From the time of the pioneering work by Fombrun and others in the 1990's, market observers generally agreed that reputation was a source of equity value. When good, it drove customers to buy more at higher prices, employees to work harder for less, vendor and creditors to offer superior terms, equity investors to bid up multiples, and regulators to cast a more benign eye. Since then, punters have sought methods for linking to concepts into an equity strategy.

The dominant challenge has been the inherent nature of reputation. It is an epiphenomenon of the interplay between culture and operational matters on one hand, oversight and governance practices on the second, and allowing for a third hand -- how the package is presented and delivered to stakeholders. The latter is recognized as being generally in the domain of marketers, and since it represents the "last mile" to the stakeholder, it has received the lion's share of attention.

Reputation value can be teased out of equity value through major adverse reputational events. Many have been documented in this blog over the years. Informal estimates suggest that the cost of an adverse reputational event is around 5% of market cap. Steel City Re, the reputation risk insurance specialist, calculate a value closer to 7% but their model arguably ignores "lesser" reputational events. Since 2005 when the Economist Intelligence Unit published its seminal article on reputation risk, reputation management gained a new internal stakeholder - the enterprise risk manager.

These data affirmed management's need to avoid reputational risk, but they provided little in the way of guidance of how to avoid it. Also, while they suggested how much to invest in the avoidance effort, the lumpy nature of reputational events ensured that any classical actuarial model would leave a firm statistically comfortable with its risk management strategy and yet woefully underprepared.

In November 2011, Steel City Re announced that its data on reputational value indicators had been incorporated into an equity strategy and was available through Dow Jones Indexes. The ten-year history, several years of which have been published weekly on this site, indicated a significant outperformance relative to the benchmark S&P500 index. Critics suggested that the outperformance could be attributed to higher beta securities rather than an inherent value proposition associated with exploiting latent reputation value.

We now report an additional analysis of the RepuStars algorithm in which the stock selection was limited to the S&P500 constituent members only. Details on the 3-year old RepuStars Variety algorithm and the underpinning reputational statistics are provided elsewhere. In this study, stocks were selected by the algorithm at the beginning of each of ten years beginning December 2001. In general, the portfolios comprising stocks selected using the RepuStars Variety algorithm outperformed the universe of S&P500 firms (the Index) each of the ten years. The single exception was 2008 (image below). The ten year average was 6.5%, a value surprisingly similar to the 7% losses realized with adverse reputational events.


From an investment perspective, the portfolio based on the above would have produced an annual 9% cumulative return which is within 10% of the RepuStars Variety price index returns that are reported each Monday (image below).


The upshot is the reputation management is not only good risk management. It is a source of value creation. Firms that do it right can expect, on average, an additional 6.5% in equity value growth, and protection against 7% in equity value loss, all other things being equal. Arguably, there are very few managerial strategies a firm can pursue today short of inventing the next i-device or replacement for facebook that can deliver such value.

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.

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.
 

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.

There are national accounts, and national intangible assets. Our ability to account for the latter may be no better than what we show on corporate balance sheets. Worst, absent an indicator like market capitalization that reminds us that there is significant value in excess of book (x2-3), we may not even be aware of them.

National Public Radio’s Planet Money, a multimedia team covering the global economy, recently aired a program in which the benefit of the overarching term we use at the Society, reputation, was addressed in a geopolitical setting.

We used to talk about the G-7 — the world's seven biggest economic powerhouses. Every so often, the leaders of the G-7 countries would get together and hash out the important issues facing the global economy. That grew to become the G-20, which included big players in the developing world (China, India, Brazil). In the heat of the financial crisis, the G-20 made a good show of cooperation. But as the crisis has faded, so has the cooperation. What's left is a world where there's no clear economic leadership. That creates a new set of problems, David Gordon says. Gordon, research director at the consulting firm Eurasia Group, calls this new world "G-Zero."

The G-Zero is a concept that acknowledges that there is no longer any center of power and marks the end of the most recent era where the one remaining superpower provided global leadership.

According to Gordon, “the United States reputationally has been weakened by the financial crisis – blamed for it – and our model of capital markets and all of this, combined, are no longer seen as things that countries should aspire to. That reputation hit, combined with our own relatively weak recovery and fiscal challenges, means that we are no longer able to give the kind of leadership to the world economy that we did forever.”

Listen to the NPR Planet Money G-Zero podcast on the NPR website (click here) or to the current Planet Money program (click below).
 

SAP is the dominant solution provider in the $8 billion enterprise management and business intelligence software sector. The company's products provide businesses with an integrated view of their operations for cost and asset value optimization, and predictive analytics to help identify opportunities and risks. But their software doesn't manage intangible assets, and the risk their software didn't help them see was a breach of ethics and intellectual property management best practices by a partner company that they subsequently acquired.

Cutting to the chase, Oracle (NASDAQ:ORCL) last week won a $1.3 billion jury verdict against rival SAP (NYSE:SAP), netting the biggest copyright-infringement award ever. According to Bloomberg News, the jury delivered the verdict Tuesday, after an 11-day trial in federal court in Oakland. The lawsuit started in 2007, with Oracle claiming the German company's TomorrowNow business made hundreds of thousands of illegal downloads and several thousand copies of Oracle's software as part of a plan to steal customers.

SAP acquired the TomorrowNow in 2005 and closed it in 2008. SAP had hoped to use the unit to lure thousands of customers of PeopleSoft and JD Edwards, which Oracle had acquired, to purchase SAP software, according to evidence presented at trial. The unit garnered 358 customers.

The award was more than analysts had estimated - and far beyond the $160 million that SAP had set aside for the litigation.The immediate equity costs -- SAP is underperforming the mean of its 217 peers in the Systems and Subsystems sector by 7.71% -- are therefore understandable. What about the long-term reputation effects?

One week out from the verdict,  the signals are mixed. Over the trailing twelve months, The Steel City Re Corporate Reputation Index has risen from the 92nd to the 96th percentile. The Exponentially Weighted Moving Average of the volatility of the Index, which had been falling for most of the past six months, has been rising over the past few weeks to .4%. This is a negligible amount. On the other hand,  the trailing twelve week Index velocity is negative and the vector is negative, and these are worrying signs. The intangible asset fraction is unchanged at around 93% beating the sector mean of around 80%.

If the stakeholder community looks at SAP and concludes that they are really a good company that had a rogue unit, then they will come through this period with a loss equal to the cash costs of litigation. If the stakeholders view SAP as a behemoth that may harbor other TomorrowNow-like risks, then there will be significant long-term costs.

Justice Potter Stewart’s concurring opinion in Jacobellis v. Ohio 378 U.S. 184 (1964) enshrined the qualitative standard “I know it when I see it” into business culture. Now there is a quantitative standard too. For features other than the content of films, that is, as well as other intangibles.

The International Organization for Standards (ISO) has adopted a standard for the valuation of brands - a common term for many of the assets comprising some fraction of the typical ~70% gap between market value and book value. As abstracted from the report in the IAM blog,

ISO 10668 applies to brand valuations commissioned for all purposes, including: accounting and financial reporting; insolvency and liquidation; tax planning and compliance; litigation support and dispute resolution; corporate finance and fund raising; licensing and joint venture negotiation; internal management information and reporting; strategic planning; and brand management. The last of these applications includes brand and marketing budget determination, brand portfolio review, brand architecture analysis and brand extension planning.

ISO 10668 is a meta standard which succinctly specifies the principles to be followed and the types of work to be conducted in any brand valuation. It specifies that when conducting a brand valuation the brand valuer must conduct three types of analysis before passing an opinion on the brand’s value. These are legal, behavioural and financial analysis.

1. Definitions: The first requirement is to define what is meant by brand and which intangible assets should be included in the brand valuation opinion. The brand valuer is required to assess the legal protection afforded to the brand by identifying each of the legal rights that protect it, the legal owner of each relevant legal right and the legal parameters influencing negatively or positively the value of the brand.

2. Behavior: The brand valuer must understand and form an opinion on value drivers; ie,  likely stakeholder behaviour in each of the geographical, product and customer segments in which the subject brand operates.

3. Financial:  [The standard] specifies three alternative brand valuation approaches - the market, cost and income approaches.

The above, which seem to enshrine common practice, may move valuation experts to apply these principles to patents and other intangible assets, and the fact that these practices now have the imprimatur of the ISO may enable the capital markets to accept more readily these indications of value.

To find out if this is the case and to get the latest news from the valuation front, the Society will be hosting three consecutive Mission Intangible Monthly Briefings programs on the subject of intangible asset valuation: markets, value management, and valuation, on Nov 5, Dec 3 and Jan 7. Registration is free. You won't want to miss these!

Goldman Sachs (NYSE:GS) is back. As reported by the Dow Jones wire service Monday 27 September 2010, Goldman Sachs has retained its coveted position at the top of the league table of M&A advisers by both revenue and number of deals globally, and for the U.S. and Europe, during the first nine months of 2010, figures from Dealogic show Monday. Goldman's dominance in the coveted list--only twice broken in the past ten years--is unchanged compared with a year ago on a global basis for the first nine months of the year, reinforcing the idea that the investment bank continues to see little fallout from the negative publicity it has garnered this year.

On a global basis, Goldman advised on 225 deals, with a total value of $401.6 billion, Dealogic figures show, giving them a market share of just over 20%. Goldman generated $961 million in revenue from its global M&A advisory. It also topped the rankings according both to deal value and advisory revenue in the U.S. In Europe, although it took the top position measured by deal value, it fell to fifth position according to advisory fee revenue, beaten by Morgan Stanley (MS), Rothschild, JP Morgan and Deutsche Bank AG (DB). In Asia Pacific excluding Japan, however, Bank of America Merrill Lynch topped the M&A ranking, according to value of deals, with a nearly 20% market share. UBS A.G. (UBS) topped the Asia Pacific ranking measured according to the M&A fees ranking, Dealogic says. For Japan, Nomura (9716.TO) dominated the rankings over the same period for both criteria.

The reputation metrics indicate that Goldman Sachs has retained its position at a cost. The Steel City Re Corporate Reputation Index™ ranking for the Company has dropped a net 9 percentile points over the trailing twelve months from the 98th percentile to the 89th percentile as shown in the top chart. Concurrently, the reputation rankings for the entire industry improved, as shown in the 4th chart, with little change in the inter-sector variance. Goldman Sachs' return on equity, in the top chart, and its fractional intangible asset value, shown in the last chart, reveal under performance by 19% and a persistent material loss of intangible asset fractional value.

When we last looked at the Company's metrics, we speculated that the equity markets were not appreciating the Company's value. With the benefit of hindsight, we see that the markets were underpricing the Company relative to its reputation ranking, but were nevertheless sensing real expected loss. A loss of pricing power. We interpret these metrics, in the aggregate, to suggest that Goldman Sachs has had to yield a bit on price. We believe customers want Goldman Sachs for their intellectual prowesss, but sense that they can squeeze Goldman on price. A bit, anyway. For now.  And so it goes.

In its annual meeting held on May 21, 2010, a majority of shareholders considered the executive compensation plan at KeyCorp (NYSE:KEY) and channeled Nancy Reagan. They just said no.

KeyCorp, headquartered in Cleveland, Ohio, is one of the nation's largest bank-based financial services companies, with consolidated total assets of approximately $95 billion. KeyCorp is the third U.S. company after Motorola Inc. (NYSE:MOT) and Occidental Petroleum Corporation (NYSE:OXY) that failed to get a majority support during a management-sponsored "say on pay" vote.

In the last fiscal year, KeyCorp's CEO Henry Meyer III saw a boost of 40.8% in his annual compensation to $8.7 million. For the corresponding period, the company reported a net loss of $1.335 billion. The raise in pay package came from an increase in the value of stock option grants and a large salary stock increase.

The company’s reputation has been in the doldrums. KeyCorp is a constituent of the S&P500 Composite Index. Compared to 283 other companies that are constituents of the S&P500 Composite Index – and have market capitalizations between $7 and 67 billion – the company’s Steel City Re Corporate Reputation Index ranking touches bottom.

Not surprisingly, there is no measurable intangible asset value in the company. As shown in the graph below, while the average S&P500 company’s value is about 82% intangible, KeyCorp has very little of that stuff. 

Many, such as Weber Shandwick’s Chief Reputation Strategist, Dr. Leslie Gaines Ross, have opined that the CEO is the focal point for corporate reputation. If this is the case, Mr. Meyer has some catch up work to do, quickly, for the pressure is building. On Tuesday 8 June, an investigation was announced on behalf of the long-term investors of KeyCorp alleging possible violations in fiduciary duty related to the past and future compensation of senior officers of the company.

Intangible assets are the primary source of enterprise value, and the Society’s mission is to advance best practices in their financial management through education, advocacy, and the promulgation of standards. The Society engages in several educational activities including a regular series of articles in Intellectual Asset Management magazine, regular call-in Mission Intangible Monthly Briefing, the recently published book, Mission: Intangible. Managing risk and reputation the create enterprise value, and of course, this blog. Click here to view the full menu of Mission: Intangible-branded educational opportunities.

One of the hallmarks of financial management is process monitoring through financial metrics and the collective measure of intangible asset value, reputation. Today we illustrate the value of intangible asset management with anecdotal metrics for constituents of the S&P500 Composite Index.

To recap and update, intangible assets comprise approximately 66% of the value of the median material publicly traded company. The chart below shows how the intangible asset fraction of companies over the past few years sampled from about 7000 publicly traded firms has dropped from its peak in 2007 of 78% and is now around 65% which, coincidentally, is the period median.


Using the Steel City Re Corporate Reputation Index as the reputation metric, only 61 constituents of the 10 June 2010 S&P500 Composite Index over the past 128 weeks has ranked in the top 1 percentile relative to approximately 7000 companies traded on the major western exchanges. The other 436 constituents of the current Composite Index have not held that reputation rank during this recent period. Of the 61 companies, the frequency at which they held rank in the top 1 percentile over the 128 week period is reflected in the order in which they appear in the table below, and is shown graphically on the chart. These are the reputation titans of the post-bubble period.




Berkshire Hathaway (NYSE:BRK.A) holds the distinction and lonely outpost at the far right of the graph having ranked in the top 1 percentile of all companies 97% of the time. To its left, the next three highest ranking firms comprising Colgate Palmolive (NYSE:CL), Google (NASDAQ:GOOG), and CR. Bard (NYSE:BCR)  each appeared 88.3%, 86.7%, and 85.2% of the time, respectively. 

Turning to corresponding economic performance, the 61 most highly ranked constituent members of the S&P500 Composite Index that had ranked at least once in the top 1% of the Steel City Re Corporate Reputation Index over the past 128 weeks -- Reputation Titans -- returned, as a group, -7.3% over the period compared with a negative 12.6% return for the portfolio as a whole (reflecting survivor bias) and a -23% return to the actual S&P 500 Composite Index. The remaining 436 (balance), of course, underperformed the portfolio. These data show that the Reputation Titans exhibited relative reputation resilience, a behavior fully consistent with a superior reputation and described in greater detail in the Society's book, Mission: Intangible.


Looking at the S&P500 Composite Index constituents from another perspective and dividing the group into top 15%, Mid Range Rankings, and Bottom Quartile as measured by the Steel City Re Corporate Reputation Index rankings, the top 50 most highly ranked firms over the entire period returned -8.7%, the 50 top-ranked companies that dominated the mid-range rankings returned -20.9%, and the 30 companies that essentially owned the bottom quartile for the period returned -28%. These compare, as expected, with the S&P500 Composite Index returns of -23%.


Summarizing, as shown repeatedly since 2005, there is a positive correlation between reputation ranking and economic return. Because superior reputations favorably impact pricing power, market share, vendor terms, operating costs, credit, costs, equity value, and price stability, executives seeking to maximize enterprise value would do well to concentrate on managing the intangible assets underlying reputation value.

One way to learn how to manage those assets is to become active in the Society. Why not sign up to our group on Linked-In to tap into a wealth of fresh content daily on intangible asset finance, management, policy, marketing and security? Or better still, become a member. We look forward to welcoming you.