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39/4 August 2006



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Special Issue


Robert G. Eccles, Robert M. Grant and Cees B. M. van Riel Theme Editors

Reputation and Transparency: Lessons from a Painful Period in Public Disclosure



Charles Baden-Fuller Editorial

I am delighted to present this special issue on “Controlling the Public Corporation”, edited by Robert Eccles, Robert Grant and Cees van Riel. The corporate governance scandals and accounting failures of recent years have substantially damaged trust in many companies. While many regulatory measures have been taken to improve corporate governance, accounting and auditing, these do not address the issue of how managers can act to Regain Public Trust, especially if their companies have had lapses of behaviour. The overarching message of the papers in this Special Issue is that reputation and rebuilding reputation fundamentally depend on a high level of transparency. However, transparency alone is insufficient as it must be transparency about a well-chosen strategy that is being well executed to deliver strong financial results in the present and in the future.

The five papers in this issue provide good guidance on how to create a virtuous circle of performance-based reputation and transparency. The opening essay by Eccles, Grant and van Riel summarises the situation and brings out the two interrelated themes regarding the way in which managers can restore public trust: “strategy and proper internal control systems” and “reputation and transparency”.

The paper by Grant and Visconti insists that sound strategy precedes the foundation of public trust and they show that ill-conceived strategies foster governance breakdowns and accounting manipulation and that this overrides any improvement in internal control systems or moves such as aligning management's incentives with shareholders or having auditors do a better job.

Mazzola, Ravasi and Gabbioneta show how active communications about a company's strategy and internal control systems by the firm's leadership help to establish and maintain a strong reputation. They stress that it is not enough for the CFO to be involved; the CEO has to be in the front line too. Moreover, it seems that honesty really does pay in the field of corporate reputations.

Gietzmann's paper is based on some preliminary field research and suggests that another potential benefit of greater transparency is a more stable base of large institutional investors. Such stability makes it easier for management to anticipate and meet the information needs of these key investors, which will result in a lower cost of capital (and less likelihood of hostile takeover).

Finally, the paper of Gertsen, Van Riel and Berens looks at consequences of bad governance and how to restore the damage. Restoring reputation requires clear communications about what the company has done to solve its problems and what it intends to do to keep these problems from reappearing. However, transparency per se is not enough. The bottom line results must be there and these come from a sensible strategy which is well executed, including strong internal control systems which provide the necessary discipline and which protect shareholders from fraud.


Robert G. Eccles, Robert Grant and Cees B.M. van Riel INTRODUCTION - Reputation and Transparency: Lessons from a Painful Period in Public Disclosure criel@rsm.nl

The purpose of this Special Issue of Long Range Planning is to examine the following question: How can managers of public companies (re)gain the trust of the public? This question is obviously an important one. The corporate governance scandals and accounting failures starting in late 2001 have substantially damaged trust in many companies. As a result of these events, a variety of regulatory measures have been taken to improve corporate governance, accounting and auditing. The most notable — and controversial — example of regulation is the Sarbanes-Oxley Act of 2002. While some have praised it for forcing much-needed improvements in governance and auditing, others have criticised it for placing excessive costs on companies with little demonstrable benefit. Even worse, its critics argue, this legislation has made management and boards averse to taking the kind of intelligent risks that are necessary to create value for shareholders.

The concern about whether initiatives to improve governance have had the unintended consequence of actually hurting instead of protecting the shareholders is a global one. While not as controversial as Sarbanes-Oxley, the Higgs Report in the UK, which was then incorporated into the Combined Code, also stirred up significant debate and went through a number of revisions before it was more-or-less accepted by the corporate community. Similarly, the Tabaksblat Committee in the Netherlands issued a code of conduct that emphasised better internal controls and better audits. While the US has adopted a “black letter law” approach by embedding mandatory corporate governance reforms in legislation, the European equivalents applied a more “principles” approach based on “comply or explain”. Both approaches tried to solve problems that appeared to be highly damaging for companies and society in general.

The evidence available so far suggests that the costs incurred by the new regulations may be substantial. According to a CFO Executive Board survey on the impact of Sarbanes-Oxley, the average large corporation must spend “more than 20,000 hours annually on compliance efforts” and “70 per cent of global companies said they had delayed new product introductions, postponed or cancelled acquisitions, or shelved process improvements as a result of the new rules.” Although much of the evidence presented is from interested parties, the impact appears to be significant, particularly for those companies that are listed on multiple stock exchanges and therefore have to comply with the variety of new regulations imposed by multiple national authorities. In March 2005, it was estimated that 60 European companies were in the planning to delist from US exchanges.However, delisting by public companies is not unique to the US. Additional compliance costs have also caused significant numbers of non-European companies (especially Japanese) to terminate their listings on European exchanges.

In addition to the costs involved, the wave of new legislation and regulation did not seem to be preceded by systematic comparative analysis of existing measures. For example, on the topic of auditor rotation, it is notable that since the mid-1970s, Italy has required large listed companies to rotate their auditors at least every nine years. Yet, according to a Bocconi University study, these measures had done nothing to increase competition among auditors, improve audit quality or provide any discernable benefit to shareholders.

In light of the controversy surrounding regulatory initiatives to improve corporate governance, an important question for managers is what they themselves can do to create and rebuild trust in their companies. That is, what kinds of managerial actions either increase or decrease public trust? This question is the focus of the current special issue.


Robert M. Grant and Massimo Visconti The Strategic Background to Corporate Accounting Scandals grantr@georgetown.edu

The recent spate of accounting scandals that have rocked the corporate world have largely been blamed on unethical behaviour among executives and lack of independence by monitors. The names of Enron, WorldCom, Parmalat, among others, have been held up by academics and practitioners as examples of companies brought down by fraud and negligence, with an emphasis on individuals’ ethical failures. This paper introduces an additional cause: weaknesses in strategic management. Its thesis is that the 1990s boom was associated with less attention by major companies to the fundamentals of strategic analysis. Supporting evidence is provided by case studies of 12 US and European companies involved in major accounting scandals during 2001-3. The authors identify a misfit between the strategy pursued and either the requirements of the external environment or the companies’ resources and capabilities. Examples of strategic misfit included: overambitious growth targets such as expansion into new markets, multiple acquisitions and excessive debt financing. Most of the strategies achieved initial success, or were applauded by investors and observers, thereby reinforcing managers’ faith that they were pursuing the correct path. However, the inappropriate strategies led to deteriorating performance and an increasing divorce between top management aspirations and business reality, thereby creating conditions conducive to the manipulation of financial information. As authorities on both sides of the Atlantic have since sought to put into place systems of governance, such as Sarbanes- Oxley, to ensure that such corporate scandals cannot reoccur, the authors argue that this shifts the focus of corporate boards towards compliance, rather than strategic decisionmaking.


Pietro Mazzola, Davide Ravasi andClaudia Gabbioneta Building Reputation in Financial Markets davide.ravasi@unibocconi.it

Some companies are perceived by financial analysts and the markets as being more reliable, trustworthy and accountable than others. Possessing such a reputation is a great asset for a company: if the financial community has faith in it, the company is more likely to be able to attract the financial resources necessary to sustain its, sometimes risk-taking, strategies. However there has been little research to date into examining how companies build and preserve the trust of the financial community. The authors of this paper studied the formation of corporate reputation among financial analysts and investors by analysing 62 strategic plans presented to the financial community by companies listed on the Milan Stock Exchange between 2001 and 2004. Through an archival search, a study of share price movements and comments in the financial press and in analysts’ reports, the authors were able to discriminate between which companies had been effective and which were ineffective in presenting their strategic plans. A comparative analysis then allowed the authors to identify the distinctive traits of plans that seemed to positively or negatively influence the reactions of analysts and investors. They found that a company’s reputation among analysts and investors rests on synergy among three elements: a reputed and committed leadership; detailed and realistic presentations of strategic plans; and credible and independent internal control systems. This paper also uses case studies from its research to illustrate each of these elements.


Miles Gietzmann Disclosure of Timely and Forward-Looking Statements and Strategic Management of Major Institutional Ownership m.b.gietzmann@city.ac.uk

While corporate transparency is often cited as being in the interest of investors, another factor is the self-interest of the companies themselves. Some argue that improved disclosure is in fact in companies’ interest as it will be rewarded by a lower cost of capital. In this context management needs to balance the needs for greater transparency with those for commercial confidentiality. This paper starts from the perspective of how senior management manage disclosure to attract and retain institutional investors. Identifying desirable institutional investors is very important as their clout can determine the outcome of corporate actions such as hostile takeovers, refinancing or AGM votes. This paper explores
whether organisations that make more transparent corporate disclosures experience more stable patterns of institutional ownership. It classified disclosures into five types: relating to plans and strategy; regulation; performance; new products; and research and development. The author then tested for a link between the disclosures and share volatility and then whether there was a link to major institutional trading patterns. While as expected there is consistent evidence that additional disclosures are associated with short-term share price volatility (especially disclosures relating to performance and R&D), evidence suggests that increased corporate disclosure of industry-specific, non-financial and non-routinised information increases the stability of the holdings by major institutional investors.


Fred H. M. Gertsen, Cees B.M. van Riel & Guido Berens Avoiding Reputation Damage in Financial Restatements GBERENS@rsm.nl

When a company admits that its financial situation is not as previously signalled, the response of its investors and the markets is crucial to its ability to pull itself out of its difficulties. In the worst-case scenario, as demonstrated by Enron and WorldCom, a financial restatement can expose underlying control and governance problems and trigger a crisis in
confidence among investors which leads to bankruptcy. Not all restatements need lead to such devastating results however, although the severity of the outcome will often depend on the company’s approach to its restatement and its ability to handle the speculation and inquiries afterwards. This paper argues that companies can control the amount of damage to their market value resulting from a restatement. It outlines two ‘‘axes of evil’’: the distortion of value-relevant information; and the degree of intent. The authors say that the degree of distortion and intent as perceived by the public can be aggravated by the discrediting of management, by comprehension gaps, the ‘‘tip-of-the-iceberg’’ effect, paralysis in acting and communicating, and by non-alignment of management and external gatekeepers. On the other hand, companies that acknowledge the existence of a problem, take the blame for it, communicate about it openly, take appropriate actions aimed at corporate governance and comply with standards and regulations, are likely to limit the level of perceived distortion and intent and therefore limit the amount of damage suffered. The authors reached their findings after a study of 14 cases of restatements from European and US companies, and use the examples of Freddie Mac and Nortel to illustrate two management approaches that resulted in two contrasting outcomes.



This issue is available in full on-line at www.sciencedirect.com





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