OVERVIEW
In October 2017, Japan’s Kobe Steel, a company with more than a century of reputation on the line, admitted that it had falsified data to show some of its copper, aluminum and steel products met the specifications requested by customers. In fact, it was all bad metal; customers included Boeing and Toyota. In March, the CEO resigned, other execs stepped down, all in an effort to restore the reputation of an industry giant.

The authors of this series of papers on corporate reputations and the trust or lack of it those reputations engender lead off one of their studies with a few words from the New York Times about Kobe Steel’s journey of self-discovery — it self-reported the deceit by admitting that a hunger for short-term profits had clouded its adherence to quality-control standards.

The authors point out that in the last decade Kobe hasn’t been the only corporate giant to confess to misguided business practices and take dramatic steps to avoid future transgressions and restore reputations. Wells Fargo & Co. comes quickly to mind. In 2009 and 2010, Toyota, a company with a reputation for quality, the authors point out, recalled cars, redesigned systems and developed the “ToyotaWay” in response to acceleration problems in some models.

Out of the desire, or need, for damage control, “an increasingly sophisticated multi-billion dollar industry of reputation-management consultants has emerged to help firms navigate and lower the costs of reputation crises caused by {the results of} opportunism,” the authors said, noting that corporate reform efforts designed with the consultants “sometimes succeed in repairing damaged reputations.”

“It’s not just corporate reputations, it’s trust in general. At some level, a well-functioning economy relies on trust. At a basic level, we have to trust each other to make exchange happen. You can’t contract for everything, so trust matters. Trust can occur in a simple exchange (and we’ve worked some on that) and in institutional settings, such as a corporation building a reputation,” said Thomas Rietz, professor of finance in the University of Iowa’s Henry B. Tippie College of Business.

METHOD
To date, there are four papers in the series on reputation and trust. In most studies, the authors combined game theory — a method that relies on mathematical models and is common in economic research — with observations of behavior in an experiment.

To create a unique model for testing reputation management in Ownership Structure, Reputation and Recovery, they devised a laboratory formula that tested three time periods in an economy made up of a single company that operated variously under an owner-manager arrangement and under an independent, professional management structure.

“In the model, firm reputation is synonymous with the expected quality of its products. Product quality determines the price of the firm’s products. Quality is controlled by a manager (who might be the owner) whose opportunism — diverting firm resources, intended for investment in quality assurance, to personal consumption — can lower product quality. The firm has an oversight system that polices the manager. The effectiveness of the oversight system is known by the manager but not by outsiders,” they said.

What they wanted to discover was whether a firm managed by an owner was more susceptible to making opportunistic choices — doing things on the cheap — to manipulate prices.
They made these interesting observations:
“A. Reform has a dark side. When reputation is attached to an anonymous entity rather than an agent, the possibility of re-engineering the entity makes commitment to reputation-assuring policies more difficult. Thus, as the effectiveness of corporate reform technology improves, corporate reputations may become more unstable. 

“B. In the shadow of reform, separating ownership and management can provide a competitive advantage in reputation maintenance. Thus, the option to reform should increase the degree of association between firm reputation and professionalized management. 

“C. Because product market pricing deviates from rational expectations, in practice, efficient reputation management is likely to involve considerable investment in coordinating consumer expectations, e.g., public relations and advertising. Such investments are complements, not substitutes, for effective oversight and managerial incentive programs.”

RESULTS
In many cases, the research flipped conventional thinking on its head.

Following rules, for example, “may undermine more trusting and reciprocal (trustworthy) behavior that otherwise would have occurred, leading to worse outcomes,” they said in Trust, Reciprocity and Rules.

In Product Market Efficiency, which examined the influence of short-term financing on decisions regarding product quality, “We show that, having an outside owner and delegated management can create better outcomes for consumers in terms of product quality than owner-managers,” Rietz said.
Organizational Reputation in Firms with Owner-Manager Conflicts found that separating owners and managers can support long-run reputations better than in companies that combine ownership and management.

Remarkably enough, knowing that companies can fall back on corporate reform strategies seems to encourage those companies to cut corners. “This shows that, having an opportunity to reform a reputation increases the chances you’d cheat,” Rietz said. The problem is worse for companies that are owner-managed than for those that have separate owners and professional managers.

“In each of the corporate reputation papers, we find that in theory and by observing behavior in an experiment, that separating owners and managers can help the firm focus more on building long-run reputations and avoid short-term temptations, Rietz said.

TO LEARN MORE
Read the four studies.

Trust, Reciprocity and Rules
– https://onlinelibrary.wiley.com/doi/pdf/10.1111/ecin.12512 

Product Market Efficiency: The Bright Side of Myopic, Uniformed and Passive External Finance
– https://www.biz.uiowa.edu/faculty/trietz/papers/NRR.pdf 

Organizational Reputation in Firms with Owner-Manager Conflicts 
– https://www.biz.uiowa.edu/faculty/trietz/papers/NRRTheory.pdf 
 
Ownership Structure, Reputation and Recovery: Theory and Experiment
– https://www.biz.uiowa.edu/faculty/trietz/papers/NRRExp.pdf.