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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New fundamentals

Nir Kossovsky - Monday, October 05, 2009
Nell Minow, editor and co-founder of the Corporate Library, a provider of corporate governance research, ratings and investment risk analysis, penned a Financial Times op ed piece on 2 October suggesting that going forward, fund managers and analysts will look at four new fundamental elements “that will become as important as cash flow and return on investment.” To no surprise around here, these four comprise intangible asset metrics and business processes. While we do not necessarily agree with Minow's views, her comments are worth noting. This is what she wrote, briefly:

1. Accounting: Investors will demand better information about human and intellectual capital, risk management processes, and sustainability. Our friend, Ken Jarboe of the Athena Alliance, has been delving into this topic for years. You can link to the Athena Alliance here.

2. Boards of Directors: Investors will demand greater competence and selfless engagement from members of the Boards of their companies. They will want from Directors what private equity firms demand of early stage company executives: "skin in the game." This notion compresses to the concept of Governance, about which the Society has organized a Committee chaired by Cathy Reese. Without leaving with us a pound of flesh, you can download her 6 Feb 09 "how to" presentation on this subject from our Events page.

3. Compensation: We read Minow’s comments in this light: executive compensation must better align the interests of senior management with the long-term interests of the firm and its stakeholders. Compensation processes, writes Minow, are a key indicator of risk. While we still see benefits in incentives and material compensation, notwithstanding the growing chant of mobs with pitchforks, we like the part in Minow's piece about processes and risk management. In fact, we like anything that links risk management to overall corporate reputation. This is especially when a company uses financial instruments to signal superior risk management. The Society presented a Mission:Intangible Monthly Briefing on Risk and Reputation Management 10 July 09 that you can download from our Events page.

4. Investors: Going forward, investors will look to see if the existing investors are providing sufficient oversight to ensure that the Board of Directors is providing sufficient oversight to ensure that management is providing sufficient oversight of the firm’s operations. Did you follow that? The business process is oversight; the intangible asset affected is trust. To us, the take home message is this. The greater the trust (a product of transparency), the less oversight burden for all. And how can investors signal trust? According to Minow, investors can signal trust by being "overweight relative to the index." In other words, extra skin in the game. See #2 and #3 above. 

The bottom line is this. Investors will seek companies that have their business processes under better control, can quantify and report the value of these proceses to their stakeholders, can manage their risks, and can signal their material conformance with the preceding  through non-traditional channels. The Society provides a working environment for best-practices discovery for executives seeking to accomplish the above. Won't you join us?

It's personal

Nir Kossovsky - Thursday, September 24, 2009
During the 6 February 2009 MISSION:INTANGIBLE Monthly Briefing, Fish & Richardson’s Cathy Reese, who chairs the Society’s IA Corporate Governance Committee, indicated that under Delaware Law, Directors and Officers had a Duty of Care to oversee the management of the business processes that help establish reputation. She noted that absent oversight systems, Members of the Board could be personally liable to shareholders for adverse events that impaired a company’s reputation.

Cathy’s warning of shareholder-driven exposure is just the beginning. Now companies are seeking restitution, too. According to the newspaper Deutsche Welle, after spending nearly 2.5 billion euros to cover legal bills and fines stemming from an international bribery scandal, Munich-based Siemens AG (NYSE:SI) is seeking payments from its former leadership team. Siemens was investigated for paying 1.3 billion euros in kickbacks between 2003 and 2006 to potential buyers in 12 countries, including Italy, Greece, Russia and Nigeria. In Germany and in the United States, the company was found guilty of corruption and ordered to pay combined fines of just over a billion euros. After the 2006 investigation, Siemens then accused some of its former managers of having failed to stop illegal practices and wide-ranging bribery.

It gets more interesting. The Financial Times reports that some of Siemens’ investors have threatened to sue the company if it did not claim damages from its former managers.

The value of risk and reputation management at the board level should be painfully obvious. The consequences of failing to manage a firm’s business processes for ethics, sustainability, innovation, quality, safety, security, etc. – the drivers of reputation – can place officers and directors at great personal peril. Yes, it’s personal.

Ethical pharmaceuticals II

Nir Kossovsky - Friday, September 04, 2009

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.


Ethical investigations

Nir Kossovsky - Tuesday, August 11, 2009
As a follow on to last week's note on the fall of Huron Consulting due to ethical issues, the Financial Times reported Monday  that a study commissioned by KPMG of UK companies found that four out of 10 respondents had begun investigations in the past three years. This compares with 27 per cent a 2007 survey.

Companies had a further incentive to set up better anti-corruption practices after big fines were imposed on Siemens of Germany and KBR-Halliburton of the US for overseas bribery.

Despite the rise in anti-fraud activity by British business, however, the survey showed that an even greater number – 43 per cent – had no anti-corruption measures in place, suggesting that many companies still did not take the issue seriously.

And while 67 per cent of respondents said there were places where it was impossible to do business without bribery, only 35 per cent had ever declined to work in a country because of fears of corruption.

Even among companies that had adopted anti-bribery measures, the survey found that only 42 per cent conducted regular audits of overseas agents – the middlemen who have been found at the centre of corruption allegations.

There was also a lack of awareness about the far-reaching “extra-territorial” powers of US authorities through the Foreign and Corrupt Practices Act, which had been used to pursue British companies and executives.

Six out of 10 companies said they worked in the US, but only three in 10 realised they were subject to the law.

In the UK, a new bribery bill which could become law next year creates an offence of “negligent failure of a commercial organisation to prevent bribery”. Executives could be held responsible for wrongdoing in their company or by third-party agents, regardless of whether they knew about it. In the US, that standard is already in place as the result of In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996), and Stone v. Ritter, 2006 Del. LEXIS 597 (Del. 2006).

NGO no no

Nir Kossovsky - Thursday, July 16, 2009
We dedicate most of the time and effort of this communication channel to a discussion of the intangible assets that underpin reputation. Usually, the subject matter involves corporate behavior.  Awareness of issues associated with corporate behavior may come to light because of government regulatory action. More often, it is the result of NGO-driven publicity. In a break with tradition, the subject of today's note comprises NGO transparency. 

An on-line Wall Street Journal op-ed posted earlier this week alleged that Human Rights Watch, a 30-year old NGO dedicated to defending and protecting human rights, sent its leading Middle East official, Sarah Leah Whitson, to extract money from potential Saudi donors by bragging about the group's "battles" with the "pro-Israel pressure groups." The ongoing dialogue appears to affirm the allegations.

NGOs are important actors in both the geopolitical and commercial worlds. They encourage and monitor corporate compliance with many of the best practices comprising key business processes that underpin reputations for ethics, safety, and sustainability. They are respected and feared by much of the business community. Their primary tool is the threat of headline risk. Their moral authority depends on their reputation for independence. Their value is ephemeral. Loss of reputation and moral authority can be catastrophic.

Ronelle Burger and Trudy Owens from the University of Nottingham recently published a study that was motivated by “widespread calls for NGOs to become more accountable and transparent.” They conclude that “… NGOs with antagonistic relations with the government may be more likely to hide information and be dishonest.“

Human Rights watch has an antagonistic relationship with the Israeli government. The Israeli government wasted no time questioning HRW's "moral compass. "

Quis custodiet ipsos custodes?


Sustainable sustainability?

Nir Kossovsky - Monday, July 13, 2009
Amongst our master list of key drivers of reputation recognized by the Society are ethics, innovation, quality, safety, sustainability and security. We gave the top post to ethics and its derivatives, confidence and credibility. We haven’t shared our thoughts on the pecking order for the five remaining intangible asset business processes, although recent events suggest that the market is moving sustainability into a lower ranking.

What is happening? A few weeks ago we noted that United Technologies (NYSE:UTX) had quietly terminated its sustainability-led advertising strategy. Now we read that BP (NYSE:BP) is moving from renewables back to petroleum.

We intend no offense. However, in light of the above, there is a open question: while sustainability is certainly a public good, can it be practiced by individual companies profitably? Or more specifically to the intangible asset aspects, "is a reputation for sustainability valued?" We invite your comments here and on the IAFS Linked-In platform.

Nobody doesn't like Sara Lee

Nir Kossovsky - Wednesday, June 10, 2009
On June 30 2008, Margaret (Peggy) M. Foran was appointed to executive vice president, general counsel and corporate secretary of Sara Lee Corp (NYSE:SLE).  In addition to overseeing the company’s worldwide legal activities, Peggy led Global Business Practices, risk management, internal audit and insurance activities, as well as environmental, safety and sustainability efforts. In our parlance, she was Sara Lee’s risk and reputation officer. She reported to Brenda C. Barnes, chairman and chief executive officer, Sara Lee Corp. On June 9th, after less than one year on the job, she abruptly stepped down “for personal reasons.”

What’s going on in the background? Dogs -- hot dogs, to be exact. There is the May 2009 lawsuit filed by Sara Lee against Kraft Foods (NYSE:KFT) for false advertising – the so called hot dog wars. There is the concurrent recall of 1700 pounds of Sara Lee Ball Park brand hot dogs for mislabeling.  Hardly steamy stuff.

Is there some reputational risk lurking for which an indication or warning might be found in the Steel City Re IA (Corporate Reputation) Index?. The Index, which correlates with reputation surveys such as those published by Forbes, Fortune, and Harris Interactive, captures the financial implications of stakeholder behaviors and expectations of stakeholder behaviors as determined by corporate reputation. The Index is a good leading indicator of financial performance and returns on equity.

 

The Steel City Re Index shows that the reputation metric has been hovering in the 40th percentile amond the 48 companies in the Packaged foods & meats sector this past year. Although there is a distinct upward movement from the 40th to the 50th percentile co-incident with Ms. Foran's appointment, the trend has otherwise been downward until a recent recapture of lost ground. Although EWMA volatility has been declining, it is still at 4log orders of magnitude. Economically, over the past twelve months, SLE has underperformed its peers by 16.5%. In short, the mystery is why the dog didn't bark.

By our indications and warnings metrics, this type of economic underperformance in the setting of an already low reputation index increases the risk of business process corner-cutting -- actions that can lead to business process failures and expose a company's reputation to a myriad of perils and headline risk.

Ms Foran joined Sara Lee with a stellar reputation of her own. In CEO Barnes' welcome announcement last year, she said "During her three-decade long career, Peggy has earned the respect of corporate leaders, stakeholders, directors, investors and peers. She is recognized worldwide as a true leader with a reputation for the highest levels of personal integrity." She had tours of duty at Pfizer, ITT, and JP Morgan. 

We'll be following this one closely.

Beverage grandmasters

Nir Kossovsky - Wednesday, May 06, 2009
This note explores whether a proposed transaction by a $75B beverage company, Pepsi Inc. (NYSE:PEP), is motivated by costs savings, brand enhancement, or reputation protection. Seeing no perceptible movement in the reputation index of either the company or its arch rival, we conclude that notwithstanding which of the three was the initial trigger, the greatest value may be in reputation risk management.

On 20 April 2009, Pepsi proposed buying the outstanding shares it does not own in its two largest bottlers, Pepsi Bottling Group (PBG.N) and PepsiAmericas (PAS.N), in a $6 billion cash and stock deal. Many in the financial press suggested it was a cost-cutting initiative. Jon Baskin, a marketing iconoclast, a keynote speaker at the Society’s 2008 annual conference, and the author of the book, “Branding OnlyWorks on Cattle,” opined that the move represented brilliant, strategic branding. In Jon’s words:

Think about it. New packages and formulations, available at new and different locations, priced and supported in novel ways...all thanks to a holistic approach to the brand, vs. some archaic top-down application that sees it only as image and words. It's these actions, and real investments, that will build sustainable, long-term brand growth.

Cost savings and long-term brand growth are both good things, reflect well on management and enhance reputation. So, with two weeks having now elapsed during which the market has had an opportunity to digest the news, and while the deal is still in the negotiation phase (the bottlers rejected it on Monday), we called on the Steel City Re corporate reputation index to see what impact the news has had on the reputations of Pepsi and its arch rival, The Coca Cola Company (NYSE:KO).

As shown in the charts below, the short answer is “not much.” Pepsi tops the fifteen-member Soft drink sector; Coke is in the 92nd percentile. Volatility is nil. In fact, in the midst of the most tumultuous market since the great depression, these two iconic firms emerge with nearly identical profiles comprising exceedingly stable reputation metrics. With Pepsi and Coke’s market caps at $75B and $100B respectively, are they too big to budge?






Big, yes, but not too big to trip and fall. As we see it, both pay exquisite managerial attention to their reputations. Ethics, quality, safety, security and sustainability are all watchwords. Innovation is alive and well. So the competition between these two is analogous to that of two chess grandmasters. They see all, know all, and understand the implications of every move and its derivatives. The game, therefore, is waiting for one or the other to make a mistake. It is a game where risk management is the winning play. And given the relative values of the physical assets and intangible assets at the two companies, reputation loss arising from a business partner where visibility and control are weaker – supply chain headline risk, if you will – is one of the major risks we believe needs to be managed.

So let us put our own spin on Pepsi’s announced acquisition: from an intangible asset finance management perspective, it is a prudent move to manage reputation risk arising from a third party. While it may not increase Pepsi’s brand value or enhance its reputation, it may prevent the sort of reputation loss that destroyed nearly 14% of Coke’s value 10 years ago.

Ethical pharmaceuticals

Nir Kossovsky - Friday, May 01, 2009
Earlier this month, Novartis was named one of the three most ethical pharma and biotech companies in the world by Ethisphere Magazine, following an in-depth analysis over a six-month period by several non-governmental organizations and the publication's editors. Ethisphere claims that firms found to be more ethical outperform their peers. We're inclined to agree in principal, because it is our observation that superior stewards of intangible assets build resilient reputations and outperform their peers, and "ethics" is a major intangible asset. On the other hand, league tables are often disparaged as "rank and spank."

It seemed ironic that we should question an organization with a name such as "Ethisphere." Ok, we trust them. But we are obliged to verify. And what better tool to use than the Steel City Re Intangible Asset Finance (corporate reputation) Index, a quantitative tool that measures the financial impact of stakeholder behaviors that are reasonable indicators of corporate reputation.

As shown in the chart below, Novartis (NYSE:NVS) IA index ranking has fluctuated around 0.93 this past year. The EWMA IA volatility was generally very low with a log magnitude of 2. Overall, good IA index values suggesting a strong reputation and creating expectations for an above average return. And indeed, financially, it is outperforming its 84 peers in the Pharmaceuticals sector with an ROE this past year of 13.14% above the median.



As points of comparison, let's look at Pfizer (NYSE:PFE) and Eli Lilly (NYSE:LLY), two strong US-based pharmaceutical companies. Over this same time period, Pfizer's IA index decreased from 0.79 to .72 which is a worrying sign of reputation loss. On the other hand, IA volatility has been dropping slightly suggesting a tightening of the variance on reputation -- a feature we attribute to management's improving command, control and communications. Financially, it is marginally outperforming its peers with an excess ROE of less than 1%.



Last, take a look at Eli Lilly, a firm that has had ethical issues lately relating to criminal and civil charges, now settled, that it illegally marketed its schizophrenia drug Zyprexa. Over the past year, Eli Lilly's IA index decreased from a lofty 0.94 to .85. IA volatility has been fluctuating at levels much higher than either Novartis or Pfizer. Financially, it is underperforming its peers by 3%.



That Lilly's IA index dropped to below 0.8 and then rebounded is testimony to the firm's reputation resilience and is a feature we tend to see in companies with overall high IA index values. Still, there appears to be a rank order in these quantitative market-driven metrics measuring reputation that appear to substantiate, at least in part, the designation conferred by Ethisphere. And yes, the one other pharmaceutical firm that was recognized for its ethics, and that we cover for corporate reputation metrics with the IA index, also scored well. Astra Zeneca (NYSE:AZN). During this period, Astra Zeneca's IA index increased from 0.77 to .88 while its IA volatility has been dropping. Financially, it is outperforming its peers with an excess return of 23%.

The highly regulated ethical pharmaceutical industry (prescription drugs) emerged from the chaos, misbranding, and adulterated products world of the late 19th century. The public benefits derive from the confidence stakeholders have in the safety and effectiveness of the products when used as directed. Knowing how important the distinction between ethical and other products is to market confidence and price point, it should not be too surprising that both the regulatory hammer and the reputation impact can be significant.

Valuation truth vs truthiness

Nir Kossovsky - Friday, April 24, 2009
The past week, Intellectual Asset Management magazine, the official publication partner of the Society, has been hosting a debate on intangible asset valuation. As Joff Wild, editor of IAM magazine describes it,

One subject area that always seems to generate a large number of reader comments is valuation. Witness, for example, the fantastic thread tha developed following a post I wrote back in January entitled Intangible values collapse - the old 70% to 80% claim is now officially dead and buried. Among those taking part in that conversation - indeed the man who indirectly inspired it - was Nir Kossovsky, executive secretary of the Intangible Asset Finance Society and CEO of Steel City Re. Now Nir has written in to question some of the points made by Pat Sullivan and Alexander Wurzer in their IAM article on IP/intangible valuation myths, which I recently previewed on the blog.

The Intangible Asset Finance Society has weighed in on the debate along with our colleagues at the Athena Alliance, with classic language and arguments from the school of American Pragmatism that reflect the financial market principles we support. To follow the debate on the IAM site, click here. To read the comments of Ken Jarboe, President of the Athena Alliance on the Alliance blog, Intangible Economy, click here.



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