In this month's issue of IAM magazine, #48, the regular contribution on reputation explains how this epiphenomenon can provide management with freedom to operate. In the words of editor Joff Wild, who also recently penned a much appreciated shout out, "Although it is intangible, reputation allows businesses and executives operational freedoms that lead to very tangible results."

Now for an update from the National Association of Corporate Directors. According to their daily newsletter, NACD Directors Daily (13 July), "In an rare example of how 'say-on-pay' votes can influence companies' relationships with some shareholders," Cincinnati.com (July 12, Boyer) reports that "a lawsuit has accused Cincinnati Bell Inc.'s outside directors of breaching their duty to investors and the company's top executives of 'unjust enrichment' over pay raises granted last year." The raises range from 54 percent to 80 percent for three of the company's top officers despite a 68 percent drop in 2010 net earnings. A non-birding shareholder vote in May opposed the pay raises. "The lawsuit was brought in U.S. District Court in Cincinnati last week by attorneys for the Illinois-based NECA-IBEW Pension Fund, a Bell shareholder," the website reports. "It seeks a court order and unspecified damages on behalf of the corporation, possible return or impoundment of the pay increases, and implementation of internal controls preventing excessive compensation to the company's top executives."

We've discussed "sue-on-pay" before. And we will again. It appears compensation is evolving into a contact sport.

NB: Further to recent queries from attentive followers of this blog, Huygen's will opine on the reputational crisis gripping News Corporation (NASDAQ:NWSA) presently.

In the current issue of IAM magazine (Vol 48, Jul/Aug 2011), Steel City Re's Nir Kossovsky observes that a strong reputation creates freedom to operate. No where is this more important to many managers than in the area of executive compensation. As IAM summarizes, although it is intangible, reputation allows businesses and executives operational freedoms that lead to very tangible results.

Now we have this from the National Association of Corporate Directors newsletter, the NACD Director's Daily (1 July 2011):

"Companies may not have to abide by shareholder advisory say-on-pay votes mandated under the Dodd-Frank Act," the Wall Street Journal (June 30, Chasan) notes, "but lawyers specialized in securities class action suits have already brought a half dozen suits against directors and executives for ignoring their results." A number of firms have tried to settle the claims quickly. Among the companies that have settled include KeyCorp and Occidental Petroleum. Others facing suits are Beazer Homes, Hercules Offshore, and Umpqua Holdings. Law firms also have investigations pending at Dex One, Masco Corp, and Stanley Black & Decker, among others. "In addition to legal fees," the Journal states, "the suits could impact companies more widely in areas like the cost of director and officers liability insurance, and how much compensation consultants charge."

Huygens suggested previously (1 July 2010) that low reputational rankings might have explained the say-on-pay verdicts at KeyCorp. Taking now all into account, perhaps executives will find the arguments to enhance corporate reputation that much more compelling?

Earlier this week, the Supreme Court of the United States (SCOTUS) addressed an issue that has been a persistent thorn in Walmart's reputation - allegations of gender bias. The firm, which has reportedly shed up to 10% of its market capitalization over the years due to stakeholder unease with a range of labor practices, breathed a sigh of relief. According to the newsletter of the National Association of Corporate Directors (21 June):

"The Supreme Court threw out a sweeping sex-discrimination lawsuit against Wal-Mart Stores Inc.," the Wall Street Journal (June 21, Bravin, Zimmerman) confirms, "ruling Monday that the 1.6 million women allegedly victimized had too little in common to form a single class of plaintiffs." The court ruled 5-4 along its ideological divide, concluding the allegations against the retailer were too vague and the evidence too weak to establish the common injury essential to encompass all females employed since 1998 in the nearly 3,400 U.S. Wal-Mart stores. "The decision is sure to reverberate in other employment class actions," the Journal states. Attorney John Fox says the impact of the ruling on other cases will depend in part on companies' personnel policies.

With this decision, the New York Times (June 21, Greenhouse) reasons, the Supreme Court has significantly tightened the rules for how a large group of individuals can join together to sue a corporation for alleged harm done to them. "The court's decision will not just make it harder to bring big, ambitious employment class-action cases asserting discrimination based on sex, race or other factors," the Times reasons. "The court set higher barriers for bringing several types of nationwide class actions against a large company with many branches." Robin S. Conrad, executive vice president of the U.S. Chamber of Commerce's National Chamber Litigation Center, applauded the high court for affirming that mega-class actions are inconsistent with federal law. He added, "Too often the class-action device is twisted and abused to force businesses to choose between settling meritless lawsuits or potentially facing financial ruin."

The Montgomery Advertiser (June 21, D'Innocenzio) concludes that despite the legal victory, Wal-Mart has taken steps to address the issues raised in the suit. "Since the sex-bias lawsuit was given class action status in 2004 on behalf of 1.6 million women," the newspaper points out, "Wal-Mart Stores Inc. has set up a women's council that represents each of the overseas markets and focused training and other efforts on advancing women into management roles. As a result, Wal-Mart says the percentage of entry and midlevel women managers has increased over the past five years from 38.8 percent to 41.2 percent." Gisel Ruiz, executive vice president of people at Wal-Mart's U.S. stores, confirms that she has definitely seen the advancement opportunities grow for women. Specifically, she noted that Wal-Mart has created a series of training and mentoring programs to help prepare women for opportunities at all levels of the company.

Turning to the reputation metrics, the Steel City Re Corporate Reputation Index shows that Walmart's reputation has been unusually volatile over the trailing 12 months. Of the fourteen companies comprising the Discount Store sector, the company's metrics currently rank it in the 61st percentile thus matching its ranking at the beginning of this period. Walmart did exhibit a small uptick this week thanks to the court ruling. Over the trailing twelve weeks, however, its reputational volatility velocity has been negative at -15% and its vector has been negative at -11% as its exponentially weighted moving average volatility has climbed to 100%. These reputational challenges are associated with an overall economic under performance that is 15.9% below the median of its peer group.

The sector, too, has experienced significant volatility as of late in what is a rather volatile period for the equity markets (risk assets). The variance in reputation ranking metrics among the peer group has been extreme ranging from a low of 10% to a high of 25%. The VIX (S&P 500 Volatility Index) closed June 23 at 19.29 having bounced over the trailing twelve months between 14.27 and 37.58.  None of this is good for Walmart, whose fractional intangible asset value has now slightly dipped below the median of its peer group.

A few weeks ago, two of the biggest names in technology found themselves grappling with huge and potentially embarrassing debacles. As the Economist newspaper (28 April) summarized in their colorful headline, Online reputations in the dirt, on 26 April, "Amazon’s finance chief, Thomas Szkutak, said the firm was still trying to get to the bottom of a glitch that caused numerous websites it hosts for other businesses to crash or run painfully slowly during the previous week. The same day, Sony of Japan revealed that names, addresses, passwords and possibly credit-card details of 77m accounts were stolen when hackers gained access to the network it runs in 60 countries for its PlayStation online-gaming system, as well as for Qriocity, a service offering music, films and television shows.”

Reputation, of course, is the amalgam of impressions held by stakeholders, and it is shaped by such intangibles as these six (6): the means by which a company fosters ethical conformance, innovates, assures quality; and assures safety, sustainability and security. Business processes, really. And reputation manifests in many ways. Importantly, it sets expectations.

Of these six reputation drivers, Amazon faced a quality issue while Sony faced a security issue. The reputational consequences to these two companies are explained, in part, by stakeholders’ preexisting expectations, the degree to which those expectations were impacted by events, and the nature of expectations set going forward. Related, in that like reputation, it is forward looking, is the equity market’s reaction to these two different reputational experiences.


The Amazon reputational experience following the quality event shows increased volatility these past few weeks that is actually less than historic reputational volatility. In other words, stakeholders as a group seem overall unimpressed over background levels. As such, the equity jump is less surprising than it would be otherwise. It reflects the fact that Amazon suffered a reputational even and was resilient (relative to its baseline).

The experience at Sony is quite different. Sony's baseline reputational volatility is almost an order of magnitude less than Amazon's, and its reputation ranking is near the top of the peer group. Its stakeholders believe they have a good sense of what drives the company, and the degree to which it is a state of control. Equity investors, however, don't appear to understand how such a major security event could occur in the setting of what reputationally would appear to be a company in control. Their response is panic, and in our interpretation, suggests that Sony is now undervalued by the equity markets.

Turning to crude metrics of fractional intangible asset value, Amazon is almost purely intangible and thus the high degree of volatility is not too surprising. There may be much upside, but -- excluding IP -- there is probably no floor to the downside

Sony, in contrast, has a surprisingly small intangible asset fraction that is far lower than the median of its peer group. The large book value fraction of the company's value speaks to the relative stability of its economic metrics, but the huge drop from 40 to 20% intangible, as with the drop in stock price, is unreasonable for a company with such iconic brand and technology prowess.

Perhaps it is the overlay of the background geophysical crises in Japan that is making Sony's equity investors especially jumpy?

Warren Buffet is well known and much respected for his earthy aphorisms. He is admired for his lofty valuation. Berkshire Hathaway (NYSE:BRK), an insurance-based conglomerate has been rewarded historically with outsized intangible asset values owing to the reputation of its founder. Those valuations are approaching the median of the Property and Casualty Insurance sector and the polish continues to come off.

What is the evidence? The man who made reputation management a "household" phrase in the C-suite and boardroom, who famously said, "“If you lose dollars for the firm from bad decisions, I will be very understanding. If you lose reputation for the firm, I will be ruthless,” is named in a shareholder suit alleging -- you guessed it -- loss of reputation for the firm.

The National Association of Corporate Directors NACD Daily (April 20), a compilation of other news sources, shares that "Warren Buffett and the rest of Berkshire Hathaway Inc.'s board of directors were sued by a shareholder Tuesday over presumed heir apparent David Sokol's trading in the stock of a company that was later bought by Berkshire," the Montreal Gazette (April 20, Hals) reports. Sokol, who purchased shares of Lubrizol Corp. before pitching the company as a possible acquisition, was also named in the lawsuit. He resigned from Berkshire Hathaway last month. "The lawsuit filed by Berkshire shareholder Mason Kirby in Delaware's Chancery Court calls for Sokol to give up any improper gains to Berkshire," the Gazette notes. "It also calls for Buffett and other directors, including vice-chairman Charlie Munger, to compensate Berkshire for the damage they caused to the company's reputation and goodwill."

In total, the Omaha World-Herald (April 20) states, Sokol purchased just over 96,000 shares of Lubrizol in early January prior to recommending that Omaha-based Berkshire acquire the company. In the suit, Kirby charges: "Sokol knew that Buffett would closely consider and likely take his recommendation. As a result of Sokol's unethical behavior, Berkshire suffered significant reputational losses and other damages."

The metrics affirm that something is up. The reputational value changes to the Steel City Re Corporate Reputation Index rankings noted two weeks ago persist, and both the reputation volatility and vector trends are on track upwards and downwards respectively.

Most telling, however, is that the loss of intangible asset fraction now makes the Company look like a typical property-casualty insurer. Sure, relative to other conglomerates, the Company's intangible asset fraction of some 10-20% was materially below the peer group's median. But seen as an insurer, the Company had a 20% higher valuation.

That valuation ascribable to intangibles, what we call for lack of a better term "reputation," is disappearing quickly (see asterisk below). Berkshire Hathaway's lofty intangible asset valuation is coming down to earth.
 

As an iconic firm with a damaged reputation, you should expect to be in the cross hairs when stakeholders need to make a point. This is especially true when the stakeholders are elected officials. Such was the case with British Pinata, and apparently so with Goldman Sachs.

According to the daily newsletter of the National Association of Corporate Directors (15 April 2011), TheStreet.com (April 15, Woelfel) confirms that the SEC "is in talks with several major Wall Street banks to settle fraud allegations related to mortgage-bond deals that helped begin the financial crisis," with some of these settlements to be reached as early as next week. Others, meanwhile, could take months. The banks in the negotiations range from JPMorgan Chase and Citigroup to Morgan Stanley and Merrill Lynch. According to the website, "The SEC is aiming to reach a series of settlements with individual firms over the sales of the investments, rather than a big industry-wide deal." The settlements will likely vary significantly among banks. Few, if any though, are expected to be more than the $550 million penalty Goldman Sachs paid out in 2010 to settle SEC charges.

The newsletter adds an observation from the Wall Street Journal (April 15, Eaglesham), that "The cases highlight the aggressive tactics banks used to sell these securities to investors who suffered big losses. They also show how the banks' desire to keep the $1 trillion mortgage securities business going helped fuel the housing bubble." According to the newspaper, the settlements come amidst "mounting political pressure on the law-enforcement agencies to take more aggressive action against Wall Street over the financial crisis." Considering the damage done to Goldman's share price when the securities firm was sued by the SEC last year, the various banks will likely be keen to reach deals rather than get involved in an extended public fight with the agency.

Reuters (April 15, Prasad) concludes, adds the newsletter, "The regulator's decision to go for individual settlements reflects substantial differences in the nature of the civil fraud allegations faced by each bank." All of the banks named in the report have so far declined to comment.

But the stakeholders are commenting, and the metric that captures those comments is 'Reputation.' The Steel City Re Corporate Reputation Index Rankings show that over the trailing twelve months, Goldman Sach's reputation ranking dropped just a hair from the 94th percentile to the 93rd percentile relative to the 231 peers comprising the integrated Multi-bank Holding and Security Brokerages sector.  Of course, still visible is the short-term catastrophic drop in reputation to below the 50th percentile nearly one year ago. But such resilience. Note that the exponentially weighted moving average volatility of Goldman Sachs' reputation is less than 1%.

Goldman's been in the cross hairs for a year, and stakeholders are no longer worried about surprises. JP Morgan, one member of the list of "others," is relatively new to this particular game (though no babe in woods by Wall Street standards). Over the trailing twelve months, its reputation index ranking has dropped from the 90th percentile to the 76th percentile relative to this same group of peers, and its exponentially weighted moving average of index volatility is only now calming down to around 3%, although over this past week, its reputation vector went negative hinting at more volatility.


Reputation is linked to economic performance, of course, but it is not synonymous with either net cash flow nor balance sheet size (or intangible asset fraction) -- rather, reputation provides measurable additional juice, all other things being equal.

 Over the trailing twelve months, Goldman's superior reputation did not prevent the company from underperforming its peers by 10% -- a number attributable in part to the $0.5B fine the company paid for the alleged aggressive behavior noted above. JP Morgan, on the other hand, outperformed it peers by less than 1%.

With respect to the intangible asset fraction of enterprise value, Goldman Sachs' valuation is supported by a few more book assets (read, lower intangible asset fraction) relative to the median of the peer group as of late, while JP Morgan is on the other side of the mean with a greater intangible asset fraction value.



 

The Financial Times is concerned that the nuclear crisis in Japan may adversely impact the reputation of General Electric (NYSE:GE).

According to the FT, GE designed the Mark 1 boiling water reactors (BWR) used at the Japanese plant, and supplied the No 1 and No 2 units that went into service in the early 1970s. It has also had engineers at the site up until last week; a team of 44 had been working on maintenance at the shut-down No 4 reactor when the earthquake hit. GE’s nuclear operations are now part of a joint venture with Hitachi of Japan that has two businesses: Hitachi GE Nuclear Energy, which is owned roughly 80-20 by the Japanese and US groups, and is based in Japan, and GE Hitachi, which has 60-40 US-Japanese ownership and covers the rest of the world.

Although the businesses are formally separate, they are closely linked. As well as the 70 people working on the crisis in North Carolina, they have a centre in Tokyo, near the Japanese government’s main response centre, to provide technical support and advice. You can read the balance of the FT article here.



Looking at the reputation metrics, GE’s ranking has been sliding as of late. The Steel City Re Corporate Reputation Index shows that after a steady rise, GE’s ranking shows a net drop over the trailing twelve months from the 60th percentile to the 50th percentile among its 86 peers of General Diversified companies. Consistent with the FT's concerns, the exponentially weighted moving average of the reputation ranking has been climbing lately and measured this past week at just above 6%.

The ten point slide in the Corporate Reputation Index has been associated with a trailing twelve week reputation velocity of -14% and a trailing twelve week reputation vector of -0.8%. Both, being signs of significant reputation volatility, reflect especially acute changes over the past week and suggest growing concerns about GE's reputation for design quality and safety excellence - key intangible assets in the nuclear reactor construction industry.

Now to bring this all back to finance. While GE has been outperforming its peers recently, as of 17 March, its return on equity over the trailing twelve months is only 2.3% greater than the median of its peer group. And it is trending negative.

Seconds after Rajat K. Gupta, then a director of Goldman Sachs, finished up a board call during which he learned that Warren E. Buffett had agreed to invest $5 billion in the firm, he picked up the phone and called his friend Raj Rajaratnam, regulators contend. Minutes later, Mr. Rajaratnam placed bets on shares of Goldman Sachs that netted his firm, the Galleon Group, $900,000. As Andrew Ross Sorkin’s Dealbook observes, “The fact pattern looks bad, very bad."

Gupta has resigned from the boards of Harman International Industries Inc. in the wake of the SEC's accusations. He has also resigned from the boards of AMR Corp., Genpact Ltd., and Procter & Gamble. It is a rapid fall from grace. In October, Alan Lafley, the former chief executive of Procter & Gamble, described Mr. Gupta thusly. “I think of him like Thomas Aquinas,” the philosopher and priest.

This is why. Gupta has a far longer and more important connection to the world’s most prestigious consulting firm, McKinsey. He worked at the firm for 34 years, eventually rising to become its managing director—the McKinsey equivalent of chief executive. He was elected to the top job at McKinsey by his fellow partners at the firm for three consecutive terms—the maximum allowed by the firm’s rules. NetNet's John Carney worries that Rajat Gupta may destroy McKinsey.  Or at least generate bad publicity for the Firm.

McKinsey, which has watched this story grow over time, is also worried. On 4 March, the day Lloyd Blankfein, CEO of Goldman Sachs, agreed to testify for the U.S. government at the coming trial of Rajaratnam, McKinsey posted a job opening for a reputation risk specialist whose major responsibilities are described thusly:

1. Monitor globally public references to McKinsey, select clients or specific issues appearing in media and consumer generated media (CGM)/ social technologies, which are potential or actual reputation risks for the Firm
2. Collaborate with the Director of Reputation Risk Management to help report key reputation risks
3. Collaborate with the Reputation Risk Management team to help research and prepare for potential and actual situations:

This job may be based in Brussels, Belgium, London, UK or New York, NY

Learn More

If the above moves you to action, but you are not sure what that action should be, consider joining the conversation at the Society's Mission Intangible Monthly Briefings. Our 1 April program is titled, How reputation drives principled performance ; our 6 May program is titled: Economic value of trust.

In an August 2010 post, Huygens observed that St Joe (NYSE:JOE), the real estate firm, was pursuing a litigation strategy to rebuild value allegedly lost to environmental challenges affecting the Gulf of Mexico. Many other firms were pursuing the same strategy, of course, but only a few had reputation rankings that were approaching "0." It was a metric that screamed for attention, and apparently certain key stakeholders thought so as well.

From the  National Association of Corporate Directors "Director's Daily", we quote:

"The chief of embattled Florida real-estate developer St. Joe Company agreed to resign along with three board members yesterday," the New York Post (March 1, Whitehouse) reports, "marking a victory for the company's largest shareholder, investor Bruce Berkowitz." Berkowitz, who heads mutual fund firm Fairholme Capital Management, has been fighting to save his 30 percent stake in St. Joe for months while vying with hedge-fund manager David Einhorn. Einhorn targeted St. Joe last fall. "The challenge spurred Berkowitz to join the company's board only to resign a few weeks later," the Post notes, "citing concerns about the board's commitment to 'shareholder value, pay for performance and effective corporate governance.'" Berkowitz launched a campaign to replace St. Joe's board with his own candidates instead of selling his ownership interest and siding with Einhorn. On Monday, he emerged the victor. St. Joe CEO Britt Greene has agreed to resign by the end of this week, and the firm has hired an executive search firm to help it find a successor. In addition, Greene stepped down from the board along with three other directors. "In their places," the Post concludes, "St. Joe will add four new directors proposed by Berkowitz, including Berkowitz" himself. Additionally, St. Joe will engage an executive search firm to find at least one additional independent director.

The Wall Street Journal (March 1) notes, "The board's capitulation happened suddenly as it appeared to be dug in for a long battle." Indeed, the first hint that Fairholme might win came a week ago when Fairholme stated in a regulatory filing that it was "in discussion" with the board about possible changes -- changes that were delayed while the company's existing board negotiated the terms of Greene's resignation. St. Joe's Hugh Durden, who will remain in place, remarks, "St. Joe is committed to acting in the best interests of shareholders, and in light of the feedback the Board of Directors has received, we are taking steps to change the Company's governance and leadership."

Turning to the most current reputation metrics for St Joe, the Steel City Re Corporate Reputation Index ranking as of last Thursday, 24 February, was zero relative to the 88 firms in the Land and Real Estate sector.

The exponentially weighted moving average of its reputation ranking was 0.1%, its trailing twelve week reputation velocity was -1%, and its trailing twelve week reputation vector was -.40%. In short, a chronically poor reputation. Economically, the company underperformed the median of its peer group over the trailing twelve months by 25.48%.

Looking at the sector as a whole, St. Joe's reputation ranking is at the bottom of a group whose reputation ranking over the past year has risen relative to the broad market, although there is greater than average internal variance. Last, while the intangible asset fraction of the sector rose to around 15% on average (from negative values in the early summer), St. Joe's fraction of around 60%, while much greater than that of the group overall, declined slightly.

On Monday 14 February, Barron’s released its list of the world’s most respected companies. Apple (NASDAQ:APPL) tops the list at #1 yet again. And lest your curiosity be left hanging, finishing off the top 5 are Amazon (NASDAQ:AMZN), Berkshire Hathaway (NYSE:BRK), IBM (NYSE:IBM) and McDonald’s (NYSE:MCD).

And then there is Nokia (NYSE:NOK), the world’s biggest telephone handset-maker. Quotes the Economist, “We are standing on a burning [oil] platform,” Nokia’s CEO, Stephen Elop, wrote in a memo to all 132,000 employees. If Nokia did not want to be consumed by the flames, it had no choice but to plunge into the “icy waters” below. In plainer words, the company had to innovate -- quickly.

The value of Apple’s reputation for innovation, earned by actually being innovative, is that while the most respected company in the world only commands 4% of the telephone handset market, it commands 50% of the profits. That's pricing power, a benefit of a superior reputation, in the extreme.

Turning to the reputation metrics, Apple’s popular standing is reflected in its stable top ranking in the Steel City Re Corporate Reputation Index. Over the trailing twelve months, it has made the jump from the 97th percentile to the 100th percentile among the 51 companies in the Electronic Data Processing Equipment sector, and over the past six months, it hasn’t budged from that spot. Its corresponding trailing twelve month return on equity is 58.63% greater than the median of its peer group, its EWMA volatility is 1%, its trailing twelve week reputation velocity is 0.0, and its trailing twelve week reputation vector is undefined.

Its peer group shows a U-shaped drop and recovery in reputation standing relative to the market as a whole, and the intra-sector volatility is at the upper end of average. Significantly, the intangible asset fraction of the group has been progressively rising these past 12 months.

Nokia should wish for such metrics. Over the trailing twelve months, it has dropped from the 36th percentile to the 19th percentile among the 30 companies in the Diversified Electronics sector. Its corresponding trailing twelve month return on equity is 52.22% below than the median of its peer group, its EWMA volatility is 2%, its trailing twelve week reputation velocity is -10%, and its trailing twelve week reputation vector is -.8% which is a material level.

Its peer group shows a slight rise is reputation standing relative to the market as a whole, and the intra-sector volatility is at the low end of average. Last, its intangible asset fraction has dropped from 86% to 78% of market capitalization while the median of its peer group now stands at 88% of market cap.

Mr. Elop believes that one advantage Apple has over Nokia that he believes he can overcome is its access to the innovative genius that is resident in Silicon Valley. Stay tuned, as Finland comes to California.