LITERATURE OVERVIEW

Reputation is identified as a key intangible asset that adds value to a company. However, it should be noted that intangible assets almost never create that value alone, but in combination with other company‘s resources (Hall, 1993).

Strong corporate reputation can serve as a defense against market rivals, in a way that complicates their situation when competitors try to imitate the characteristics of companies with a superior reputation.

Therefore, it does seem likely that the reputation of a company affects its financial performances.

However, it should be noted that, when a company achieves outstanding financial performances, these performances can also have a positive impact on company‘s reputation (McGuire, Schneeweis, Branch, 1990).

Company’s reputation affects the its relationship with other stakeholders, such as, for example, potential employees. A company with a good reputation can attract competent people. In addition, a good reputation can reduce transaction costs, because it allows company to save on the cost of writing a

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contract. On the other hand, the suppliers of a company will have lower costs of monitoring (Bromley, 2002). The Stakeholder Reputation Matrix shows the various stakeholder groups and other influencers that can impact a company’s reputation.

Figure 1 - Stakeholder Reputation Matrix. Source: Resnick (2004).

Many researchers have examined the relationship between corporate reputation and financial performances, and have found that there is a strong and a non-linear relationship between corporate reputation and financial performances. Determining the relationship between reputation and financial performances means responding two questions: 1. Does company reputation have an impact on financial performance? 2. Do financial performances affect reputation? Good financial reputations, induced by, for example, high accounting profits, should create immediate value for investors because such signals are easily observed and processed. Investors should be more willing to buy and hold stocks of firms.

The issue of an interrelationship between financial performance and reputation is noted by Roberts and Dowling (2002). Their data sample is based on a Fortune’ s report of America’s Most Admired Corporations. They found that firms with superior corporate reputations have a greater chance of sustaining superior financial performance over time

Anderson and Smith (2006) also use Fortune’s Most Admired Companies list to test whether a great company – they define as “great” all companies listed there – is a great investment by comparing the market performance with the S&P 500 index. They find that portfolios of stocks from higher- reputation companies mentioned in Fortune’s list significantly (both economically and statistically) outperformed the index, regardless of whether the stocks were purchased on the publication date or 5, 10, 15, or 20 trading days later .

Wang and Smith (2008) focused on determining “if a market value premium is associated with reputation and an evaluation of whether the market value premium, if it exists, is derived from superior financial performance or lower risk” and they found that “indeed high reputation firms do enjoy a market value premium”. They concluded that the behavior of reputable organizations creates intangible assets that are as valuable as would distinguish them from their peers in the industry.

Rose and Thomsen (2004) has examined the relationship between company's reputation and financial performances in Danish firms. They found that corporate reputation does not impact firm value (the market-to-book value of equity) whereas corporate financial performance improves corporate reputation.

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Eberl and Schwaiger (2005) explore the relationship between corporate reputation of the company and future financial performances by using the data of German companies. They come to two important conclusions. The first one, financial performances in the past are only one component which affects reputation. The second one, the reputation is a "cognitive component" that has a positive impact on future financial performances, while there are strong evidences that "affective component" has a negative impact.

Sobol and Farrell (1988) revealed the potential impact of financial performance on reputation. They conducted study and introduced earnings per share ratio, price earnings ratio and dividend per share for the ten-year period of time. The results showed that the relevance of financial performance varies according to different attributes of Fortune survey and varies from company to company. During the second part of the study, the above mentioned authors presented possible crucial factors that affected the reputation.

Dunbar and Schwalbach (2000) also explored the relationship between reputation and financial performance, but based on the research in 63 German companies in the ten-year period. They found that the financial performances in the past had a strong impact on the future reputation. They gave more support for size and property concentration as factors that favor corporate reputation.

A pioneering study setting forth a wider concept of reputation was that of Fombrun and Shanley (1990), who regarded reputation as the overall perception of a firm’s performance by its various stakeholders.

The final aim of their study was to illustrate the diversity of information sources used by stakeholders to evaluate and establish the reputation of firms. Among the several variables they selected, the most significant signals were accounting variables, profitability and risk during the previous period, followed by market valuation.

Sabate and Puente (2003) pointed out that the relationship between reputation and financial performances included the answers on two questions, whether the relationship was positive or negative and whether the reputation had an impact on financial performances, or vice versa. They pointed out that, in developed countries, the positive impact of financial performances on corporate reputation had always been confirmed. Moreover, they suggested that a positive relationship between corporate reputation and financial performances would contribute to increased competitiveness.

2.1 Corporate reputation and shareholder value

A good corporate reputation influences stakeholders’ decision-making processes because it helps create a closer relationship between the firm and its stakeholders, creates value for the stakeholders, and increases their satisfaction and willingness to be involved with the company.

Corporate reputation has a market impact, for example higher market shares, premium prices, lower remuneration of employees, that strengthens the firm’s market position. Possessing a high reputation is also valuable for firms regarding specific stakeholder groups: customers of more reputable companies show not only increased confidence in products and services, as well as advertising claims, but also a lower level of cognitive dissonance.

Understanding the relationship between corporate reputation and shareholder value requires knowledge about the various paths that explain how reputation influences investors: although reputation can have a direct impact on investors, certain effects cannot be directly linked to stock prices. This indirect path includes effects on stakeholder behaviour. Depending on how investors use information about corporate reputation as a value-relevant signal, either the direct path, in which investors react immediately to changes in reputations and adapt their willingness to buy and hold a stock, or the indirect path, in which investors underestimate the signal strength of reputation, becomes more important.

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Figure 2 - Effects of corporate reputation on investor behaviour. Source: Raithel (2012).

Schwaiger et al. (2011) described three basic effects associated with any piece of (potentially) value- relevant information (metric) and their relationship to stock price movements: announcement effect, occurence effect and mispricing effect.

Figure 3 - Financial performance effects associated with corporate reputation. Source: Raithel (2012).

Investors react immediately to unanticipated information caused by discrete events such as the metric announcement. They react to unanticipated events correlated with metric realization. Therefore, investors have already formed expectations about the outcome of an event, such as the metric announcement. This expectation means the stock price incorporates the announcement effect before the announcement actually occurs. Investors, not fully appreciating the long-term value implications of corporate reputation, adapt their initial under- or overreaction to the metric announcement using, for example, unanticipated information ‘caused’ by higher/lower corporate reputation, such as unexpected higher/lower sales and profit.

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Corporate reputation values were calculated by modelling the influences on investor behaviour impacting on share price. Analysis is a two-stage process. To start with, the main factors that influence the investment community, and thus the market capitalisations, of individual listed companies as a whole are identified. This is achieved by means of statistical regression analysis of hard financial metrics. The financial data were sourced from Factset and Bloomberg. The data comprised reported and consensus forecasts from relevant industry analysts including:

EBITDA and EBIT