MISSION INTANGIBLE

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MISSION:INTANGIBLE, the blog of the Intangible Asset Finance Society, offers critical comments on intangible asset, corporate reputation, and finance; supplemented by quantitative reputation metrics. Intangible assets include business processes, patents, trademarks; reputations for ethics and integrity; quality, safety, sustainability, security, and resilience; and comprise 70% of the average company's value. MISSION:INTANGIBLE is a registered trademark of the Intangible Asset Finance Society.

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Walmart: Not out of the woods yet

C. HUYGENS - Friday, June 24, 2011
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.

Avon: Ethical calling

C. HUYGENS - Wednesday, May 25, 2011
Several months ago, in the ongoing post-mortem of the BP disaster, John Kay noted in the Financial Times that, “today’s willingness to cut corners is tomorrow’s headline risk.” Were this observation to be appreciated more widely, many reputations might have been saved.

Which brings Huygens to the happy story of Avon Products, Inc. (NYSE:AVP). Under financial pressure, the rumor mills last fall suggested the Company was in the cross hairs of L’Oreal S.A. In early October, the call volume on Avon surged relative to puts giving holders a whopping 18% 3-month return. L’Oreal didn’t take the bait, and Avon moved quickly to cut costs. In mid-October, it announced plans to cut about 400 jobs and to shut down an Ohio manufacturing facility. On early November, it announced that it had agreed to tender its 75% ownership interest in its Avon Japan business to an affiliate of TPG Capital, the global private investment firm. There were a number of intellectual property licenses associated with the deal. The stock priced tumbled.

Yet when faced with a major ethical issue whose resolution could have further impaired cash flows, the Company avoided the temptation to cut corners. In mid April 2011, Avon suspended the president, chief financial officer and top government affairs executive at its China unit and a senior executive in New York who was the company's head of internal audit until the middle of last year. According to Business Ethics (13 April, Connor), in its most recent SEC 10-K filing, Avon said it had voluntarily disclosed to the SEC and the Department of Justice internal investigations and compliance reviews which had “started in China” and focused on “certain expenses and books and records processes, including, but not limited to, travel, entertainment, gifts, and payments to third-party agents and others, in connection with our business dealings, directly or indirectly, with foreign governments and their employees” Avon said in its 10-K filing that the investigation had grown to include “additional countries.”
The Wall Street Journal cited a source as saying those countries were in Latin America, a major source of revenue and earnings for Avon.

With the benefit of a month’s hindsight, we can see how the financial and reputation markets have reacted. Over the trailing twelve months, the Company has underperformed the median of its 41 peers in the Household/Personal Care sector by 19.44%. The big fall off from parity traces back to the actions in the fall of 2010.


The reputational metrics, however, suggest that the Company is on a value-creating path. According to Steel City Re, the Company’s reputation index metrics are unchanged over the trailing twelve months with a most recent ranking at the 70th percentile. The Index’s exponentially weighted moving average volatility has been drifting downward consistently since the fourth quarter and is now at 66% -- a high value for sure, but a trend that is value-creating. The twelve-week reputation index velocity and vector values show recent upward movement s of 19% and 5% respectively suggesting a positive response to the corporate actions and disclosures.


Looking last at enterprise value, the intangible asset fraction of the company is now greater than it was a year ago, affirming that all other things being equal – as Alan Greenspan noted several years ago – “in a market based on trust, reputation has value.”

Berkshire Hathaway: Halo slipping?

C. HUYGENS - Tuesday, April 05, 2011
In late February, Alice Schroder writing for the Financial Times  challenged Warren Buffett to show his sage side on succession. Call it a governance thing. But the fact is that both last year, and again this year, Mr. Buffett failed to clarify how roles will be allocated when he inevitably steps down. According to Ms. Schroeder, “the market is fed up with the ‘trust me’ approach and is no longer giving Mr. Buffett the benefit of the doubt."

Fast forward to late March when the market is shocked to learn, according the Gainesvill Sun, "David Sokol has abruptly resigned from Berkshire Hathaway, the company run by the billionaire Warren E. Buffett, raising major questions about the future stewardship of the conglomerate." The 54-year-old was considered to be the top candidate to succeed the 80-year-old Buffett -- a major concern to Berkshire's investors." Furthermore, his departure occurs under a cloud of questionable trading.

According to the Economist,  “this is toe-curling stuff for the great investor, who prides himself on fair-dealing and likes to stake out the moral high ground. Think derivatives, which he has damned as dangerous. Or his tut-tutting over Wall Street’s book-cooking. (In both cases there is a whiff of hypocrisy: Berkshire dabbles in derivatives and it was recently forced to write down holdings that regulators deemed overvalued.) The affair will fuel talk that Mr Buffett’s halo is slipping."

What do the numbers say? The Steel City Re Corporate Reputation Index shows a tinge of negative reputational activity at Berkshire Hathaway -- and a rather droll economic performance over the trailing twelve months.

The Index ranking for Berkshire Hathaway (NYSE:BRK) has dropped from the 100th percentile to the 98th percentile,  the exponentially weighted moving average volatility has inched ever so slightly to 0.1%, and the reputation vector and velocity have been negative for a full month. These are insignificant movements -- perhaps, like the dog that didn't bark, they are notable because the economic performance of Berkshire Hathaway, a conglomerate, is trailing the median of its peers by 13%.

The halo may not yet be slipping, but it is increasingly vulnerable.

UBS: Truth in Libor

C. HUYGENS - Thursday, March 17, 2011
“We are committed to retaining the reputation and integrity of BBA Libor, which continues to be the authoritative benchmark of the wholesale money market,” said a spokesman for the British Bankers’ Association, according to the Financial Times. 

That there should even be a question about the  London interbank offered rate's -- Libor’s -- integrity is problematic. As the Financial Times explains, Libor is used as a reference rate for about $350,000bn in financial products.

Regulators in the US, Japan and UK are investigating whether some of the biggest banks conspired to “manipulate” this benchmark interest rate. The investigation centres on the panel of 16 banks that help the British Bankers’ Association set  Libor – the estimated cost of borrowing for banks between each other.

The probe came to light on Tuesday when the Swiss bank UBS (NYSE:UBS) disclosed in its annual report that it had received subpoenas from three US agencies and an information demand from the Japanese Financial Supervisory Agency. The other banks on the panel are: Bank of America, Barclays, Citigroup, Credit Suisse, Deutsche Bank, HSBC, JPMorgan Chase, Lloyds, Rabobank, Royal Bank of Canada, Bank of Tokyo-Mitsubishi, Norinchukin Bank, Royal Bank of Scotland and West LB.

As to the Libor calculation algorithm, “…it is fully transparent – all of the data inputted by the contributor banks is publicly available, as is our methodology,” said the BBA.

McKinsey & Co.: Help wanted

C. HUYGENS - Thursday, March 10, 2011
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.

HP: Ethics takes a holiday?

C. HUYGENS - Thursday, January 27, 2011
There's never a dull moment in the HP (NYSE:HPQ) boardroom. At the firm that just released its last CEO for ethical issues, the National Association of Corporate Directors newsletter this morning cites a story from the Denver Business Journal raising concerns about the close business ties between the ostensibly independent directors and the new CEO.

The Journal (Jan. 26, Schubarth) cites the concerns of several corporate governance experts that Hewlett-Packard Co. recently recruited executives to its board of directors who all have business ties to CEO Leo Apotheker. Consequently, they will need to prove they can act independently.

Dominique Senequier, for instance, manages an investment buyout arm of French insurer AXA SA, where Apotheker is on an advisory board. Three other new directors -- former General Electric Co. Chief Information Officer Gary Reiner, former Alcatel-Lucent CEO Patricia Russo, and ex-eBay Inc. CEO Meg Whitman -- all did business with SAP AG while Apotheker was on staff.

Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, comments, "If directors have significant relationships with the CEO or other directors of a company on whose board they sit, it's harder for them to be objective. Directors are supposed to be representing shareholders, not the CEO or one another, and that's why companies typically try to recruit directors who are independent of one another and management."

It  is an interesting problem, and one that will confront any CEO who's business (or prior business) has a large global footprint. After all, it could be argued that anyone coming from a firm that did not work with, or use, SAP products is coming from a business still operating in the dark ages. And that appears to be the reaction of the majority of stakeholders, as reflected in the Steel City Re Corporate Reputation Index metrics. In a word, no impact. No change in the relative ranking among 18 peers in the Computer Processing Hardware sector, no change in reputation volatility, and no change in reputation vector or velocity.


Yet given the governance challenges HP has faced over the past few years, the concerns in this instance merit deeper consideration.

Johnson & Johnson: Pining for antediluvian days

C. HUYGENS - Thursday, January 20, 2011
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."

SAP AG: Blind to intangible risks

C. HUYGENS - Wednesday, December 01, 2010
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.


Office Depot: Announcing departures

C. HUYGENS - Tuesday, October 26, 2010
The study of ethics must be daunting judging from frequency corporate officers stumble. The latest: the chief executive of Office Depot (NYSE:ODP), the US office supplies retailer, is to resign less than a week after the company agreed to pay a penalty to regulators for selectively providing investors with earnings guidance.

For the academically challenged, the principles of ethical behavior can be summarized thusly: for the rationally minded, there is the Kantian categorical imperative; for the spiritual or religiously inclined, there is the golden rule.

The company said Steve Odland would step down on November 1, after serving five years as chief executive. The reputation metrics say this is reasonable.



The Steel City Re Corporate Reputation Index metrics show that Office Depot began the trailing twelve month period with a reputation ranking in the 12th percentile and dropped by last Thursday evening to the 7th percentile relative to the 125 companies in the Miscellaneous Retailers sector. Over the trailing six months, the Exponentially Weighted Moving Average (EWMA) of the Index's volatility has been high closing last week at a whopping 68%. The trailing twelve week reputation velocity and vector have been negative at-.35 and -.126 respectively. Consistent with this picture is an economic return that is both negative and nearly 50% below the median of the peer group.



Office Depot's reputation volatility stands out in contrast to the sector where the group's median reputation ranking steadily declined from the 60th to the 55th percentile over the trailing twelve months while volatility within the sector rose steadily from 0.24 to more than 0.26.  Last, Office Depot's intangible asset fraction has bounced quite a bit from more than 70% of market value to less than 30% settling down last week to around 40% -- some 30% below the sector median.

The rationale for providing investors selectively with earnings guidance was to reduce volatility. At the time, it may have seemed like a good idea.

BP: FTSE4Good bids adieu

C. HUYGENS - Wednesday, September 15, 2010
This coming weekend, the good people who manage the FTSE4Good ethical investment index will show BP (NYSE:BP) the door. From 18 September, BP will be excluded from the index which many managers of ethical funds use to screen companies before including them in their portfolios. (BP is not a constituent member of either of the RepuStars composite indices.)

All we can ask is, "what took the FTSE so long?" Below, the Steel City Re Corporate Reputation Index ranking for BP and other reputation and intangible asset-related metrics. The pictures are worth thousands of words.



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