It is heartbreaking to watch a company whose reputation was built on a credo in a crisis fail to appreciate the lesson it taught the world. Yes, J&J's PR was fabulous back in 1982 when cyanide found its way into bottle(s) of Tylenol. More importantly, J&J instituted robust changes in its supply chain security and at the end of the day, it was the company's ability to demonstrate extraordinary control that won it both accolades and a 30% boost in market value.

Now, plagued by one quality crisis after another, the company appears to be turning to a major PR campaign to save the day. But as Jonathan Salem Baskin, who moderates the Mission Intangible Monthly Briefings, writes for Forbes, "It’s established fact that no company (or individual) can declare truth any longer. We’ve all gotten too suspicious and jaded, and tech tools empower us to fast-forward past promises, and get to checking-up on follow-through. So company values, credos, and mission statements are worthless unless they’re translated into action. The world doesn’t need an ad campaign to show what’s “behind” J&J since it can judge the behaviors it sees. Stakeholders determine truth, not marketers."

The truths determined by stakeholders are captured, in part, by the Steel City Re Reputational Value Metrics. The measures of reputational value for Johnson & Johnson, the bases of which are described in detail in the book, Reputation, Stock Price and You, show a relatively high reputational ranking (CRR) in the 90th percentile relative to the 30 companies in the major pharmaceuticals sector. Surprisingly for a company of its size, both its historic and its current RVM volatility, measures of volatility of its reputational value, are above median and climbing. Overall, the data suggest that it is a company stakeholders would love to respect, but are having trouble understanding its current narrative.

The chatter is nice, but to borrow from another campaign, "where's the beef?"

From time to time, we quote a line we found in the Financial Times some years ago describing the sequence of events following an adverse event that heralds the onset of a reputational value crisis. When you are Questcor Pharmaceuticals and have been accused of unethical marketing practices, "the pile on of litigators, regulators and mommy bloggers" over a ten day window looks like this:

• Law Firm of Wohl & Fruchter LLP Announces Investigation of Questcor Pharmaceuticals Inc 
• Harwood Feffer LLP Announces Investigation of Questcor Pharmaceuticals Inc
• Bronstein, Gewirtz & Grossman, LLC Announces Investigation Of Questcor Pharmaceuticals Inc
• Holzer Holzer & Fistel, LLC Announces Investigation Into Questcor Pharmaceuticals, Inc.
• Robbins Umeda LLP Announces Investigation Of Questcor Pharmaceuticals Inc
• Goldfarb LLP Investigation Against Questcor Pharmaceuticals Inc
• Robbins Geller Rudman & Dowd LLP Files Class Action Suit Against Questcor Pharmaceuticals Inc
• Glancy Binkow & Goldberg LLP Announces Investigation Of Questcor Pharmaceuticals Inc
• Federman & Sherwood Announces Securities Class Action Lawsuit Has Been Filed Against Questcor Pharmaceuticals, Inc.
• Ryan & Maniskas, LLP Announces Class Action Lawsuit Against Questcor Pharmaceuticals Inc
• Faruqi & Faruqi, LLP Encourages Investors Who Suffered Substantial Losses in Excess of $100,000 Investing In Questcor Pharmaceuticals, Inc. to Contact the Firm

And yet the reputational value metrics from Steel City Re show a drop of less than a 0.5 standard deviation of the two year historic mean. Are equity investors over-reacting?

Last week, Questcor Pharmaceuticals (QCOR) appeared to be the victim of the shorts. Monday, analysts at Leerink Swann downgraded Questcor to "market perform" after the company revealed that is it under investigation by the U.S. government regarding its promotional practices. Last week's surprise shaved less than one standard deviation from Questcor's reputational value. Bloomberg reports that "Questcor said it intends to cooperate with the investigation and that the company doesn’t plan further comment except for regulatory-compliant disclosures." The reputational value effects of yesterday's news -- a failure in ethical controls -- will be revealed at week's end when we receive the next installment of Steel City Re reputational value metrics. Below are the effects from last week's news supplementing the charts posted Saturday.   Loss Gate markers below Questcor's Reputational Value metric (GU) are set at 0.5, 1.0, 1.5, 2.0 and 2.5 standard deviations of the two year historic average value, adjusted for elevated ratios of the CBOE VIX.

Earlier this week, Questcor's (QCOR) return on equity dropped to the bottom 10% of the RepuStars® Variety Corporate Reputation Index calculated by Dow Jones Indexes after shares plunged when insurer Aetna Inc.'s announced that it would limit reimbursement for the pharmaceutical company's only drug, Acthar. Well, that's not exactly what happened.  Fox Business reported this past Thursday that Wednesday's stock crash was precipitated by a report from "short-seller Citron Research (that) highlighted a policy bulletin on Aetna's website ... that called Acthar medically necessary for West syndrome, a relatively rare neurological disorder that causes infantile spasms, but described its use for several other conditions as medically unnecessary, or investigational and experimental." Aetna said it will review its policy in light of any new clinical data on 13 October.

In the spirit of social activists who use the threat of bad news as a tool to influence management, short sellers find value in bad news. Only firms like Citron Research are less interested in social action, and more interested in the value. It's what the US Navy calls "battle of the narrative."

Questcor responded saying, "Currently, the Company does not believe that the bulletin represents a material change in insurance coverage for Acthar by Aetna. During 2012, Aetna has accounted for approximately 5% of the Company's shipped prescriptions for Acthar. Based on its current assessment of the Clinical Policy Bulletin, the Company does not believe that the bulletin will have a material impact on the Company's results of operations."

If the loss of revenue is material, it could be a revenue crisis. The company acknowledges that it relies "...on Acthar for substantially all of ...(its) net sales and profits." If the loss of revenue is not material, but Questcor is unable to restore investor confidence, then it will at least be a reputational crisis. The Steel City Re reputational value metrics reflected minor downward changes in Questcor's reputation in the past few weeks, but there do not appear at this time to have been indications of major changes that would have anticipated either Aetna's policy changes nor Citron Research's plans to short the stock. As we currently review the data, all spot, time series, trend and benchmarking indicators shown below appear to have been reporting stability or subtle reputational rises up to the Wednesday pounce. Our interpretation at this time is that Questcor is the victim of a shorting opportunity that will, in due course, rebuild its value by better communicating its product development and market indications process to its equity stakeholders.

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.

The past two years have witnessed a flood of bad news at the world’s largest diversified healthcare company, Johnson & Johnson (NYSE:JNJ). Ethical breaches, quality failures, and safety recalls by the bucketful, a few of which we noted previously. In more recent times, the Company has witnessed the inevitable pile on of regulators, and now--you guessed it--litigators.

On 17 December 2010, a shareholder group filed a lawsuit against the board as well as managers for an unspecified amount alleging failure to uphold their duty of oversight, breaching their duty of loyalty, and allowing adverse events to proceed which inevitably "destroyed the company's hard earned reputation." According to Tony Chapelle who participated in a recent Mission Intangible Monthly Briefing and who reports for the Financial Times' Agenda Week, “Governance experts say that J&J’s board should step in and more closely oversee the company’s business processes in three vital areas: quality, safety and ethics.” 

According to Cathy Reese who chairs the Society’s Governance Committee and who also participated in a recent Mission Intangible Monthly Briefing, lawsuits that claim a breach of the director duty of oversight warrant serious attention. That’s because in the 2006 case of Stone v. Ritter, the Delaware Supreme Court created a new directorial duty — the duty of oversight. In turn, the court said, directors who breach that duty have breached the duty of loyalty, for which they can be held personally liable.

The quantitative metrics point to both a loss of reputation and value. The first chart is based on the Steel City Re Corporate Reputation Index and reports reputation movement over the trailing 30 months. Beginning in mid 2009 (in red), the data disclose the slow decline of Johnson & Johnson’s reputation ranking relative to 78 peers comprising pharmaceutical sector companies valued at greater than $1B as of 6 Jan 2010.


The Company's relative decline is further accentuated by the overall decline of the industry's ranking. Shown in blue is the slow steady decline of the the average ranking of the 78-member pharmaceutical sector relative to approximately 9000 publicly traded companies on the main US and European exchanges.

There may be any number of explanations for the steady decline of the relative reputation of the pharmaceutical industry. One potential factor, according to Public Citizen, a consumer watchdog group that is no friend of the industry, is that the drug industry has now become the biggest defrauder of the federal government, as determined by payments it has made for violations of the False Claims Act (FCA). The drug industry has surpassed the defense industry, which had long been the leader. Public Citizen reports that of the 165 pharmaceutical industry settlements comprising $19.8 billion in penalties during the past 20 years, 73 percent of the settlements (121) and 75 percent of the dollar amount ($14.8 billion) have occurred during the past five years.

The economic consequences of the reputational decline appears to be an erosion in enterprise value. The chart below shows (in red) the slow decline of Johnson & Johnson’s relative return on equity compared to
 the average of 15 peers (in blue) comprising pharmaceutical sector companies valued at greater than $40B as of 6 Jan 2010. Also shown is the period return of the S&P500 Composite Index. During the 30 month window shown below, JNJ’s economic returns progressively decreased relative to its peers from outperforming them prior to mid 2009, to parity until mid 2010, to underperforming since then. The difference between the two sets of 30-month returns as of Jan 2011 is about 7% - coincidentally, the median cost of a headline risk event according to Steel City Re's research. The S&P500 returns over this 30 month period are essentially zero.


The ramifications extend internally. The National Association of Corporate Directors newsletter adds this morning that "Johnson & Johnson won't give eligible employees their full bonuses for 2010," according to the Wall Street Journal (Jan. 19, Rockoff). The Journal's sources explain the reasoning as "hits to the company's reputation and the 'mixed performance' for the year."

Stakeholders expect pharmaceutical products to be safe and effective by design and meet quality standards by process. The complaints lodged against GlaxoSmithKline (NYSE:GSK), which last week agreed to pay the fourth largest fine in FDA’s history in relation to the production and sale of “adulterated” drugs, are therefore notable. From the Financial Times last week:

“… investigations unearthed manufacturing issues that included micro-organisms in Bactroban ointment, a topical antibiotic used to treat skin infections in babies; non-sterile doses of Kytril injection, an anti-nausea drug used by cancer patients; Paxil CR tablets for depression that lacked the active ingredient; and Avandamet tablets for diabetes that were super-potent and sub-potent.”

The issues have been on the table since at least 2003, and the costs were booked in the 2nd quarter financial results. Still, the lack of reputational consequences other than what may be minor recent equity movement is curious.

Over the trailing twelve months, GSK’s reputation ranking as measured by the Steel City Re Corporate Reputation Index rose from the 92nd to the 96th percentile among the 233 companies that comprise the ethical drug manufacturers sector. The exponentially weighted reputation moving average volatility was barely measurable at 0.3%, and the trailing twelve week velocity and vector values were 0. Its intangible asset fraction has been flat at nearly 100% which is greater than the industry mean of about 83%. In fact, the only sign that anyone was trading the stock was the fall in equity value so that the company’s performance this past year is about 7% below the median of this peer group.




Stakeholders may not have reacted to a large extent for one of several reasons. One could be that GSK’s reputation is so strong and resilient that this minor event was viewed as an aberration rather than a core risk. Another could be that, as with the airline industry, stakeholders have become complacent. The latter explanation is consistent with the relatively low ranking of the entire sector (less than 20th percentile) and its decreasing internal volatility.

Ho hum, indeed.

On 18 August, Johnson & Johnson (NYSE:JNJ) said it is creating a new position to oversee companywide quality, manufacturing and compliance issues and appointing chief quality officers for each of its three major business units. Vice President Ajit Shetty will fill the position overseeing the push for quality improvements in its pharmaceutical, consumer products and medical device and diagnostics groups.

The Company has announced eight recalls involving millions of bottles of nonprescription medicines since last September. They involved products made at factories in Pennsylvania and Puerto Rico. Now the Company, which has come under scrutiny for quality problems with its drug units, is starting to experience similar problems with its device divisions. DePuy Orthopaedics, a J&J company, last week announced a recall of some hip-replacement devices that appear to fail excessively. DePuy also received a warning letter citing it for marketing the TruMatch Personalized Solutions System in the U.S. without clearance or approval.

Quality is one of the six key intangible assets that underlie the value of reputation. (The other five are ethics, innovation, safety, sustainability, and security). Increasing, protecting, and restoring the value of these assets, you might say, is a company’s Mission:Intangible.

This is why. The Steel City Re Corporate Reputation Index, which tracks the financial consequences of intangible asset management, shows that over the trailing twelve months, Johnson & Johnson’s ranking dropped from the 93rd to the 88th percentile relative to the 28 companies in the Major Pharmaceuticals sector. As is often the case with a deteriorating reputation profile, the Company has underperformed the median of this sector this past year by nearly 13%.

The numbers show three other trends. The Company is large with a long history and used to hold the number one reputation rank in this sector, and according to some surveys, among all companies. That standing has provided resilience, but has not been able to arrest the slow and steady decline evidenced by the low volatility. That loss comes almost exclusively from an impairment of the Company’s intangible assets. Whereas a year ago, the Company’s intangibles comprised 91% of the firms market value – right in line with the median of the sector – today that fraction has dropped to less than 88%. All this comes amidst challenges for the industry as a whole, whose reputational standing relative to all companies has also declined from the 91st to the 88th percentile.

With all this going on, Mr. Shetty, a vice president, will have his hands full. And his work will have little impact on enterprise value (and potential derivative law suits and D&O claims) unless signals start emanating from even higher levels that the Company’s credo – written by General Johnson himself – has been once again found and will be honored to the letter. Attention Board of Directors! Are you listening?

Several months ago, we took a look at ethical pharmaceutical companies on the occasion of a publication by Ethisphere magazine that ranked the "most ethical companies." We now revisit those companies on the occasion of the formal announcement that Pfizer and a subsidiary have agreed to pay $2.3 billion to resolve criminal and civil claims stemming from the illegal promotion of certain pharmaceutical products (read, unethical behavior).

The Society is interested in the economic value of business processes that support intangible assets such as ethics, innovation, sustainability, etc that stakeholders percieve as reputation. Companies reputed to be more ethical, the Society suggests, will reward shareholders with above average returns.

In our 1 May MISSION:INTANGIBLE posting, we noted that the reputation ranking of Novartis (NYSE:NVS), as measured by the Steel City Re Corporate Reputation Index, was superior to Eli Lilly (NYSE:LLY), whose index ranking, in turn, was superior to Pfizer (NYSE:PFE). We noted, however, that Pfizer’s ranking appeared relatively stable while Lilly’s ranking was drifting down rather quickly.

In our experience, firms with superior reputation rankings as measured by the Steel City Re Reputation Index outperform their peers. Those with declining reputation indices tend to underperform their peers. We therefore expected that going forward, Novartis would outperform Pfizer, and that Pfizer would outperform Lilly. The stability of the reputation index data for Pfizer suggested that stakeholders had already factored the alleged ethical breaches into their respective assessments.

Yesterday’s announcement provided an excellent test of our expectations for economic behavior going forward from 17 April (4/17).

The data, summarized above from a Big Charts graph (pasted below), confirm the forecast we made based on the Reputation Index. From the period beginning 17 April (when we ran the index data for the 1 May blog note on these companies) through yesterday, Novartis rewarded its shareholders with a 29% return on equity. Pfizer rewarded its shareholders with an 18% ROE, and Lilly disappointed its shareholders with a ~0.5% gain.

On 29 April 2009, the Reputation Institute released its annual survey on the nation’s most respected companies. Based on its surveys of the general public, the Institute ranked 153 companies on how esteemed, admired, trusted and liked each was. The top and bottom ranks were held by Johnson and Johnson (NYSE:JNJ) and Halliburton (NYSE:HAL), respectively.

The Intangible Asset Finance Society is interested in the relationship between the intangibles (the business processes that underlie reputation) and finance. So we turned to the Steel City Re Index for an independent quantitative view (and second opinion) of stakeholders’ collective assessments of the corporate reputations of these two iconic firms.

Unlike the Institute survey, the Steel City Re index is designed to capture forward looking indications of expected stakeholder behaviors that impact cash flow, enterprise value, and cost of credit. These indicators are good predictors of stock price, which remains the single most useful metric of value.

Data through 1 May 2009 show that Johnson & Johnson is in the top tier of the Pharmaceutical sector (see Ethical Pharmaceuticals) with an index ranking this past year that started in the 98th percentile and ended in the #1 position (100th percentile). Index EWMA volatility was low averaging only two orders of magnitude. It is therefore not surprising that its return on equity outperformed the median of 84 of its peers by 13%.



Halliburton, on the other hand, bounces between the upper quartile and second quartile of the Energy equipment and services sector having started the year in the 91st percentile and ended the year in the 86th percentile. Index EWMA volatility was much higher averaging four orders of magnitude. A falling index and high volatility, notwithstanding an above average percentile ranking, is rarely associated with superior economic returns. And indeed, over the past year, Halliburton outperformed the median of 69 of its peers by only .75%.



In fairness, there are significant sector effects behind these numbers. The median pharmaceutical index value among the 5000 companies tracked by Steel City Re ranged between the 20th and 30th percentile and the sector showed an index variance of between .35 and .4. In contrast, the Energy equipment and services sector began the year with a median index ranking in the 70th percentile which then fell precipitously in the fall of 2008 to a median in the 50th percentile. Overall variance, however, is much narrower indicating that the perceived differences among firms in this sector are much smaller than the perceived differences among pharmaceutical firms.




In summary, these data show that a top performer in a sector that is in the reputation doldrums will effectively surprise the markets and significantly outperform its peers; and that a good performer in a sector that has disappointed the markets may still marginally outperform its peers. But with the median pharmaceutical ROE closely matching the S&P500 returns, and the median energy equipment and services ROE underperforming the S&P500 by 20%, Halliburton’s low “popularity” is not surprising.

Bonus: Top and bottom ranked firms on the Steel City Re corporate reputation index for the Pharmaceutical and Energy services sectors as of 1 May are, for Pharma: Johnson & Johnson and Discovery Laboratories, Inc. (NASDAQ:DSCO); and for Energy equipment and services: Seacor Holdings, Inc. (NYSE:CKH) and ION Geophysical Corporation (NYSE:IO).