One of the hallmarks of a reputational value crisis arising from an operational failure is that the latter is appreciated by stakeholders as a systemic problem. While Boeing has not yet received approval by the US FAA to fly, and international airlines are watching closely, the investigations suggest that the series of problems each represented unique idiosyncratic events. As Boeing's engineers explained, "things happen."

The Huntington Post reported last week that "a probe into the overheating of a lithium ion battery in an All Nippon Airways Boeing 787 that made an emergency landing found it was improperly wired," according to Japan's Transport Ministry. Boeing reports that it has developed a "fix" for the batteries and that once the FAA approves the 22 February plan, the company is ready to execute. Details of the fix are not being widely circulated. Meanwhile, the Europeans are hedging their bets and moving to the older battery class for the Airbus.

James Surowiecki, writing for the New Yorker, sides with the Europeans. In a culture were the expectation for safety is now paramount, it is not clear how the FAA is going to be able to give Boeing clearance. "Boeing is in a business where the margin of error is small. It shouldn’t have chosen a business model where the chance of making a serious mistake was so large." The author of the Wisdom of Crowds suggests it was a mistake to "give other companies responsibility for the Dreamliner."

Turning the the measures of expectation, the Steel City Re Reputational Value Metrics, Boeing (BA) is one of 80 in the aerospace and defense sector and currently ranks in the 77th percentile. The chart of vital signs shows a rising Current RVM volatility. RVM is a non-financial measure of reputational value, and its volatility is the quantitative expression of the uncertainty reflected in the narrative above.  That being said, the current RVM volatility is still in the 1-2% range which is very low. Of note, should things go badly for Boeing, the odds of a material market cap fall are much greater than for the average company because its stakeholders, as evidenced by the low RVM volatility, are not used to being surprised. Ironically, a gently rising RVM volatility may help reduce the shock.

The indications are for little or very gradual change in the near future with a forecast for ongoing downward slope from the 77th percentile for the CRR, a measure of relative reputational ranking. ROE can be expected to lag. Background on the metrics can be found in the book, Reputation, Stock Price and You: Why the market rewards some companies and punishes others.

Everybody has problems. Boeing has an airplane problem. Tesco has a hamburger problem. And YUM! has a chicken problem. Three different commercial sectors each with quality problems, often leading to safety issues, with one common element. All of the problems originated within the companies' supply chains, comprise failures in operational oversight and control, and have the potential for blossoming into full-on reputational crises.

Reputational crises are expensive. Customers slow down their purchase frequency and extend the their purchase decision cycle, to say nothing of their resistance to premium pricing. But the pain goes further. Vendors offer less favorable terms; creditors raise the cost of capital, employee turnover is but one indicator of morale problems that start brewing, NGOs take interest, and regulators start paying more attention. And of course, equity investors, who have the shortest fuse, sell. That is why Huygens prefers to call them, "reputational value crises."

CNBC reported yesterday that Yum Brands, the parent of restaurant chains Taco Bell, KFC, and Pizza Hut, reported surprise weakness in China. "This skews to the worst case for the company," said David Palmer, managing director and senior food & restaurant analyst at UBS, who covers the company. China represents almost half of the business, in profit terms, for the company, he said in an interview on CNBC's "Squawk on the Street."

Forbes reported, "At YUM’s analyst day on December 6, 2012, we asked CEO David C. Novak what his “defense” was to media exposes that one of KFC China’s suppliers had pumped its chicken full of chemicals to expedite their growth. The story prompted a furious social media reaction. His answer was “No worries. It will blow over.” When asked how, he shrugged: “It always has.”

Turning to a measure of reputational value, the Steel City Re reputational value metrics, the measures for YUM! in contrast to McDonald's, the sector reputational leader, are informative. The problem, it seems, hasn't blown over. The company's reputation ranking is sinking steadily and the forecast last week as shown below, before this week's news, was for further deterioration. The steadiness of the deterioration was suggested by the RVM volatility measures and the median forecast stability numbers. RVM, as Huygens' followers know, is a non-financial measure of reputational value.

YUM!'s loss would reasonably be expected to by McDonald's gain. MCD, with a CRR, a measure of relative reputational ranking, buried at 1.0 for the sector, could only gain in RVM.  MCD's RVM volatility suggests this is the case, and not surprisingly, its ROE has been climbing as YUM!'s has been sinking. 

The moral: supply chains are great sources of cost savings, value, operational risk, and reputational value risk. Their operations need to be overseen and controlled no less so than organic operations. And if the excuse is that the whole point of outsourcing was to reduce the costs associated with organic controls and oversight, well, then, add that sentence to the ever-growing collection of things that seemed like a good idea at the time.

Last week, several Boeing model 787 aircraft were plagued with problems: fuel leaks, electrical fires, and faulty brakes. It is not a problem Boeing said. All new aircraft models go through this sort of shakeout on launch. Mission Intangible Monthly Briefing moderator Jonathan Salem Baskin, writing the CMO column for Forbes magazine, disagrees. "The 787 project was unlike any others — ACCORDING TO BOEING — and to then after-the-fact claim that every aspect of it has a corollary in the routine world lacks credibility." In other words, the safety of the 787 aircraft is a matter of growing concern and a standard PR-based reassurance campaign is unlikely to work. A slew of heated comments and strongly-worded views propelled the article to the most read list.

Huygen's commented previously in 2009 on the reputational risks that appeared to be brewing in Boeing's supply chain. Fast forward to 2013, and the Steel City Re Reputational Value Metrics are suggesting that the safety issue has created for Boeing both an airplane problem and a reputation problem. CRR, a measure of relative reputational rank, slipped to the 81st percentile this past week. RVM volatility, a measure of the variance of RVM -- a non financial measure of reputational value -- is up over historic trends. Forward-looking reputational value trends are negative. Collectively, these measures of reputational value loss help explain Boeing's poor return on equity at the 38th percentile of the 80-member Aerospace and Defense peer group.

This past week, Knight Capital Group (NYSE:KCG), a major market maker in global equities, watched briefly as its electronic systems began trading for themselves. Knight Capital picked up the tab for the bad trades: $440 million. Knight's safety system, like BP's blowout protector on the Deepwater Horizon, failed, but unlike BP, the company is not too big to fail. Knight’s reputation as a safe platform for US equity trades is in tatters. It's future is bleak.

Meanwhile, as with most reputational disasters, the regulators – soon to be followed by the litigators – are joining the mommy 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 Friday. "And, naturally, we will consider whether such compliance measures were followed in this case."

Ironically, Knight Capital Group’s reputational metrics were signaling danger. According to Steel City Re's data, starting 19 July, and then again 26 July, there were two great drops in the company’s reputation ranking and a surge in reputational value volatility from the 52nd to the 92nd percentile. Also, both forward looking trend indicators predicted a further deterioration in the company's reputation standing. The weekly data calculated Thursday night 28 hours into the crisis show a bleak reputational picture. The vital signs signal terminal. Ranking near zero, volatility near 100%. Trends strongly negative. In short, stakeholders, knowing that technology companies rarely recover from bad core events, and knowing that regulators are not being kind to the sector, are already mourning the firm’s passing.



A lesson to be remembered is that reputation is a consequence of corporate behavior that motivates stakeholders to behave in ways that either reward or punish the corporation. A safety failure of a mission-critical aspect of a company's core business motivates adverse behaviors in most stakeholders: customers, employees, vendors, regulators, creditors, and of course, investors.

In contrast to the more commonly understood surveys of reputation comprising stakeholder opinions that are ephemeral, stakeholder behaviors leave artifacts such as pricing power, sales volume, labor costs, credit costs, vendor terms, regulator burden, and equity prices. These quantitative artifacts can be captured and reported back to boards on an accelerated, algorithmic, and cost-effective basis. Call them Reputation Metrics. Reputation metrics that capture in near real time the "wisdom of crowds" -- such as those from Steel City Re -- can give management and boards operational situational awareness from a perspective not typically available through traditional corporate operational controls.

In businesses where reputation affects either capital liquidity or regulatory admonishment, factoring reputational metrics into both strategic decision making and active crisis management can be valuable. As Alan Greenspan noted four years ago in a speech at Georgetown University, “In a market system based on trust, reputation has a significant economic value.”

Francesco Schettino, captain of Costa Concordia, the Carnival Corporation (NYSE:CCL) ship that ran aground last week, is the latest rogue to abuse his station of authority and damage the reputation of his parent firm by triggering a business process control failure. Micky Arison, chief executive of Carnival Corporation, admitted that the Costa Concordia’s grounding and capsizing had “called into question” the company’s safety and emergency response procedures and practices.

The Steel City Re Corporate Reputation Index metrics for Carnival Corp dropped from the 81st percentile among nearly 7000 firms measured, to the 43rd, and from the 39th percentile among the S&P500 constituent members to the 8th. It also lost nearly $3B in enterprise value, or about 10% of its market capitalization. This is more than the median cost of a major reputational event which is 7% of market cap according to Steel City Re's research.

As the post mortem examination is already disclosing, Captain Schettino’s deviation from the approved navigational plan was not the first. Deviations in processes that result in operational disasters and reputational losses are rarely one-offs. Rather, as investigators are now finding, prior deviations were not observed, or if observed, did not trigger processes to mitigate future deviations. And that is but one of many lessons for operational executives who may have been lulled into thinking that rogues only reside on Wall Street.

The Financial Times (November 11, Bullock) focused on it right away: "'Higher education is first and foremost a business that is driven by reputation,' said John Nelson, head of higher education research at Moody’s. 'Student demand, the attraction of faculty and the ability to draw donations are all based on reputation.' Moody’s said it will evaluate 'the potential scope of the reputational and financial risk' arising from the allegations, including potential lawsuits and settlements, weaker student demand or philanthropic support, changes in the university’s relationship with the state and significant management or governance changes."

The Washington Post's (November 12, AP Wire) headline was blunt: "Moody’s warns Penn State’s bond rating could be downgraded because of sex abuse scandal."

Reputation is an epiphenomenon. It is a product of how an entity executes one or more of six core functions: ethics, quality, innovation, safety, sustainability, and security. Three of these have been called into question by the Penn State University sexual abuse scandal. The Pennsylvania attorney-general has filed criminal charges involving child sexual abuse against Jerry Sandusky, a former assistant football coach, as well as perjury and failure to report charges against two senior university officials, including the chief financial officer.

In our current culture, the path to reputation restoration includes rolling heads. Swift retribution is demanded, and and innocent blood may be part of the cost to save the many. The reign of terror had its merits, but it was not necessarily the best path towards a just and democratic system. We can only hope that the lessons taken from this latest reputational crisis are that better preventative processes are preferable to the guillotine.

Meanwhile, in Happy Valley Pennsylvania, a normalcy is already returning.

In early 2008, Baxter International (NYSE:BAX) began a series of product recalls involving the drug, Heparin, that was manufactured with ingredients sourced from a supplier in China. Yesterday, the first of the product liability litigation cases arising reached the verdict stage.

According the to the Chicago Tribune (9 June, Japsen), a Cook County Circuit Court jury Thursday awarded $625,000 to the estate of a man who his attorneys say was given a dosage of a blood thinner made by Baxter International Inc. that contained a contaminated ingredient found in the company's supply chain in China.

The verdict is the first from a case against Baxter and its supplier, Wisconsin-based Scientific Protein Laboratories, from hundreds of lawsuits filed against the Deerfield-based medical product giant. A mountain of litigation has been leveled against the companies after U.S. regulators determined in 2008 that Baxter's heparin was contaminated, from fake ingredients sourced in China.

The Wall Street Journal (9 June, Kell) quotes Baxter spokeswoman Deborah Spak as saying the company is taking responsibility for legitimate cases of harm related to the contamination seriously, adding that Baxter will "vigorously defend claims that are not consistent with the definition established by public health authorities." Baxter's therapies treat serious medical problems such as cancer, immune disorders and trauma. The company is coming off a challenging year due to economic weakness, costs pegged to the U.S. health-care overhaul and some product-quality and regulatory challenges.  It's stock price has appreciated around 50% over the trailing twelve months and shares rose an additional 0.3% to $59.05 in after-hours trading -- not the sort of economic performance associated with a company facing new challenges.

Turning to the reputation metrics from Steel City Re, Baxter is wrapping up the trailing twelve months ahead at the 88th percentile from a start at the 72nd. Its reputation metric volatility, exponentially weighted, is down to about 6%, its reputation velocity is on the upswing at 7% and its reputation vector is positive at 1%. All are signs of reputational recovery. Economically, it is outperforming the median of its peer group comprising 172 companies in the Pharmaceutical sector by a comfortable 17.82%



Finally, while the sector as a whole is demonstrating increased level of reputational volatility reaching around 36%, the Company's intangible asset fraction got a small boost and is now around 90%, slightly above that of the median of its peer group.

We conclude that as with Johnson & Johnson's supply chain issue of the early 1980's, Baxter took the hit early on (2008) and has since progressed with the expected long-term costs of this quality/safety issue already deeply embedded in the stock price and in reputation-related expectations.

In a curious twist on the Ashford/Simpson love duet, Massey Energy (NYSE:MEE) shareholders have signaled that they intend to pursue claims aggressively against the board of directors notwithstanding efforts by the latter to make a wash of the whole thing. The matter is now before the West Virginia State Supreme Court.

The case elements center about liability, reputation, and board oversight. Simply put, plaintiffs allege that the Board of Directors failed in its Duty of Loyalty by not ensuring that safety processes were being implemented. Safety, as we have noted before, is a key business process underpinning reputational value. And the safety-linked disaster at Massey certainly did knock with wind out of the company's reputational value.

We've seen this movie before -- most recently with Johnson and Johnson (see below). Here is how the National Association of Corporate Directors explains the current situation in their 31 May newsletter:

"The fate of a shareholder vote on Massey Energy's proposed $7.1 billion sale to rival coal producer Alpha Natural Resources is up to the state Supreme Court," the Washington Post (May 31) reports. The court is expected on Tuesday to take up the request by a trio institutional investors who are seeking to prevent a June 1 vote by Massey shareholders. The shareholders will also urge the court to seal case records. "The Charleston Gazette and National Public Radio are asking the court to open the files," the Post notes. "They argue the documents may shed light on the April 5, 2010, explosion at Massey’s Upper Big Branch mine that killed 29 miners." The investors state that the explosion and other actions damaged the company's value.

The Wall Street Journal (May 31, Maher) adds that the court will decide whether to grant a temporary injunction sought by the investors, "who allege that Massey's board agreed to the sale to escape any personal liability for a coal-mining accident last year that killed 29 miners and drove down the company's stock price." The suit claims the company not only gave Alpha preferential treatment during the bidding process, it also failed to disclose key information about the negotiating process in its filings with the SEC. In addition, the Journal states, "The West Virginia suit alleges that the board failed to comply with a 2008 court order to institute new safety systems at the company." The plaintiffs include the California State Teachers' Retirement System.

Combined, Benzinga (May 31, Wilcox) notes, "Alpha Natural and Massey would the be largest U.S. producer of metallurgical coal." Additionally, Massey is facing a separate suit brought by the New Jersey Building Laborers Pension Fund, which also seeks to halt the sale.

Here's the background as summarized recently in Intellectual Asset Management magazine, the official publication partner of the Society. According to Cathy Reese, a partner with law firm Fish & Richardson and chair of the Intangible Asset Finance Society’s Committee on Intangible Asset Governance, the Delaware Supreme Court’s 2006 opinion in Stone v Ritter adopted the concept of oversight liability, which had been discussed some 10 years earlier in the influential 1996 In re Caremark decision by the Delaware Court of Chancery. Importantly, this duty of oversight applies to all corporate assets, including intangible assets.

The court in Stone v Ritter stated that director oversight liability may be predicated on facts showing that either: “(a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.”

Now the West Virginia Supreme Court gets to weigh in on the matter.

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.

The Wall Street proverb, “buy low...sell high” applies to many metrics. On 31 January, Alpha Natural Resources Inc. (NYSE:ANR) said it had reached a deal to buy rival coal company Massey Energy (NYSE:MEE) for $7.1 billion in cash and stock. The sale price was driven by expectations that 2011 will bring both high prices and high demand for the metallurgical coal produced by many Massey mines. That there was a sale at all was driven by mounting losses precipitated by last year's deadly explosion at Massey Energy's Upper Big Branch coal mine in West Virginia. And by Massey’s rock-bottom reputation.

In its final financial report for 2010, Massey said it suffered a net loss of $166.6 million last year. That's down from a $104.4 million profit in 2009, despite higher revenues in 2010. Close to 70 percent of last year's loss, or $115 million, were the result of costs associated with the Upper Big Branch disaster that killed 29 coal miners. The April explosion focused attention on the company's record of safety violations and drew intense scrutiny from federal mine safety regulators. Massey has cited the increased oversight, an ongoing mine disaster investigation and resulting production declines as reasons for its losses. The company also blamed its lower productivity on difficulty in finding enough mine workers.

In short, the reputational consequences of the catastrophic safety event have been costly -- in the last quarter of 2010 alone, the company's losses totaled $70.1 million. This is why. While firms with superior reputations outperform their peers, firms with damaged or poor reputations command lower prices and market share, have higher operating costs, pay more for credit, and have inferior vendor terms. And in heavily regulated industries, they have higher regulatory burdens.

The Steel City Re Corporate Reputation Index shows the precipitous fall in reputation ranking in April, a moderate rebound, and then a final collapse by the fall of 2010. The exponentially weighted moving average (EWMA) of reputation volatility peaked at 80% in October. And the equity value, reflecting the effects of the costs of the safety event, is giving investors an return on equity over the trailing twelve months that is underperforming the median of its peers by 14%.




The story continues. On 2 February, Massey Energy held a conference call with industry analysts. Among the key reputational message points were the comments by COO Chris Adkins that "voluntary quits" were up 12% in the 4th quarter over the same period last year; and from an operational perspective, Massey's labor shortage and increased federal regulation in response to the Upper Big Branch explosion account for a quarterly production shortfall of 300,000 tons.

And then there's the litigation related to reputation and its drivers: ethics, innovation, quality, safety, security and sustainability. In June 2010, a securities class action complaint charged the company with issuing false and misleading financial information to investors. The complaint alleges that Massey Energy claimed to be one of the safest coal mine operators in the industry, but in fact, safety at Massey Energy’s coal mines was allegedly sacrificed so that production goals could be met, and Massey had received undisclosed citations arising from uncorrected safety and other regulatory violations.

There's more. Shortly after the agreement was announced, a prominent plaintiff's law firm announced an investigation as to whether the 21% premium offered over the prior day's close, and accepted by the board, was consistent with the Board of Directors' duty to maximize value for Massey Energy investors.