Professional Documents
Culture Documents
ERVIN L. BLACK*
THOMAS A. CARNES*
VERNON J. RICHARDSON**
April 1999
The authors would like to thank Mark Hirschey, Jim Guthrie and Kelly Welch at
the University of Kansas and participants at the Central States Accounting
Workshop for their helpful comments on an earlier version of this paper.
Schneeweis and Branch (1990) extend these results to all eight dimensions of
perceived firm performance contained in the Fortune rankings and find that high
returns (both return on assets and market returns) are highly correlated with
subsequently high firm image the halo effect of Brown and Perry (1994).
However, they find that the Fortune rankings have little value as a forecaster of
future firm financial performance.
Our research extends the existing literature by undertaking an explicit
search for market effects of nonfinancial factors affecting firm reputation. We
employ the Fortune Americas most admired corporations rankings, thereby
investigating a broader definition of reputation than the specific aspect studied by
Ittner and Larcker (1998). By applying a variation of the model developed by
Brown and Perry (1994), we remove the halo effect of financial performance
and isolate the other influences upon the Fortune rankings in order to extend the
research of McGuire, Sundgren and Schneeweis (1988), and McGuire,
Schneeweis and Branch (1990).
METHODOLOGY
The market value of equity (MV) is the expectation of the expected future
cash flows (CF) accruing to stockholders discounted at the appropriate riskadjusted rate r:
MV =
t
(1 + r ) t Et =0 [CFt ]
t=0
(1)
(2)
where intangible assets represent, for example, the discounted cash flows
accruing to shareholders due to a competitive advantage, an anticipated growth
opportunity, or positive net present value projects.
Fortune annually rates Americas largest corporations in its Americas
most admired corporations issue. Brown and Perry (1994) find that this rating,
which is a measure of the firms competitive advantage, is heavily influenced by
the firms previous financial results, thus creating a halo effect. This effect must
be removed or controlled for before these qualitative reputational measures can
be used appropriately in this study to measure the value relevance of the
intangible asset unexplained by financial reporting data. Brown and Perry find
several financial factors that affect the Fortune rating score (SCORE): return on
assets (ROA), market-to-book value (MKTBV), size, growth, and risk. Adding in
dummy variables for each year to control for other economic effects yields
equation 3.
SCORE t = a 0 +
96
y =82
(3)
where:
SCOREt
ROAt
MKTBVt
SIZEt
BETAt
The residuals and estimated coefficients from this model are used to test
the value-relevance of the nonfinancial factors (the invisible assets). The
estimated coefficients are used to calculate a predicted reputation score which
measures the portion of the Fortune rating score that financial statement users
can obtain from financial performance data. The residuals from estimating
equation 3 represent the intangible assets related to reputation effects that a firm
has which cannot be obtained through the analysis of the financial statements
and market data.
(4)
where,
MVt = the market value of equity at time t.
BVt = the book value of equity at time t.
NIt = net income at time t.
Modifying this equation to control for annual effects and to allow for the
measure of intangible assets including the nonfinancial factors estimated from
equation 3 yields:
MVt = b0 +
96
y = 82
(5)
where,
MVt
DMYy
BVt
NIt
NonFREPt-1 =
10
11
RESULTS
We first estimate equation 3 in order to control for the halo effect
described by Brown and Perry (1994). Each of the variables in equation 3 is
statistically significant, with signs the same as found by Brown and Perry .
Descriptive statistics for the variables used in estimating equation 3 are found in
Table 1.
Insert Table 1 about here
12
13
14
15
REFERENCES
Beatty, R.P., and J.R. Ritter. 1986. Investment banking, reputation, and
underpricing of initial public offerings. Journal of Financial Economics, 15: 213232.
Brown, B., and S. Perry 1994. Removing the financial performance halo
from Fortunes Most Admired Companies. Academy of Management Journal,
37: 1347-1359.
Caves, R.E., and M.E. Porter. 1977. From entry barriers to mobility
barriers. Quarterly Journal of Economics, 91: 421-434.
Edvinsson, L., and M.S. Malone. 1997. Intellectual capital: Realizing your
companys true value by finding its hidden brainpower. New York:
HarperBusiness.
Fombrun, C., and M. Shanley. 1990. Whats in a name? Reputation
building and corporate strategy. Academy of Management Journal, 33: 233-258.
Ittner, C.D., and D.F. Larcker. 1998. Are nonfinancial measures leading
indicators of financial performance? An analysis of customer satisfaction.
Journal of Accounting Research, Supplement: 1-35.
Lindsmeier, T., J. Boatsman, R. Herz, R. Jennings, G. Jonas, M. Lang, K.
Petroni, D. Shores, and J. Wahlen. 1998. American Accounting Associations
Financial Accounting Standards Committee Response to IASC Exposure Draft
E60, Intangible Assets. Accounting Horizons, 12: 312-316.
McGuire, J., T. Schneeweis, and B. Branch. 1990. Perceptions of firm
quality: A cause or result of firm performance? Journal of Management, 16: 167180.
McGuire, J., A. Sundgren, and T. Schneeweis. 1988. Corporate social
responsibility and firm financial performance. Academy of Management Journal,
31: 854-872.
Milgrom, P., and J. Roberts. 1986. Relying on the information of
interested parties. Rand Journal of Economics, 17: 18-32.
Ohlson, J.A. 1995. Earnings, Book Values and Dividends in Security
Valuation. Contemporary Accounting Research, 11: 661-687.
16
17
Table 1
Descriptive Statistics for firms used in Equation 3
Variable
Mean
Median
Std. Deviation
SCOREt
6.445
6.480
0.881
ROAt
4.824
4.840
5.776
MKTBVt
2.597
1.999
3.777
SIZEt
8.072
8.086
1.395
BETAt
0.905
0.881
0.401
GROWTHt
65.224
42.029
194.007
18
Table 2
Estimation of Fortune Reputation Score
(3)
Variable
Coefficient
T-statistic
Constant
4.106
6.480
ROAt
0.058
23.471
MKTBVt
0.012
3.390
SIZEt
0.245
24.367
BETAt
-0.086
2.663
GROWTHt
0.024
3.665
F=107.732
19
Table 3
Descriptive Statistics for Variables Used in Market Value Model
Variable
Mean
Median
Std. Deviation
MVt
6702.344
2974.555
10983.647
BVt
3261.155
1623.376
4978.992
INCOMEt
458.549
206.443
894.561
SCOREt-1
6.445
6.480
0.881
NonFREPt-1
0.000
0.041
0.684
FREPt-1
6.446
6.470
0.561
20
Table 4
Market Valuation of Nonfinancial Components of Firm Reputation
MVt = b0 +
96
y = 82
(5)
Equation 5
Coefficient
(t-statistic)
1261.419
(3.67)
Coefficient
(t-statistic)
-11566.977
(-13.87)
Coefficient
(t-statistic)
1283.959
(3.68)
Coefficient
(t-statistic)
-24687.711
(-18.39)
BVt
1.068
(32.49)
1.048
(33.29)
1.073
(32.30)
1.030
(32.97)
NIt
4.961
(26.927)
4.398
(24.53)
4.924
(26.49)
3.898
(21.45)
1023.691
(6.41)
1081.10
(7.22)
Constant
NonFREPt-1
FREPt-1
4170.684
(19.95)
SCOREt-1
Adj. R2
2062.755
(16.74)
71.77%
74.20%
72.02%
75.41%
ENDNOTES
1
We also ranked the residuals and used the ranking rather than the residual, with no qualitative
effect upon the results.
2
It is possible that firm reputation varies by industry. As a test of robustness, we include industry
dummy variables in the estimation of models 3 and 5 and find similar results. As another test of
robustness, we control for the possible endogeneity between market value and the estimation of
the Fortune reputation score by estimating the incremental market valuation of the financial
(FREPt-1) and non-financial components of reputation (NonFREPt-1) beyond the lagged market
value of common equity, MVt-1 and find NonFREPt-1 to still be positive and significant.
22