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Home > Business Strategy Best Practice > Sustainability and Corporate Reputation: Who Needs Reputation When You’ve Got Cash Flows?

Business Strategy Best Practice

Sustainability and Corporate Reputation: Who Needs Reputation When You’ve Got Cash Flows?

by William Cox

This Chapter Covers

  • Attempts to link reputation to financials and their weaknesses.

  • The illusory links between sustainability, reputation, and financials.

  • How individual projects, including sustainability projects, generate financial returns, which renders “reputation” an empty concept.

Introduction: Executives See Link Between Reputation and Sustainability

Of 1,749 corporate executives from various sectors worldwide, 72% see sustainability as very important in managing corporate reputation. In the manufacturing sector, this proportion was as high as 79%—in both cases sustainability’s impact on reputation was the number one reason cited for getting involved in sustainability (Bonini, Görner, and Jones, 2010). Although these and similar data suggest that executives believe that sustainability impacts reputation, does it really? And what if we could demonstrate a direct connection between sustainability and revenues, cost savings and free cash flows, among other financial indicators? If sustainability investments were to contribute directly to financials, why worry about the undefined and perhaps undefinable concept of “reputation”?

Attempts to Link Reputation to Financials

Consider typical arguments that suggest a connection between reputation and financials.

The first such attempt claims that companies with good reputations benefit from better equity price development than the average, as suggested by two RepuStars indices. Both are run by the Intangible Asset Finance Society, tracking the equity prices of companies it considers particularly reputable according to data on customers, vendors, investors, and employees. The surveyed behavior and expectations of these groups are said to correlate positively with companies’ equity and credit performances (Intangible Asset Finance Society, 2011). The indices admit three companies from each of 19 key sectors.

“Since January 2009, the RepuStars Variety and RepuStars Prime Composite Indices have gained 99.03% and 99.24%, respectively; the S&P 500 Composite Index has gained 38.33%” (Huygens, 2011). What both indices demonstrate is that there is a correlation between equity performance and some characteristics of the companies that comprise the index. These characteristics may or may not have anything to do with “reputation.” The outperformance by the stocks in the reputation indices may be related to investor relations efforts, marketing, fundamental financials, governance, investment technicals, or transparency. To invoke the concept of “reputation” adds little explanatory value as to why they are performing better than the S&P benchmark index.

The suggestion among advocates of reputation is that good management produces a residual “asset” which drives revenues even if management and products were to decline in quality. Thus, for reputation to be considered a real asset, it would first have to be highly memorable. Yet if this memory is to be credibly linked to financial results (higher revenues, investor behavior, or a more efficient workforce—i.e. higher productivity), we have little choice but to look at how the remaining useful life (RUL) of individual projects impacts revenues, for example.

A second approach that attempts to link reputation to financials is exemplified in the work of such companies as the Reputation Institute, which simply assigns “factors” to the value of companies’ reputations. While these may be useful in helping companies to benchmark themselves against others, they do little to explain the financial value of reputation, nor to justify whether “reputation” is a definable and useful concept. An example is the Reputation Institute’s RepTrack System, which it describes as “a proprietary tool that was developed by Reputation Institute to measure corporate reputations. It is grounded on the theory that reputations are emotional attitudes stakeholders have towards companies, and can be measured by assessing their degree of Admiration, Trust, ‘Good Feeling,’ and ‘Overall Esteem’ for companies.” (see Reputation Institute RepTrack System in More Info).

The Reputation Institute’s approach is essentially to survey what people think about certain brands and assign a score to these opinion results. The problem here is that these results are not causally linkable to any substantial financial indicators, such as cash flows or other key financial metric. And, as such, it is still unclear whether “reputation” is related to financial success, and thus to building a company’s value.

A third approach is to value brands, which are typically considered integral parts of reputation. BrandZ’s study of the values of the top 100 brands considers the brand’s contribution to earnings as well as a multiple by which the brand is likely to impact future earnings. One reason this approach is closer to reality is that it focuses on a definable topic—brand—and seeks to determine its contribution to financials. Its weakness is that it presumes the very point it seeks to prove, namely that “reputation” is a reality and somehow produces financial results.

Attempts to link reputation to financial performance typically are in the form of an index of reputed companies, “factors” based on surveys, and valuations of brands. All attempts use consolidated data without sufficient causal links between reputation and financials. However, the brand valuation effort of BrandZ, a brand equity database, comes closest to actually assigning a serious value to something, in this case brands. Brands are realities, perhaps unlike the concept of “reputation.”

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Further reading

Book:

  • Anson, Weston. “Alternative valuation methodologies.” In The Intangible Assets Handbook: Maximizing Value from Intangible Assets. Chicago, IL: American Bar Association, 2007.

Articles:

  • Banick, Sarah. “ZIBS Forum: Roger Sinclair on ‘viewing brands as assets.’ Goizueta Business School, Emory University, 2010. Online at: www.zibs.com/sinclair.shtml
  • Bonini, Sheila, Stephan Görner, and Alissa Jones. “How companies manage sustainability: McKinsey Global Survey results.” McKinsey Quarterly (March 2010). Online at: tinyurl.com/y68eymb
  • BrandZ. “BrandZ top 100 most valuable brands 2009.” Online at: www.wpp.com/wpp/companies
  • Cox, William H. “Sustentabilidade deve dar lucro.” Harvard Business Review Brasil (September 2010): 60–62. Online at: www.hbrbr.com.br/index.php?codid=300
  • Cropper, Maureen L., and Wallace E. Oates. “Environmental economics: A survey.” Journal of Economic Literature 30:2 (June 1992): 675–740. Online at: www.jstor.org/stable/2727701
  • Flatt, S. J., and S. J. Kowalczyk. “Creating competitive advantage through intangible assets: The direct and indirect effects of corporate culture and reputation.” Advances in Competitiveness Research 16:1/2 (2008).
  • Huygens, C. “RepuStars 2011 June 13.” Mission: Intangible (Intangible Asset Finance Society blog) (June 13, 2011). Online at: tinyurl.com/6ld5ruy

Reports:

  • Dearden, Lorraine, Howard Reed, and John Van Reenen. “The impact of training on productivity and wages: Evidence from British panel data.” CEP Discussion Paper 674. London School of Economics and Political Science, February 2005. Online at: eprints.lse.ac.uk/779/
  • Nucleus Research. “ROI case study: SumTotal anonymous bank.” Research note D58. December 2004. Online at: www.sumtotal.com.au/assets/casestudies/large_usbank.pdf
  • SAM and PricewaterhouseCoopers. “The sustainability yearbook 2010: Sustainability
  • investing: The paradigm for institutional investors.” 2010. Online at: tinyurl.com/4y3pqez
  • SAM Research and Robeco Quantitative Strategies. “Alpha from sustainability.” White paper. 2011. Online at: tinyurl.com/5ufy6nb [PDF].
  • Ulrich, Dave, and Norm Smallwood. “HR’s new ROI: Return on intangibles.” Human Resource Management 44:2 (Summer 2005): 137–142. Online at: dx.doi.org/10.1002/hrm.20055

Websites:

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