The Sociopolitical Implications of Firm Reputation

Stakeholder Theory

In order to thrive and even survive, businesses must address a range of societal expectations, including economic, legal, ethical, and discretionary responsibilities (Carroll, 1979). Different stakeholders may assign different weights to these expectations (Freeman, 1984). For example, a local community might place considerable weight on a firm’s discretionary responsibilities (e.g., corporate philanthropy), whereas stockholders might focus almost entirely on a firm’s economic responsibilities (e.g., financial performance). In this study, we draw on stakeholder theory to explain how managers of firms attend to the dimensional components of reputation (i.e., financial and social) in order to contend with the diverse demands of their stakeholders, and how the resulting allocation of resources affects financial performance.

Since the seminal work of Freeman (1984), stakeholder theory has been used to demonstrate and predict managerial patterns of firm governance that are descriptively accurate, instrumentally powerful, and normatively valid (Donaldson & Preston, 1995). The tenets of stakeholder theory posit that, in order to achieve traditional corporate objectives (e.g., return on investment, profitability, and growth; Donaldson & Preston, 1995), managers must attend to the well-being and interests of the stakeholders of the firm, because these constituents have the ability to advance or deter the objectives of the firm.

Stakeholders are any entity that interact with or have a stake in the operations of the firm (e.g., customers, employees, financial institutions), and thus are inclusive of, but not simply the equity shareholders (Donaldson & Preston, 1995; Phillips, Freeman, & Wicks, 2003). Stakeholders often will employ influence tactics (Frooman, 1999), evoke principals of fairness, or use bases of power (Bridoux & Stoelhorst, 2014) in order to win influence or control over the scarce resources of the firm. Firm managers must contend with the often diverse needs and motives of stakeholders, and these heterogeneous obligations must be properly and ethically prioritized in order to optimally deploy resources, create a competitive advantage, and achieve firm objectives (Jones, 1995). The strategies used to interface with stakeholders depend on the needs and circumstances of the firm, and thus some strategies are contextually more fruitful than others (Jawahar & McLaughlin, 2001).

Financial Reputation and Financial Performance

Firm reputation, in and of itself, is a resource that managers have the ability to create and maintain (Boyd et al. 2010), and it can be leveraged to create a competitive advantage (Barney, 1991; Boyd et al., 2010; Shapiro, 1987; Shrum & Wuthnow, 1988). Managers attempt to create and maintain their firm’s reputation by communicating the most salient and contextually relevant advantages or attributes to the stakeholders through impression management strategies (Hooghiemstra, 2000), and this process requires firm resources. The substance behind these impression management strategies may not always be in concert, as the communication of a firm practice to the general public has the potential to simultaneously satisfy and agitate different stakeholders. If managers do not properly manage impressions and appropriately prioritize stakeholder obligations, and as a result employ improper context-specific strategies with various stakeholder constituents (Jawahar & McLaughlin, 2001), then the suboptimal level of reputation-based resource allocation will create a misalignment of firm resources, and lead to lower performance.

Reputation is composed of both performance/results and character/integrity related dimensions (Ferris et al., 2014). Much of the existing reputation literature investigates the antecedents of positive firm reputation, and a general consensus is that an observed history of high-level performance and high-level character is positively related to overall firm reputation (Ferris et al., 2014). Firms desire positive reputations, as reputations have value and have the potential to provide firms with many positive outcomes, such as access to resources (Staw & Epstein, 2000), better employees (Cable & Graham, 2000), greater profits (Hammond & Slocum, 1996), and behavioral discretion (Rindova et al., 2005). Indeed, the relationship often is argued as being bidirectional, in that a positive reputation can, in turn, result in improved performance (McGuire, Schneeweis, & Branch, 1990).

Of greatest relevance to our study, some research also indicates that financial reputation is predictive of increased profits and financial performance (e.g., Deephouse, 1997; Roberts & Dowling, 2002). The relationship between financial reputation and financial performance is rational. In order for a firm to be perceived as possessing a positive financial reputation, it is likely that the firm would have previously demonstrated high levels of performance. Firm credit rating agencies (e.g., Fitch Ratings Inc.) base their evaluations on a history of financial performance and assign ratings with the intention of aiding the prediction of future performance. High credit ratings are a form of performance-based reputation and enable firms who possess them to gain access to resources (e.g., more investors, lower interest loans, strategic partnerships) that can further enable them to perform at a high level, creating a cyclical effect. We maintain that firm financial reputation will be positively related to firm financial performance, and thus formulate the following hypothesis:

Interaction of Financial Reputation × Social Reputation on Financial Performance

Scholars have posited that positive firm social reputation also is predictive of financial performance (e.g., Schuler & Cording, 2006). Firm social reputation, as we conceptualize it, is reflective of CSR (Aguinis & Glavas, 2012). CSR involves “context-specific firm actions and policies that take into account stakeholders’ expectations and the triple bottom line of economic, social, and environmental performance” (Aguinis, 2011, p. 855). These actions are focused on societal issues and do not necessarily appear to be in line with short-term financial performance.

Evidence demonstrates that increased financial performance is a positive outcome of firm social reputation, deriving from CSR (Orlitzky, Schmidt, & Rynes, 2003). The relationship is partly attributed to increases in consumer likelihood to purchase firm products (Arora & Henderson, 2007; Trudel & Cotte, 2009) and increased consumer loyalty (Maignan, Ferrell, & Hult, 1999). Existing literature demonstrates that the reputations of high CSR firms are perceived more positively by consumers, and result in increased financial performance.

The two dimensions of firm reputation (i.e., financial and social) are valued differently by different stakeholder groups. For example, a shareholder is likely more concerned with financial performance, and a consumer is more concerned with social performance. Stakeholders form an evaluative judgment about a firm’s reputation through a process of interpreting explicit or implicit signals from managers, as well as interpretations from the media and other third party sources (Fombrun & Shanley, 1990). With respect to the financial dimension of firm reputation, a firm may explicitly communicate its performance through the release of quarterly or annual financial reports demonstrating a reduction in costs and resulting increase in net profit. The firm also may communicate the likelihood of improved financial performance via an announcement of a switch to a lower-cost vendor. These impression management activities help create and maintain a positive financial image of the firm in the eyes of stakeholders.

With regard to the social dimension of reputation, a firm may explicitly communicate its stance on a particular social issue through marketing or public relations, or send this message more implicitly through their strategic use of production inputs and product offerings. Based on the social reputation of the firm, certain advocacy groups may either endorse or boycott the firm’s products. Firms dedicate scarce resources to try to manage the impressions of both stakeholder groups with the goal of optimally extracting benefit from their stakeholders, as they have the ability to either help or hinder the performance of the firm.

If firms efficiently and effectively allocate resources, and are successful at satisfying the obligations of each stakeholder group, their resources are optimally aligned, and they are likely to realize a positive financial result beyond a simple additive effect. Reputation is perceptual in nature and may be subject to influence. Those stakeholders who typically are more likely to be influenced by the financial dimension of reputation (e.g., financial institutions, investors, employees) may take the social dimension of reputation into consideration when making firm-relevant decisions (e.g., extend low cost loans, join the firm). Stakeholders find companies that implement CSR initiatives more attractive and easy to identify with (Aguinis & Glavas, 2012), which likely can influence decisions that affect the operations of the firm. This could in turn result in increased resources available to the firm that further increase financial performance.

Stakeholders who typically are more likely to be influenced by the social dimension of reputation (e.g., consumers) may take the performance dimension of reputation into consideration when making firm-relevant decisions (e.g., purchasing goods and services). Consumers prefer to purchase goods and services from firms that they know are financially stable and can provide after-purchase services (Ravald & Grönroos, 1996). Although some stakeholders may prioritize social initiatives, a positive performance reputation may lend credibility to the firm and positively affect purchase decisions.

Academics and practitioners alike tend to view CSR as a nonstrategic activity, which involves “giving back” to society only after profits have been made (Freeman, Harrison, Wicks, Parmar, & de Colle, 2010). Freeman et al. (2010) labeled this viewpoint the “residual” view of CSR, since what is given back is a residual of the profits earned. Hence, it is likely (whether rightly or wrongly) that a majority of stakeholders believe that businesses should focus, first, on producing products and services profitably and that a firm’s social reputation remains subordinate to its financial reputation. In other words, businesses should meet their economic responsibilities first, seeking to improve financial reputation.

The need of firms to first focus on their financial reputation-financial performance relationship is logical. Firms with low performance, by definition, have less disposable financial resources, as they experienced low return on invested capital (ROIC). Additionally, firms with low reputations likely have greater difficulty accessing loans and new financial resources. If these low financial reputation–low financial performance firms continue to allocate increasingly rare resources to “residual” CSR activities, they likely will experience even lower financial performance, possibly crippling the firm and limiting future options.

We expect that financial performance of a firm will be lowest when social reputation is high while financial reputation is low. We call this the “mind your business” hypothesis, as this state signifies to stakeholders that the firm may not be focusing on the “primary” societal expectation. On the other hand, we expect that financial performance will be highest when both financial and social reputations are high, as this represents the ideal state of the residual view: the firm is successfully earning profits, from which it is admirably giving back to society.

Figure 1 presents the theoretical model we propose in our study. Previous literature indicates that both firm financial and firm social reputation are predictive of financial performance. We agree with Boyd et al. (2010) in that the performance-enhancing effects of the dimensions of reputation are not simply the additive sum of reputational investment but have the ability to enhance each other. We argue that there is an interaction of financial and social reputation that will affect financial performance beyond the simple additive effects. Therefore, we formulate the following hypothesis:

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Figure 1.

Conceptual model: Interaction of Financial × Social Reputation on financial performance.

Sample

A convenience sample, consisting of 393 U.S. companies, within 47 industry groups, was used in this study. The following company characteristics represent values for 2012: The average number of employees ranged from 79 to 2.2 million, with a mean of 50,592 employees. Annual net sales ranged from $374.141 million to $451.509 billion, with an average of $20.826 billion. Finally, firm market values ranged from $183 million to $405.189 billion, with an average of $22.639 billion. All data were obtained from the Thomson Reuters ASSET4 Database.

Social reputation was operationalized with the Thomson Reuters Society/Community Score. Financial reputation was operationalized via the Fitch Credit Rating. Last, financial performance was measured via ROIC. These variables are described in more detail in the Measurement of Variables section below. We used 2011 data for both independent variables and 2012 data for the dependent variable. See Figure 2 for an illustration of the operational model tested in this article.

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Figure 2.

Operational model: Interaction of Financial Reputation (Fitch Credit Rating) × Social Reputation (Thomson Reuters Society/Community Score) on return on invested capital.

Measurement of Variables

Although reputation has been conceptualized as a perceptual construct (Rao, 1994; Rindova & Martins, 2012), a number of scholars have used proxies (e.g., asset quality; Deephouse & Carter, 2005) and/or composite scores (e.g., Fombrun, Gardberg, & Sever, 2000; Ponzi, Fombrun, & Gardberg, 2011) to estimate firm reputation. The proxies used for financial and social reputation in the present study are detailed below.

Financial Performance

The outcome variable in this study was Financial Performance, and it was operationalized as ROIC. This dependent variable was derived from the Thomson Reuters Worldscope database and was calculated as follows:

( Net Income before Preferred Dividends + ( ( Interest Expense on Debt − Interest Capitalized ) * ( 1 − Tax Rate ) ) ) / Average of Last Year’s and Current Year’s ( Total Capital + Last Year’s Short Term Debt & Current Portion of Long Term Debt ) * 100 .

Data Analyses

To test the statistical significance of the interaction term, a moderation model was constructed using the SPSS version of PROCESS (Hayes, 2013). There were 47 industry groups represented in the data, so 46 dummy variables were used as covariates in the model to control for industry groups. A visual representation of the moderation model was then created to better understand the nature of the interaction. Finally, the interaction was probed via the Johnson–Neyman technique, which was also available in PROCESS. The Johnson–Neyman technique established the range of the moderator variable where the independent variable exhibited a statistically significant conditional effect on the outcome variable.

Contributions to Theory and Research

Our study provides three primary theoretical contributions. First, it contributes to the corporate reputation literature by integrating stakeholder theory to explain how managing impressions with different groups of stakeholders is vital to increasing performance. Stakeholder theory posits that firm managers must effectively deal with the needs and motives of a diverse set of stakeholders (Jones, 1995) who likely place varying importance on issues of financial and social consequence. The results of the study demonstrate that when this is accomplished, and both stakeholder groups are satisfied, and thus both reputation dimensions are high, the firm will realize financial outcomes greater than the simple additive effects of high social and financial reputation. That is, when firms possess both high financial and social reputations, they realize greater financial performance than firms that possess only high financial reputations. The integration of stakeholder theory contributes greatly to the corporate reputation literature by helping to explain the mechanisms by which maintaining a positive reputation with multiple stakeholder groups properly aligns resources, and leads to better performance.

Second, this study provides a degree of validation to the view of corporate social responsibility as a residual activity in the overall strategies of firms. Freeman et al. (2010) deemed CSR “residual” in nature, and argued that firms should only partake in such activities after they had achieved their primary goal of making a profit. The results of our study show that this may in fact be completely accurate. Firms that did not have a high level of financial reputation, yet continued to strive for a positive social reputation performed very poorly relative to firms who were low in both dimensions of reputation. This demonstrates the importance of firms focusing on the economic aspects of their businesses, and how efforts to undertake the “residual” CSR prior to attaining a strong financial reputation are extremely detrimental to firm success.

Third, our study adds to our understanding of reputation. Although our study used data at the firm level, we believe that our findings are applicable to all levels of reputation, as it is thought to operate similarly regardless of the level of analysis (Ferris et al., 2014). Our findings contribute to the reputation literature by illuminating the effect of reputation–performance congruence. Just as Ajzen and Fishbein (1977) argued that attitudes must be congruent with their target in order to predict behavior, we argue, and provide empirical evidence, that in order to increase a particular type of performance by leveraging your reputation, the reputation and performance types must be congruent. Once an entity has a requisite level of reputation within its primary function, a positive reputation in the other dimension can enhance performance in the primary area.

We maintain that that our results could be applicable at lower levels of analysis (e.g., individuals and groups) as well, especially when task performance is not as vital to overall entity success. Socially likeable employees, who do not have reputations as hard workers, likely will be passed by when fruitful projects come across their supervisors’/colleagues’ desks, as they do not have reputation–performance congruency. However, these same employees’ social reputations likely make them interpersonally popular within their social circles, and their social performance is likely further augmented by a perceived competence as being task proficient. Of course, future researchers will have to specifically test these relationships, but we suspect that the relationships will hold given the results of our study.

Strengths and Limitations

Our investigation has a few notable strengths that merit attention. First, our study uses data from a large sample of 393 firms, of varying workforce sizes and financial prowess. The size and diversity of our sample affords us the statistical power to detect interactions, and the confidence that our findings are generalizable across different classifications of firms. Second, following the recommendations of Dess, Ireland, and Hitt (1990), regarding firm effects on performance, we were able to control for the potentially confounding effects of firm industry within our analysis by using dummy variables for each industry. Last, our research design employed temporally separated data, which provides us the basis to make causal arguments. This is particularly important in this study, given the likely reciprocal nature of firm performance and reputation.

As with any study, there are a few limitations that warrant mention. First, although we were able to use time separated data in our analyses, our data are not longitudinal in nature. Thus, we were unable to evaluate the likely reciprocal causal effects of firm performance and reputation on each other. This represents an opportunity for future research to evaluate how the distinct dimensions of reputation, firm performance, and social performance reciprocally interact over a longer time horizon. Second, our data did not include a measure of social performance, which would have allowed us to further test stakeholder theory by evaluating social performance as a function of the interactive effects of financial and social reputation.

Directions for Future Research

To expand this line of inquiry, we recommend that scholars pursue research in a number of areas. First, scholars should evaluate whether or not the same interactive pattern holds for the moderating effects of financial reputation on the social reputation–social performance relationship. In this study, we specifically demonstrate that financial reputation provides benefits for future financial performance and that this effect is augmented by social reputation only if there is congruence between high financial reputation and financial performance. We suspect that the same is true of congruence between social reputation and social performance; that social reputation has a positive effect on social performance, which can be augmented by high levels of financial reputation at high levels of social reputation, and hindered by high levels of financial reputation at low levels of social reputation.

For example, a socially focused regulatory stakeholder (e.g., the Consumer Product Safety Commission) will place more importance on evaluating the social performance of a firm than would a company shareholder. This regulatory body would be most likely to highly scrutinize and probe a firm who has a poor track record of social compliance, but also is enjoying large profit margins. Conversely, it would give a greater benefit of the doubt to a firm who has a high social reputation, but is struggling financially. Certainly, possessing a good reputation on both dimensions is ideal.

Second, investigation of how different types of reputation affect firm outcomes would be improved by the development of rigorously developed measures. Such measures should reflect the most recent multidimensional structure proposed within the literature (i.e., performance/results and character/integrity: Ferris et al., 2014; Zinko, Ferris, Blass, & Laird, 2007), thus reducing the reliance on proxies within empirical studies. Third, scholars should conduct longitudinal research to chart the long-term development of financial and social reputations, and their interactive effects on financial performance over time. This would provide more precise managerial direction and provide stronger indication of causality between variables.

As reputation management becomes increasingly integral to firm success, research that can inform and refine industry best practice should continue to be undertaken. Finally, scholars should examine the same relationships at different levels of investigation (i.e., individual, team, organizational). For example, scholars could investigate how the disbursement of individual resources (e.g., time, energy, self-regulation) affects the different dimensions of individual reputation, and in turn, individual performance. Ferris et al. (2014) proposed that reputation acts similarly at all levels, but further investigation into exactly what similarities and differences may exist is warranted.

Practical Implications

The present study has particular implications for the way in which firms tend to their reputations through impression management strategies. First, there has been considerable debate as to how the allocation of resources to CSR (and other activities designed to develop social reputation) affects firm financial performance, and the relationship has been characterized as being either additive or subtractive (McWilliams & Siegel, 2000). In other words, does social reputation boost financial performance by capitalizing on consumer good will, or is it a waste of resources that could have been assigned to the firm’s main production function? Based on the results of the present study, we recommend that firms prioritize their financial reputation before investing too heavily in cultivating a strong social reputation. This would be particularly pertinent for new firms that are relatively unknown to external stakeholders.

Conversely, firms with an established track record should allocate resources to CSR activities as part of revenue maximization. Signaling “prosocial behavior” as part of firm impression management has previously been conceptualized as a defensive tactic, that is, one employed in response to some type of transgression (see Bolino, Kacmar, Turnley, & Gilstrap, 2008; Mohamed, Gardner, & Paollilo, 1999). However, in light of the present results, it would appear that once a strong financial reputation has been established, signaling prosocial behavior should be actively (rather than reactively) engaged in.

Accepting that most firms nowadays engage in some of CSR, we do not recommend that firms with low financial reputations cease all efforts to cultivate social reputations, as this could result in consumer distrust. Rather, we recommend that firms promote activities related to their core business more heavily. External awareness of CSR engagement is typically low, as these efforts are often not communicated effectively by firms themselves (Du, Bhattacharya, & Sen, 2010); thus, strategic promotion of ongoing CSR engagement can ultimately benefit financial performance, while also maintaining community relations.

Conclusion

In this study, we investigated the interaction of financial and social reputation on firm financial performance. In agreement with Boyd et al.’s (2010) suggestion, we found that the positive outcomes of these two reputation dimensions are not simply additive. Indeed, an interaction exists such that increased social reputation increases financial performance when financial reputation is high. In contrast, increased social reputation lowers financial performance when financial reputation is low. The results indicate that despite the desire to satisfy some stakeholders by devoting resources toward CSR activities, firms must first focus on satisfying economic-related stakeholders and strive to improve their financial reputation. Failure to do so prior to dedicating limited resources to residual CSR activities can significantly decrease firm performance, and it is thus imperative that, in order to succeed, firms must first “mind their business.”