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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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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.

Hewlett Packard: Curse of the C-suite

Nir Kossovsky - Wednesday, August 25, 2010
It would be difficult to top the language of the Silicon Valley Mercury News. “In a stunning plot twist in the long-running Silicon Valley soap opera that is Hewlett-Packard (NYSE:HPQ), Mark Hurd resigned as CEO of the Palo Alto tech giant after an investigation into a sexual-harassment claim.” While a company "investigation determined there was no violation of HP's sexual harassment policy, the probe concluded Hurd filed false expense reports to conceal his relationship with the woman. Blame it on whatever is in the water cooler servicing the C-suite.

The Steel City Re Corporate Reputation Index indicates the event was material. To quote an HP employee website, “The performance of a leader must be measured -- and rewarded -- based on more than the numbers. Integrity matters. Trust matters. We're talking about "violations of HP's Standards of Business Conduct" by the man who held ultimate responsibility for corporate conduct.”

HP began the period with a reputation ranking in the 95th percentile and exhibited little volatility (EWMA=0.014) until the events of the recent past. At this writing, the company’s reputation index has drifted down to the 84th percentile to the benefit of both Fugitsu Ltd (OTC:FJTSY) and Lenovo Group Ltd. (OTC:LNVGY), and further distancing itself from the 22-company Computer Processing Hardware sector leader, Apple Inc. (NASDAQ:AAPL).

Economically, HP is currently underperforming the median of this sector by 27.53%, but this is largely legacy effect from having both outperformed most of the sector, and having shown material resilience over the past five years. However, the future is not promising. The sector, as a whole, is in decline with the median reputation ranking relative to the whole market drifting from the low 40th percentile to the high teens over the trailing twelve months. Thus HP’s reputation slippage at this juncture does not bode well for teh company's future economic returns.

Walmart: Laboring to protect its reputation

C. HUYGENS - Wednesday, May 12, 2010
As April came to a close, Walmart Stores Inc. (NYSE:WMT) received bad news. The United States Court of Appeals for the Ninth Circuit, in San Francisco, ruled that the plaintiffs alleging unfair labor practices against female employees (read, unethical practices) can head to court as a class action. This decision transforms a nine year old matter into the largest class-action employment lawsuit in U.S. history.

Besides being a welcome break from the headline risk crises on safety, quality and ethics facing BP (NYSE:BP), Toyota (NYSE:TM), and Goldman Sachs (NYSE:GS), the issue provides an opportunity to test a central hypothesis held by the Society and described in detail in the book, Mission Intangible. This is it.

Reputation value is the sum of the value contributed by six key intangible assets (business processes) governing ethics, quality, innovation, safety, sustainability, and security. The assets create value cooperatively like the stones in a Roman arch; loss of any one key stone can destroy significant value.

Let’s also recap what is value. Market capitalization is the obvious one. More to the point, companies with superior reputations have enhanced pricing power, lower operating costs, lower credit costs, and higher earnings multiples. It's that simple.

Walmart has invested significant time and effort into building authentic credentials and a reputation for excellence in sustainability practices. Is its reputation for sustainability sufficient to compensate for its less-than-stellar reputation in labor (ethics)? The hypothesis would suggest that they are independent, and that failure in either could erase the reputation value created by the other. Let’s look at the numbers.

The Steel City Re Corporate Reputation Index, also described in greater detail in the book, Mission Intangible, shows that Walmart’s reputation ranking has slipped from the coveted #1 slot of the 100th percentile among 39 peers in the multiline retail sector. Over the past 16 months, Walmart has moved from the top ranking to the 94th percentile. Economically, its return on equity has underperformed both the median return of its peers (by 42%) and the S&P500 benchmark index.

In contrast, Target Inc. (NYSE:TGT), a rival whose charting in this Mission Intangible blog back in June 2009 has been the most popular post ever, raised its reputation ranking among this peer group from the 46th percentile to the 94th percentile. At the same time, it outperformed the median of its peers (by 27%) and the S&P500 index.

Also for contrast look at Walgreen Co. (NYSE:WAG). During this period, their reputation ranking rose from the 69th percentile to the 81st percentile, and it outperformed its peer group by a narrow 2%, but comfortably beat the S&P500 Index.

Last, note that the multiline retail sector, as a group, slipped in its median reputation ranking relative to the broad market. Furthermore, the variance among the individual companies comprising this sector narrowed. The sector's median reputation ranking drop stands out dramatically in contrast against Target's reputation ranking rise.

Overall, these data affirm the increasing importance of reputation management in increasing, protecting and restoring enterprise value; and that reputation management involves addressing core business processes whose perceptions by stakeholders comprise reputation. These data also affirm the Roman Arch model, which plainly says, if you don't pay attention to all of your key business processes, then, when a headline crisis strikes, your stakeholders may turn on you in a heartbeat.

Ethics and anthropology

Nir Kossovsky - Monday, March 29, 2010
Because this week two of the major monotheistic religions celebrate holidays, and because on 9 April our Mission Intangible Monthly Briefing  explores the value of ethical behavior, today we take a break from headline risk to look at ethics.

Ethics comprise prescriptions for fairness. As we discuss in the Society’s latest book, Mission: Intangible, ethics are the moral principles by which a company operates; integrity is the act of adhering to those moral principles. For executives in a perpetual search for competitive advantage, the existence of fairness in the general population may be a puzzle. In a dog-eat-dog world, what possible biological advantage could accrue to those who behave in a trusting and cooperative manner with unrelated individuals?

There are two answers: financial and anthroplogical. From a financial perspective, our data show that companies with superior reputations for ethical behavior outperform their peers. And while that should be sufficient and compelling for any senior executive or board member, anthropological data suggest that fairness is an adaptive social construct.

The Economist reports in the 20 March issue that research from the University of British Columbia indicates that the variance of fairness found in difference societies has a cultural explanation -- a response to the development of trade. According to work by Joseph Henrich and colleagues,

…those societies that most resemble the anthropological consensus of what Paleolothic life would have been like (hunting, gathering with only a modicum of trade) were the ones where fairness seemed to count least. People living in communities that lack market integration display relatively little concern with fairness or with punishing unfairness in transactions. Notions of fairness increase steadily as societies achieve greater market integration. People from better integrated society are also more likely to punish those who do not play fair, even when this is costly to themselves.

Which explains the wisdom of the 1998 observation by Alan Greenspan that “in a market system based on trust, reputation has a significant economic value.

Heads Up - Date Change

As noted above, the Mission: Intangible Monthly Briefing for April 2010 will be held one week later than usual in deference to those who celebrate Good Friday. On 9 April 2010 at 12h00 EDT, the second Friday of the month, we will host a conversation featuring incoming Integrity and Corporate Responsibility Committee Chairman Paul Liebman from Dell (NASDAQ:DELL) and IA Value Signaling Committee Chairman Jon Low from Predictiv. The title for the one hour moderated discussion is: Ethics - A valuable intangible asset? Mary Adams from Intellectual Capital Advisors hosts.

As always, registration for this popular series is complimentary and slides will be available for download in advance of the event. To register now, click here.

Join Us

If the above intrigues you or challenges you to learn more, look no further. The Intangible Asset Finance Society wants to be your business resource. Join us and be part of an organization that provides a wealth of educational materials, including a new book, to further your executive career, and exciting monthly conferences such as the upcoming one on ethics mentioned above.

Lehman: Headline risk and Repo 105

Nir Kossovsky - Friday, March 19, 2010
It is water under the bridge, of course, but it is worth noting that insiders at Lehman (NYSE:LEH) thought that Repo 105 reeked of “headline risk.” And headline risk, as we have observed before, can snowball.

According to Jennifer Hughes writing in today’s Financial Times, Martin Kelly, global financial controller, warned his bosses about the “headline risk” to Lehman’s reputation if the deals were to become public. And now that the issue is public, it is snowballing.

Ms. Hughes further writes, “Lehman’s Repo 105s have attracted attention because attempts to hide assets by shifting them off the balance sheet are associated with dodgy accounting and best known for the interminable tangle of vehicles created by Enron, the failed US energy group, to hide its debts. But the reason this issue keeps rearing its head in so many guises is that the question lies at the very heart of accounting, which was originally intended to give a company’s owners a fair report of its business activities. Therefore, what goes on, and what stays off, the books is a permanent area of debate.”

Perhaps. But there is also a reputation angle to this story. In our opinion, the reason this issue is rearing its head and snowballing with the inevitable pile on of ‘litigators, regulators and Mommy bloggers’ is that it speaks to a central driver of market liquidity—trust. As former Fed Chairman Greenspan noted in October 2008, in a market system based upon trust, reputation has significant value. Linking ‘trust’ to ‘reputation’ is the ephemeral intangible asset of ‘ethics,’ for which accountants have yet to find a home.

Which is not to say that ‘ethics’ does not impact financial statements. As reported in the Intangible Asset Finance Society’s latest book, Mission: Intangible, companies with superior reputations deliver superior long-term shareholder returns by enabling (i) stronger pricing power, (ii) lower operating costs, (iii) greater earnings multiples, (iv) lower beta and (v) lower credit costs. And as for companies that do not foster conformance with ethical best practices, there are always alternatives to being a going concern. Just ask Lehman.

Whistling by the graveyard

Nir Kossovsky - Monday, March 01, 2010
It is significant that there is little public gloating from other auto manufacturers as Toyota Motors’ (NYSE:TM) leadership globally offers mea culpas. Although it is Toyota’s reputation that is melting under the heat of headline risk, competitors are only too aware that the next tolling of the bell could be for them.

This is why. While the damaged intangible assets are three of the big six: ethics, safety, and quality, the underlying problem is the global supply chain. According to Bob Rittereiser, CEO of Zhi Verden, a supply chain systems and information management company, “the stark reality today is that the global supply chain is a business operating system with global reach, thousands of participants, established practices, government requirements, blazed paths, known bottlenecks and many known risks, yet no one is in charge!” Or, said differently by John Hurrell, Chief Executive, Association of Insurance and Risk Managers, “The complexity of supply chains puts your reputation in the hands of the lowest common denominator.”

Reputation drives intangible asset value. As reported in Mission: Intangible -- Managing Risk and Reputation to Create Enterprise Value (IAFS with Trafford Press, March 2010), research shows that superior reputations pay off with (i) pricing power , (ii) lower operating costs, (iii) greater earnings multiples, (iv) lower beta (i.e., stock price volatility) and (v) lower credit costs. And when reputation is damaged, these benefits are lost. All told, we estimate the reputational impact, so far, to be a $2 billion cost to Toyota's earnings and a $25 billion cost to its market capitalization.

Previously we shared Toyota's reputation metrics from the Steel City Re Corporate Reputation Index. We take time out from our membership drive to offer this financial breakdown shown at left.

Legend. Income Statement Impact (values in $‘000). Lost sales and a 3% loss in pricing power will reduce Toyota’s gross profit by around $900 million. Costs associated with the worldwide recalls, litigation, insurance subrogation, and regulatory compliance will cost at least another $500 million. The lower credit ratings will increase borrowing costs by at least another $71 million, and non-cash depreciation expenses associated with a 3% write down of Toyota’s automobile asset base will reduce earnings by another $540 million. Data source: Steel City Re.

Join Us

If the above intrigues you, frightens you, or challenges you to learn more, look no further. The Intangible Asset Finance Society wants to be your business resource. Join us and be part of an organization that provides a wealth of educational materials to further your executive career.

Innovation: Hot Policy and Practice Issues

Be sure, by the way, to register for a complimentary seat at the 5 March Mission:Intangible Monthly Briefing, held by phone at 12h00, EST. It's an innovation smack down. Athena Alliance President and intangible asset policy expert Kenan Jarboe goes head to head with Steel City Re's Judith Giordan, Managing Director of IA Finance and former senior technology executive with Pepsi, Henkel, International Flavors & Fragrances, and Polaroid. Yes, as always, registration is complimentary and slides are already posted on the website events page.

IAFS Membership Drive

Nir Kossovsky - Wednesday, February 24, 2010
The IAFS launched its 2010 membership drive this past week. This is why. On February 28, new US SEC regulations will drive into the boardrooms risk, reputation and intangible asset management. 

You have a decision. Will you be at the table or on the menu?

These regs mean that every board member, in fact every top executive, can expect major new challenges. Members of the Intangible Asset Finance Society (IAFS) will be prepared. Here’s how:

1. Thought Leadership. The IAFS is the only interdisciplinary Society of professionals committed to the financial exploitation of intangible assets. That translates into enhanced pricing power; lower operating and credit costs; and higher net incomes and earnings multiples.

2. Risk Management. A lost reputation can destroy a firm overnight. IAFS can keep you up to date with risk management strategies for ethics, innovation, quality, safety, environmental sustainability, and security.

3. Preferential Pricing. Society members receive preferential rates for IAFS products at our new store and discounted registration to various professional meetings. Discounted registrations for the March ICAP Ocean Tomo meeting in San Francisco and the June IP Business Congress in Munich, for example, are now offered.

4. Incentive Premium. Sign on for your academic or corporate membership including payment by March 15 and receive a complementary copy of the IAFS’s latest book, Mission: Intangible. Managing risk and reputation to create enterprise value (a $29.95 value).

Click here to learn how our strengths in Thought Leaders and Risk Management, financial benefits such preferential pricing, and premiums such as the book shown at right make joining the Society today an offer you can't refuse.

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