industry & Count 50 Financial Conglomerates
SubIndustry & Count 249 Commercial Banks /-Bank Hldg Co's

The Walt Disney Company (DIS)

2012
98% 89% 91% 89% 59%

Sector & Count 420 Consumer Services
Industry & Count 11 Media Conglomerates
SubIndustry & Count 64 Miscellaneous Recreation

Apple Inc. (AAPL)

2012
100% 100% 100% 95% 98%
Parameter Metri Description

c
Sector & Count 623 Electronic Technology
Industry & Count 25 Computer Processing Hardware
SubIndustry & 47 Electronic Data Processing Equipment

Count
28
Chapter 12 | Metrics
Guidance
One of the other benefits of the data frequency and density of the algorithmic
metrics from Steel City Re is the ability to analyze reputational value trends and
identify deviations that may be the harbingers of a looming crisis.
Figure 12-2. Flag graphs of reputational value spot data for both Pepsi and Coca-Cola dated 30
August 2012 shows a sudden spike in Coca-Colas reputational ranking volatility and a negative
change of rank associated with a stock split and a surprised market. Concurrently, Pepsis trailing
12-month return on equity, if only briefly edged past Coke. In short order, the fundamental
differences discussed in Chapter 5 returned Coke to its usual dominance.
For example, the metrics for Pepsi and Coke, both members of the 20-member
Non-Alcoholic Beverages sector, show that as of 23 August 2012 the
reputational value volatility for Coke increased significantly among the entire
peer group and began to trend negative (Figure 12-2). These data suggest a
recent major operational change reduced Cokes reputation among a significant
fraction of its stakeholders, and is a signal to management that something
recently destabilized the situation. Further examples of alerts evidenced by
changes in the Steel City Re reputational metrics can be found on the Mission:
Intangible blog of the Intangible Asset Finance Society.
Another benefit of the data frequency and density of the algorithmic metrics
from Steel City Re is the ability to characterize the severity of a reputational
crisis in real time. In early May 2012, JP Morgan Chase reported a $2 billion
loss from a failed hedging strategy. The media declared it a reputational crisis.
The dollar loss, though, could be less significant than the hit to Dimon and the
banks reputation, reported Reuters.4 The insight provided by the Steel City Re
Reputational Metrics and reported 19 May in the Mission: Intangible blog
contradicted the pronouncements of the media: On the basis of JP Morgan
Chases historical reputational value metrics, and in the context of the three-
year long view, this current event could be viewed as just one more bump in a
long and volatile history of bumps.5
Four months later, the expectations reported by the reputational metrics were
realized. By mid-September 2012, the market capitalization decline had been
erased and the reputational measures had almost all returned to prior values.
The events made for great media fodder, but it never really was a reputational
crisis, as the metrics showed then, and affirm now. And notwithstanding the
personal abuse of[Congressional]hearings, etc., by mid September CEO
Jamie Dimon had reaped a 22.6% gain from his $17.1 million bet on JP Morgan
Chases reputational resilience for a cool $3.86 million in less than two
months.6
Consider This
Because managing and overseeing reputation is a
managerial activity, reputation metrics can be helpful.
High-frequency algorithmically produced reputational

value metrics provide insights more useful for day-to-day
administration, risk management, and crisis management
while annually generated survey-based scores may be more
useful for historical reviews assessing past performance.
Colorful charts, graphs. and reputation case studies of

companies recently in the news can be found on the
Mission: Intangible blog of the Intangible Asset Finance
Society:
http://www.iafinance.org/BlogRetrieve.aspx?BlogID=419.
By the Numbers
The top reasons for measurement are improving business performance and
enhancing communications. Whether you are an operating executive,
communications executive or market analyst, reputation scores and reputational
value metrics have been, are, or soon will be part of your daily fare. The table
below displays a sample of the cross-correlations of data in this chapter.
Table 12-3. Representative Pairwise Correlations between Various Measures of Reputation
Metric 1 Source Metric 2 Source Number Correlation

of (%)
Common
Compani
es
RepTrak General RQ General 48 94

survey Survey
MRC Investor SCRE Algorithmic 42 65

survey Ranking
WMAC Business SCRE Algorithmic 126 58

survey Ranking
RepTrak General SCRE Algorithmic 136 32

survey Ranking
WMAC Business RepTrak General 128 21

survey survey
1Fermi E. (Nobel laureate in physics, 1938) Available at:

http://www.brainyquote.com/quotes/keywords/measurement.html#dGcXkLYDr7wmheGD.99.
2 Wright KB. Researching Internet-based populations: Advantages and disadvantages of online
survey research, online questionnaire authoring software packages, and web survey services.
Journal of Computer-Mediated Communication, 2005;10(3): article 11. Available at:
http://jcmc.indiana.edu/vol10/issue3/wright.html. Accessed 7 October 2012.
3 Visit the Mission:Intangible blog of the Intangible Asset Finance Society at http://iafinance.org/.
4 Henry D, Rothacker R. JPMorgan has $2 billion trading loss, reputation hit. Reuters, 10 May
2012. http://www.reuters.com/article/2012/05/10/us-jpmorgan-trading-
idUSBRE8491H020120510. Accessed 18 September 2012.
5JP Morgan Chase: Is there a metric in the house? Mission: Intangible. 19 May 2012. Available
at:
http://www.iafinance.org/_blog/MISSION_INTANGIBLE/post/JP_Morgan_Chase_Is_there_a_m
etric_in_the_house/. Accessed 18 September 2012.
6JP Morgan Chase: Got better. Mission: Intangible. 18 September 2012. Available at:
http://www.iafinance.org/_blog/MISSION_INTANGIBLE/post/JP_Morgan_Chase_%5BI%5D_g
ot_better/. Accessed 18 September 2012.
CHAPTER
13
Consider These
A business can simultaneously enhance its reputation and demonstrate its
responsibility by meeting stakeholder expectations.
Carola Hillebrand and Kevin Money1
An uninitiated came before Hillel, the famed Judean sage and scholar who lived
more than 2,000 years ago, and said to him, Make me wise in your ways, on
the condition that you teach me the whole Torah while I stand on one foot.
Hillel answered him: What is hateful to you, do not to your neighbor. That is
the whole Torah; the rest is the commentary thereof; now go and learn it.2
Watch What They Do

Corporate reputation is a multi-stakeholder concept that is reflected in the
perceptions that stakeholders have of an organization based on what they
experience personally or discover from all other sources.3 These interactions
trigger economic behaviors that impact the profit and loss (P&L) statement in
many ways and ultimately affect enterprise value. There are effects too on
governance, regulators, and analysts.
2 Chapter 13 | Consider These
Much evidence in the literature and reaffirmed here shows that reputations with
different stakeholder groups create complex reciprocal behaviors in other
groups that are then again reflected in reputation. In particular, reputation with
employees is seen to have an impact on reputation with customers and
communities.4
This complexity of interplay suggests, further to the words of Hillel, that the
prudent way to manage stakeholder interactions is to foster ethical
conformance, ensure quality, drive innovation, promote sustainability, and
optimize both safety and securitythe six drivers of reputation. Authentic
behaviors will be observed by all, and reputation will follow.
We have shown that corporate culture enables board-level decisions and

operating-level actions that help create value through these six drivers, and that
the standards by which stakeholders measure success are sensitive to societal
norms. These norms are dynamic, and a culture appropriate for certain times
may not remain so, even if the corporate culture is strong and
unchangingindeed sometimes because it is strong and unchanging.
Stakeholders are always watching; the tint of their glasses, however, may shift
without advance notice. Because of the complex perceptual interplay,
organizations managing their corporate reputation should take into account not
only their direct interactions and relationships with stakeholders, but also the
influences stakeholders have on each other.5
In short, do the right thing for your stakeholders and meet their expectations.
The rest is commentary thereof; now go and learn it.
Final Guidance
This book is organized to present the origins of reputation, a dynamic
consequence of a complex web of reciprocal relationships among many
different stakeholders (Figure 13-1). But rather than risk irrelevance as an
academic discourse, this book offers readers a financial journey of actions they
may emulate. The key is to couple corporate behavior to its reputation,
appreciate that stakeholder behavior translates to measurable reputational value,
and recognize that the diverse effects of market behaviors yield profit and loss,
which then links to a companys stock price.
This book doesnt grant reputation the status of an air ball by leaving it
without an owner. It purposefully shifts responsibility for the management of
reputational value from risk and PR managers to the board of directors, COO,
and CFO by providing frameworks for governance, measurement, and financial
risk transfer.
Last, this book takes pains to clarify what is not reputational value. It
distinguishes between reputation and measurable reputational value; between
brand (a promise), and reputation (an expectation of behavior) and between
generalized market cap loss on one hand and granular details of gains or losses
in revenue and expenses on the other.
Briefly, Parts 1 and 2 are organized to help the reader appreciate how various
business processes shape a companys reputation and trigger behaviors in
stakeholders that impact specific line items on the P&L statement. The most
important of these processes are the six drivers of reputational value.
Part 3 shows how the business environment for those business processes is
influenced by corporate culture, judged by equity investors, governed by the
companys directors, observed by analysts, and overseen by regulators. A case
is made for supporting the boards oversight duties with reputational metrics
and signaling value to stakeholders through insurances.
The first two chapters of Part 4 show how appreciation of corporate actions with
respect to the six drivers of reputational value is sensitive to evolving societal
expectations in a qualitative sense, and how the market can observe, interpret,
and value those behaviors through quantitative measures of reputation and
reputational value.
This concluding chapter returns the financial journey to the executive suite and
boardroom. It is here that reputational value figures in three distinct
conversations on business strategies: increasing, protecting, and restoring
reputational value. Here we conclude the journey as we beganwith metrics
and cases, to reinforce the principle that we manage best that which we
measure.
Figure 13-1. Complex multi-stakeholder interactions, observable actions, and expectations

collectively establish corporate reputation value and stock price.
Increasing Reputational Value

The average company has an average reputation. [To increase its reputational
value,] start with what seems to be almost intuitive, suggests Paul Liebman,
formerly Chief Compliance Counsel for Dell Inc., an electronic technology
company. Doing the right thing is the right thing to do.6 Then communicate
what you are doing in a way that stakeholders can recognize, appreciate, and
value. The company that successfully transforms itself from an average
company to one with a superior reputation can expect to realize on average an

additional 6.5% in market capitalization, all other things being equal.
The right thing is for management to put in place systems that advance the
performance of the six business drivers of reputation enumerated in detail in
Table 1-1 and listed again in the preceding section. Systems include policies,
conformance monitoring solutions, and enforcement mechanisms. I learned a
long time ago, shares Robert Rittereiser, formerly CFO of Merrill Lynch and
CEO of EF Hutton, both financial service companies, whatever policies you
have, ultimately, you must have in place processes that enforce those policies.
Having been tasked by the courts to unwind complex failed structures from
financiers ranging from Michael Milken to Bernie Madoff, Rittereiser adds, If
you have a policy you can't enforce, you really don't have a policy.7
The key success metric for these performance systems is that they provide
management with an integrated, holistic view of corporate operations. The
measure of value is the degree with which the transparency created through
these systems can be appreciated and valued by the market.
George Long, Chief Governance Counsel and Corporate Secretary for PNC,
speaking on an unofficial basis, whimsically referred to the gathering of
enterprise-wide data as sideloading.8 With Dr. Urmi Ashar (formerly
president of the Three Rivers Chapter of the National Association of Corporate
Directors), he describes sideloading as a system for building dynamic
networks both intra - and extra-organizationally to share information and
developing efficient, knowledge-based processes that can transcend the
capabilities of an individual. For those out there who enjoy both anagrams and
business jargon, Long quips, I'll say that sideload also has a nice featureit
turns into silo dead." More seriously, he adds, Silos of information [are] a
bad thing in general because [they] keep information hermetically sealed from
other parts of the organization that may need it.
Just as executives protect potentially value-creating information in silos, the C-

suite sequesters potentially value-creating information from the market to
everyones loss. Its really to a companys advantage to explain its
behaviorto explain why its doing thingsbecause in the voidanalysts are
going to make their own decisions and come to their own conclusions,
observes Jonathan Low, a founder and partner of Predictiv, LLC, a management
consultancy.9 Transparency can be a source of value. Our belief has always
been that the returns to transparency exceed the returns to secrecy, says Low.
The social graph requires that companies communicate frequently, openly,
honestly, affirms Linda Locke, founder and principal with Reputare
Consulting, a corporate reputation consulting firm.10
Changes begin at the top and involve building a corporate culture that
acknowledges the expectations of all stakeholders, including society at large. A
culture that incorporates reputation into its governance increases the likelihood
that the operational benefits can be realized. I think you have to get to the
conversation early enough at the board level, says Herbert Winokur, Jr., CEO
of Capricorn Holdings Inc., a private equity group.11 This way the board can
make sure that management is thinking about the reputationthe most
valuable asset of almost every companywhen they make decisions, adds
Winokur, whos more-than-300 board meetings included time with financial
service, energy, and nonprofit groups such as the Harvard Corporation.
Executive compensation today is a variable in reputation and one of the

processes that boards of directors can change in many companies to increase
reputational value. Linking reputation and compensation at the highest levels of
corporation reflects best practices for driving a reputation-focused risk culture
throughout the organization. Linking compensation and clawbacks to a
companys reputation is made easier by systems that quantitatively monitor,
measure, and report reputation to the boards compensation committee.
Systems to help management gain transparency in a company whose board is

setting a reputation-centered tone at the top are tools. The goal, Locke offers, is
to create reputational value by pleasantly surprising the market Reputation is
built on meeting and exceeding stakeholder expectations.10
Employees are among the many key stakeholders whose improved alignment
can help create reputational value. They chart their course in an institution and
adjust their ethical standards on the basis of an institutions culture and how that
culture evolves in the course of their employment.
While it may be intuitive that an average company can exceed stakeholder

expectations, it appears that even a company at or near the top can do so as
well. Apple Inc. is an exemplary firm with a reputation that has so far proven
resilient beyond the mortality of its founder, Steve Jobs.
In transitioning leadership successfully from Steve Jobs to Tim Cook, Apple

communicated to stakeholders that its processes for innovation and operational
excellence were institutional and not located solely in one individual. To do so
was critical and explains how Apple was able to create unexpected reputational
value. When the markets expectations are exceeded, reputational value
increases. The operational benefits associated with Apples multi-stakeholder
focus have helped even this extremely valuable and successful company further
exceed investors expectations.
By the numbers, in 2012 Apple Inc. ranked no. 1 in three of four reputation
surveys and one algorithmic reputation metric described in Chapter 9. Although
in 2011 it also ranked no. 1 among the Worlds Most Admired Companies,
Most Respected Companies, and Corporate Reputation Rankings, it ranked no,
8 in the Reputation Quotient (RQ) rankings and no. 48 in the RepTrak
rankingssuggesting that, at least among members of the general public, there
was room for increasing reputation value. Its Steel City Re reputation metrics
are presented in Chapter 12.
For the trailing 12 months from 23 August 2012, Apple Inc. outperformed the
average of the top 10% of its 25-member industry computer processing
hardware peer group12 (excluding Apple) by 8.3%. The only peer company to
outperform $621 billion Apples 75% return on equity was $0.48 billion Cray
Inc. On 30 August 2012, Crays P/E ratio was 15.61.
Protecting Reputational Value

A reputation whose value is worth protecting must be authentic and not
conflated with a brand. To underscore a key concept in this book, brand promise
and reputation expectation are not the same. Brand is an emotional construct.
Reputation is a cognitive expectation of behavior held by stakeholders.

Investing in the former at the expense of the latter, as shown in the case studies
throughout this book, will not create long-term value and can degrade
reputational value. It risks an inauthentic reputation among customers, which
can lead to great disappointment.
Authentic means understanding what the key drivers of reputational value are,
above and beyond ethics. For example, in the technology sector case study in
Chapter 4, innovation was the dominant reputation pillar. In the aircraft power
plant business case study in Chapter 3, safety was the critical reputation asset.
In the jewelry case study in Chapter 3, a reputation for quality meant a
consistent customer experience with a trustworthy salesperson.
Protecting an authentic reputation means having systems to align the global

workforce with the best interests of the company, provide operational
transparency, and provide visibility. It also means having media-monitoring
systems that can provide indications of pending reputational crises. It is
important to remember that operational failures will invariably happen. With
proper preparation and quick action, reputational crises do not necessarily have
to follow them.
In a globally integrated manufacturing operation, a reputation is the product of

superior engineering design and risk management, which includes top notch
supply chain oversight and operational controlsystems comprising policies,
conformance-monitoring solutions, and enforcement mechanisms. In a global
service operation, a reputation similarly rests on supplier engagement and
earning the designation of a preferred customer. Disney explicitly believes
that its supply chain is a source of reputational value. The company has an
ongoing initiative to operationalize a holistic strategy on the supply-chain
resilience side that we believe is [already] helping to protect our reputation,
says Scott Childers, Director, Integrated Trade Management at The Walt Disney
Company.13 Total global operational visibility, the next frontier in risk
management, will help the company build on processes that Disney has had in
place for many years and further increase the value of that risk mitigation and
[help] communicate the value upwards and outwards related to Disneys value
overall, adds Childers. The resilient organization manages its entire supply
chain from the perspective of its customers, explains Locke, because a failure
at any point is blamed on the company.10
One strong motivation for developing systems that capture information from all
supply chain partners is that the volume of information is beyond the
management capacity of humans. Long notes that McKinsey, the consulting
firm, estimates that enterprises stored more than 7 exabytes of new data in
2010. One exabyte is equal to 4,000 times the information in the U.S. Library
of Congress. You need to identify where all the points of information come
in, adds Long.8
When a reputation is compromised, the value proposition for a stakeholder may

vanish. When multiple stakeholders perceive failure, a firms once stellar
reputation may be permanently damaged, with diminished enterprise valueif
not overall company viability.
Organizational culture, the driver of reputation, is a force that can reduce the
variances of otherwise unconstrained behaviorsbut only to the extent that
management and the board take the care (technically, a duty of loyalty) to both
oversee and enforce it. Ignorance, under U.S. Delaware corporate law, is
tantamount to culpability. A strong culture that establishes organizational
norms, and a board of directors that will support management even in the face
of placing revenue at risk, are essential for driving consistently ethical behavior
and mitigating the risk from rogues.
Nevertheless, operational failures will occur. They are not crises, according to
Winokur, who served for 15 years on the board of Enron, the failed energy
services company. Crises arrive, by definition, when youre not expecting
them. They are something outside the status quo.11 Knowing when an
operational failure is becoming a reputational crisis is a key reputational value
protection strategy.
There are several signs of a pending reputational crisis, says Richard S.

Levick, president and CEO of Levick Strategic Communications:14
Search engine results on terms specific to a companys business,

products, or people, and linked to websites belonging to the plaintiffs
bar, regulators, and activist nongovernmental organizations (NGOs)

appear at higher levels of relevance.
High-impact bloggers use terms specific to a companys business,

products, or people in an adverse context.
Terms specific to a companys business, products, or people appear

with Twitter hashmarks.
Reputational value metrics that sense the economic consequences of

media effects on stakeholders show increased volatility. (item added by
author).
These cardinal signs tell you that things are starting to heat up. Its pack
journalism just like Timothy Crouse described in The Boys on the Bus.14
Christopher Teas, managing director of Southport Lane, a private equity firm,
explains it this way. As the vast volume of information from the Internet
overwhelms peoples ability to process, they end up parroting the views of those
they trust.15
Monitoring the evolution of an operational crisis and being ready to address the
fallout are managerial imperatives. Having a rapid cross-functional response
team is crucial, noted Long.8 Levick agreed that a key success factor is
preparing well in advance of a crisis.14 The mantle of leadership in a crisis,
however, needs to shift to the board, says Winokur. When something unusual
happens, the executive floor becomes essentially a third- or fourth- grade soccer
team where everybody goes for the ball. Boards need to take early ownership
of the crisis response so that management can continue running the company.11
The boards assumption of crisis management is essential when the reputation

of the C-suite is at risk. In many cases, the CEO is held to a higher standard
than other employees, notes William Hernandez, a director of Kodak, Black
Box, and several other firms.16 It may be unfair, but as Low declares,
Personal behavior of every kind is increasingly a public matter. Get used to it.17
The Walt Disney Company has had its surprises from the supply chain, and its
CEO has been the object of scorn from Institutional Shareholder Services. The
company has successfully protected its reputation, as shown by the numbers.

Disney, an $88-billion media and entertainment conglomerate, ranks highly
among the various reputation surveys and algorithmic measures. In 2012, it
ranked 13th among the Worlds Most Admired, 11th among the Worlds Most
Respected, in the 97.7th percentile in the Corporate Reputation Rankings, 6th in
the RQ rankings, and 17th on the RepTrak rankings.
According to the Steel City Re reputational value metrics reported in Chapter

12, Disney raised its Reputation Value measure over the trailing 12 months by
0.17 Gerken Units (GU), an increase of 25%. Its reputational value volatility of
1.5% was at the median of its 11-member media conglomerate peer group,12 and
its return on equity of 42.4% was at the 88th percentile and 18.4% greater than
the median return of its peer group. On 30 August 2012, its P/E ratio was 16.34.
Restoring Reputational Value

Because a reputational crisis will shave an average 7% from a companys
market capitalization, reputational value restoration can yield a net additional
average of 13.5% in market capitalization. The incentives are transparent; the
pathway is formulaicprovided that its execution is authentic by the following
measures.
Identify the root cause of the process failure that

precipitated the adverse media events that are central to
reputational damage.
Identify key stakeholders and assure them that, having

identified the root cause, the company is taking immediate
action to rectify the problem while mitigating risks to all
stakeholders. Implementing authentic operational controls
linked to reputation risk and value is an exemplary
demonstration of ongoing restoration of reputation. Davia
Temin, president and CEO of Temin and Company
Incorporated, a communications consultancy, says Any
time you have a reputational crisis of any kind the best
companies, the best organizations, and the best industries
take that seriously and start putting in fixes themselves.18
Develop, implement, and promote industry-wide adoption

of process controls that can ensure that neither your firm,
nor others in the industry, will have to suffer the
consequences of a similar failure in the future.
As with all reputation-related activities, they must be authentic and they must be
executed so as to be recognized and valued by stakeholders. The challenge with
financial service firms after the 2008 crisis, adds Temin, is that the industry
waited to have the government put in the fixings for them and vilify them
some more.
When trust is violated, as it was with the financial industry, authenticity may
require a third partys validation. Properly designed reputational insurances can
help signal authenticity to stakeholders.
By the numbers, AIG, a $58 billion insurance company, ranks poorly in

reputational surveys. In 2012, it ranked only in the 6th percentile among 138 of
the Worlds Most Admired, 60tha critically poor rankingin the RQ
rankings and 144th on the RepTrak rankings.
On the other hand, it ranked in the 78th percentile of the Steel City Re
Corporate Reputation Rankings and appears by those algorithmic metrics to be
on track to restoring its reputation. Similarly to Disney, it raised its Reputation
Value measure over the trailing 12 months by 0.10 GU or 23%. Its reputational
value volatility of 7.4% was at the 92nd percentile of its 43-member multi-line
insurance company peer group. Its reputational value velocity was a strong
20.6%, and its return on equity of 24% was at the 88.5th percentile and 24.7%
greater than the median return of its peer group. Additional reputational metrics
indicating reputation restoration are reported in Chapter 12.
The reputation metrics suggested that AIG was making changes. With its P/E
ratio of 2.99 in mid-August 2012, there was ample reward available if that
multiple were to be raised through the full spectrum of reputational value
restoration efforts.
By the NumbersHighlights
Mindful of Bernsteins maximthe plural of anecdote is not datathis
book provides quantitative data evidencing the reputational value to be gained,
placed at risk, or lost, in the context of a diversity of stakeholder behaviors.19
Table 13-1 highlights some of these data.
Table 13-1. Selected Measures Discussed in Prior Chapters
Chapt Source Descriptio Measure

e n
r
2 BPs 2010 crisis Regulatory 50 hearings; 80 bills; and $15$25 billion in fines
burden and penalties
2 BPs 2010 crisis Creditor Liquidity crisis; net cost of credit 16% increase
response over 2009; credit default swap spreads August
2012 about 35 basis points higher (70% higher)
than March 2010
2 BPs 2010 crisis Investor Two board members not reelected; three
response derivative lawsuits; and friction over future CEO
compensation; net $54 billion in lost market
capitalization
3 Rolls-Royce Sustained Stock price effectInterval Gains (Losses)

reputational sales volume
value dividend and pricing Rolls- S&P500
power Royce
01-Nov- 0 0 01-Nov-10
10
15-Nov- (8.7% 1.1% 15-Nov-10

10 )
4 Apple Inc. Employee Store sales are 280% more efficient than the
reputational productivity average of a reference group.
value dividend and costs

Selling, General, and Administrative Expenses
(SG&A) costs are 65% lower than at Microsoft
4 Goldman Sachs Employee Average deal size 15% larger than the average of
reputational productivity its peers; total deal value 42% greater than the
value dividend and costs average of its peers.
Operating costs per $/revenue no less than 4%
lower than average of rivals
5 Supply chain Customer of 2%4% lower cost of goods sold

reputational choice status
value dividend
5 Toyota Motors P&L effects Credit default swap prices up 0.6%0.7%

crisis
16% fall in monthly sales
14% fall in annual market share
3% fall in secondary market pricing power
(inventory value)
Total P&L impact $2 billion
6 Creditor Credit costs All other things being equal:

reputational
value dividend Credit spreads for the largest companies
with the best reputations (Fortune) are
~0.75% lower than the prices for those with
the worst reputations.
CDS prices for the largest companies with the
best reputations (Barrons) are ~0.60% lower
than the prices for those with the worst

reputations.
7 Equity investor Market cap Average annual market cap boost of 6.5% over
reputational effects of an 10-year study period
value dividend unexpected
boost in
reputation
7 Equity investor Effects on Correlation of investor respect metric with CEO

reputational CEO pay salary: $800,000 per full notch up.
value dividend
8 Board-level Most recent 50% per year increase

reputation risk annual rate of
awareness disclosure of 71% of the S&P 500 as of June 2012
corporate
reputational
risk
8 Compensation Fraction of 11%

committee CEO bonus at
adoption of UBS linked
reputation- to measures
linked of reputation
incentives
9 Survey-based Correlation 21%

reputation of rankings
rankings from the
general
public with
rankings
from the
professional
business
community
10 Regulatory costs Estimated $69.4 million

average fine
for Foreign
Corrupt
Practices Act
violations
12 Metrics Correlation 21%94%

among a
diversity of
reputation
ranking and
reputational
value metrics
1Hillenbrand C, Money K. Corporate responsibility and corporate reputation: two separate

concepts or two sides of the same coin? Corporate Reputation Review. 2007; 10:261277.
2Modern lessons from Hillel. NPR. 7 September 2010.

http://www.npr.org/templates/story/story.php?storyId=129706379. Accessed 29 August 2012.
3Smidts A, Pruyn TH, Van Riel CBM. The impact of employee communication and perceived
external prestige on organizational identification, Academy of Management Journal. 2001;
44(5):10511062.
4Carmeli A. Perceived external prestige, affective commitment, and citizenship behaviors.

Organization Studies.2005; 26(3):443464.
5Dutton JE, Dukerich JM, Harquail CV. Organizational images and member identification.
Administrative Science Quarterly. 1994; 39:239263.
6Liebman P. Is ethics a valuable intangible asset? Mission Intangible Monthly Briefing. 9 April
7 Rittereiser RP. Process-driven reputation risk in supply chains. Mission Intangible Monthly
Briefing. 7 May 2010. Audio recordings available from the Intangible Asset Finance Society:
8Long G. Who knows what institutional memory and the role of the sideload. Mission Intangible
Monthly Briefing. 4 November 2011. Audio recordings available from the Intangible Asset
Finance Society: http://iafinance.org/monthly-briefings. Accessed 5 October 2012.
9 Low J. Is ethics a valuable intangible asset? Mission Intangible Monthly Briefing. 9 April 2010.
Audio recordings available from the Intangible Asset Finance Society:

10Locke L. Creating reputation value. Mission Intangible Monthly Briefing. 2 March 2012. Audio
recordings available from the Intangible Asset Finance Society: http://iafinance.org/monthly-
briefings. Accessed 8 October 2012.
11Winokur HS. Protecting reputation value. Mission Intangible Monthly Briefing. 13 April 2012.
12 Industry standard groupings provided by FACTSET.
13Childers S. Process-driven reputation risk in supply chains. Mission Intangible Monthly

Briefing. 7 May 2010. Audio recordings available from the Intangible Asset Finance Society:
14 Levick RS. Protecting reputation value. Mission Intangible Monthly Briefing. 13 April 2012.

15Teas C. Wall Street, volatility, and reputation. Mission Intangible Monthly Briefing. 4 May
16Hernandez W. Sex and the CEO. Mission Intangible Monthly Briefing. 8 June 2012. Audio
recordings available from the Intangible Asset Finance Society: http://iafinance.org/monthly-
briefings. Accessed 5 October 2012.
17Low J. Sex and the CEO. Mission Intangible Monthly Briefing. 8 June 2012. Audio recordings
available from the Intangible Asset Finance Society: http://iafinance.org/monthly-briefings.
Accessed 5 October 2012.
18Temin D. Wall Street, volatility, and reputation. Mission Intangible Monthly Briefing. 4 May
19Bernstein IS. Metaphor, cognitive belief, and science. Behavioral and Brain Sciences.
1988;11:247248.

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Table of Contents

<strong>Introduction (15 pages)

Anatomy of a Reputational Crisis

Reputation-Impacting Corporate Behaviors

Table 1-1. The Six Key Business Processes Underpinning Reputation5

Innovation The design, invention, development, and/or implementation of new or altered

Quality The extent to which a product is free from defects or deficiencies.

Reputation, Marketing, and Crisis

Reputation and Risk Management

Reputation is a consequence of corporate behavior that motivates stakeholders to behave in

Organization of the Book

For example, we make no judgment on what ethical behavior is. A vast

at: http://www.nytimes.com/2010/06/16/business/16oil.html. Accessed 14 June 2012.

Available at: http://features.blogs.fortune.cnn.com/2011/01/24/bp-an-accident-waiting-to-happen/

Available at: http://www.popularmechanics.com/science/energy/coal-oil-gas/bp-oil-spill-

enterprise value. Pittsburgh/Vancouver: Intangible Asset Finance Society/Trafford, 2010.

http://www.economist.com/node/21553033. Accessed 22 July 2012.

October/November 2003 (43). Available at:

Canberra Times (31 July 2012)

Headline Risk: Reputation vs. Reality

BPs observable actions affirming a commitment to sustainability were

He committed to increase the companys attentiveness to safety. Just a few

Reputationally Linked Process Failure

marine life, and threatening the livelihood of tens of thousands of fisherman,

concurrent suggestions that BP had pressured the British government into

BP Executives and Board of Directors

Capital Market Analysts

Reputational Value Lost: Summary

Cost Item per Barrel 2010 (%) 2011 (%)

Purchases (expense) 41.57 80.86

Production and manufacturing expense 198.63 7.92

Exploration expense (19.00) 41.24

Finance costs 13.03 16.41

Our development and application of technology represents [sic] a distinctive

We monitor the potential opportunities and risks presented by emerging

In 2011, the company deployed a multi-tiered risk-management solution to

safety, environmental risk, physical security, product quality, cyber security,

Restoring a reputation entails more than marketing.

Stakeholder Effects on BP plc

Employees Morale: overall employee satisfaction index score (BP internal

Vendors and suppliers $94 billion in additional expenses

(70% higher) than March 2010

Investors Two board members not re-elected; three derivative lawsuits;

Board of Directors Additional responsibilities; new compensation plans with

Analysts Credit downgrade: S&P AA (stable outlook) before the event to

Regulators 50 hearings; 80 bills; and $15$25 billion in fines and penalties

All stakeholders combined Net $54 billion in lost market capitalization

Available at: http://features.blogs.fortune.cnn.com/2011/01/24/bp-an-accident-waiting-to-

Available at: http://www.nytimes.com/2009/10/31/business/31labor.html. Accessed 22 July 2012.

at: http://publicintelligence.net/bp-gulf-of-mexico-regional-oil-spill-response-plan/ Accessed 15

Available at: http://www.newsvine.com/_news/2010/05/05/4243815-gulf-oil-spill-yet-to-affect-

Available at: http://www.economist.com/node/16381032. Accessed 16 June 2012.

2011. Available at:

Available at: http://www.ft.com/intl/cms/s/0/a51cfcbc-ec0c-11df-b50f-

July 2010. Available at:

2012. Available at: http://www.guardian.co.uk/business/2012/apr/11/bp-shareholder-revolt-bob-

March 2012. Available at: http://www.huffingtonpost.com/2012/03/09/bp-oil-spill-fines-