When a Sinner Does a Good Deed: The Path‐Dependence of Reputation Repair

• Author: Haibing Shu,Sonia Man‐Lai Wong
• Date: 01 July 2018
• Published date: 01 July 2018
• DOI: http://doi.org/10.1111/joms.12312

When a Sinner Does a Good Deed: The

Path-Dependence of Reputation Repair

Haibing Shu and Sonia Man-Lai Wong

Shanghai Jiao Tong University; Lingnan University

ABSTRACT This study examines how shareholders will interpret a socially desirable action

taken by firms with a damaged corporate reputation status. We first explain theoretically why

shareholders’ path-dependent judgments of a tainted firm increase the likelihood of

shareholders making less favourable judgments of the firm’s socially desirable actions. We then

test the theoretical predictions using a sample of Chinese listed firms that were sanctioned for

securities fraud and subsequently made donations to the 2008 Sichuan earthquake relief

funds. We find that the shareholders evaluate the donations made by fraud-tainted firms less

favourably than those made by firms that have not been sanctioned for fraud. Furthermore,

the shareholders’ evaluations of the donations made by fraud-tainted firms is less favourable if

the firms have committed more serious fraud and undertaken fewer positive remedial actions

in the post-fraud period. Overall, our evidence demonstrates that shareholders’

path-dependent judgments of fraud-tainted firms constitute a major obstacle that constrains

the effectiveness of reputation repair.

Keywords: corporate philanthropic disaster response, event study, path dependence,

reputation repair

INTRODUCTION

It is well known that reputation recovery is neither an easy nor a short-term process.

Gaines-Ross (2008) reveals that recovering corporate reputation is six times more diffi-

cult than building it, with reputation recovery taking more than three years to complete

on average.

[1]

After analysing the reputation repair experience of six large corporations

including Siemens, Mattel, Toyota, The BBC, BAE Systems and Severn Trent, Dietz

and Gillespie (2012) conclude that reputation repair usually ‘take years to resolve, and

can be both debilitating and very costly’ (p. 36). Furthermore, Farber (2005) finds that

even three years after the U.S. Securities and Exchange Commission (SEC) has

Address for reprints: Sonia Man-Lai Wong, Department of Finance and Insurance, Lingnan University,

Tuen Mun, New Territories, Hong Kong, China (soniawong@ln.edu.hk).

V

C2017 John Wiley & Sons Ltd and Society for the Advancement of Management Studies

Journal of Management Studies 55:5 July 2018

doi: 10.1111/joms.12312

identified the firms as having fraudulently manipulated their financial statements, insti-

tutional investors continue to stay away from those firms. Why does it take so long for

corporations to overcome their damaged reputation status? What factors explain the

inertia exhibited in the reputation repair process?

The literature on reputation repair mainly focuses on how firms use various impres-

sion management and communication strategies to minimize the extent of the reputa-

tion damage caused by a negative event (e.g., Carroll, 2009; Coombs, 2007; Lamin and

Zaheer, 2012; Sutton and Callahan, 1987). A small but growing body of work has

examined the contextual/organizational factors that may influence the effectiveness of

reputation repair (Chakravarthy et al., 2014; Rhee and Hadwick, 2011; Rhee and Kim,

2012; Rhee and Valdez, 2009). However, these studies largely focus on determinants

that are common to both reputation building and reputation repair. As a result, there

has been very little understanding of how reputation repair is distinctively different from

reputation building. Rhee and Valdez (2009, p. 162) suggest that ‘future research could

explore the components that are unique to the process of reputation repair’’. Our study

fills this gap in the extant literature by focusing on the most salient and defining feature

of tainted firms – the firms’ unfavourable corporate reputation status – and demon-

strates how this unfavourable reputation status affects the effectiveness of reputation

repair. Building on the core assumption that stakeholder members tend to use the exist-

ing reputation of a focal firm as a lens through which to interpret the firm’s new actions

(Darley and Fazio, 1980; Devers et al., 2009; Fiske and Taylor, 1991; Merton, 1968;

Mishina et al., 2012), we examine whether the unfavourable reputation status of tainted

firms increases the probability that members of a stakeholder group will form less

favourable judgments of the firms’ emergent positive actions, and consequently make

the task of building up new reputation capital particularly difficult for these firms.

We follow Mishina et al. (2012, p. 460) in conceptualizing corporate reputation as the

‘collective, stakeholder group-specific assessment’ of an organization’s capabilities and

character. Capability reputation represents the ‘collective evaluation of the quality and

performance characteristics of a particular firm’, whereas character reputation denotes

the ‘collective judgments regarding a firm’s incentives and behavioural tendencies’

(Mishina et al., 2012, p. 460). Recent works on corporate reputation, such as Love and

Kraatz (2009) and Raithel and Schwaiger (2015), have used similar conceptualizations.

The main theoretical foundation of our study is stakeholder members’ path-

dependent judgments of organizations. Path dependence is an important theoretical

construct in organizational research (Sydow et al., 2009; Vergne and Durand, 2010).

Broadly, path dependence refers to the various ‘imprinting effects’ that past events can

have on organizational behaviours (Sydow et al., 2009, p. 689). Previous literature has

focused primarily on how various self-reinforcing mechanisms (such as coordination

effects, complementary effects, learning effects and adaptive expectations) can lead to

rigidities and inertia at the organizational level (Sydow et al., 2009; Vergne and

Durand, 2010). Recently, scholars have used this concept to understand how socio-

cognitive biases present in stakeholder members’ evaluations of firms can lead to self-

reinforcing and persistent judgments of firms over time (Devers et al., 2009; Mishina

et al., 2012). In particular, Mishina et al. (2012) denote stakeholder members’ tendency

of using a focal firm’s reputation as a filter for interpreting its new actions as ‘path-

771Path-Dependence of Reputation Repair

V

C2017 John Wiley & Sons Ltd and Society for the Advancement of Management Studies

dependent judgments of organizations’. In this study, we examine how stakeholder

members’ path-dependent judgments of organizations influence the effectiveness of rep-

utation repair.

We first suggest a simple model to illustrate the dynamics of a reputation repair pro-

cess in which stakeholder members’ judgments of tainted firms are path-dependent. The

model highlights how the path-dependent judgments of stakeholder members allow the

unfavourable reputation of a tainted firm to continuously exert unfavourable effects on

the stakeholder members’ evaluations of the firm’s subsequent actions during a reputa-

tion repair process. As we shall explain in the next section, the path dependence per-

spective has two implications for stakeholder members’ evaluations of the actions taken

by tainted firms. First, due to the lingering influence of a tainted firm’s unfavourable

reputation, stakeholder members tend to evaluate the actions of the tainted firm less

favourably than the same actions taken by a clean firm. Second, stakeholder members’

evaluations of a tainted firm’s actions are likely to be related to the tainted firm’s previ-

ous actions, as these actions are likely to have triggered the stakeholder members to

revise their assessments of the firm and thus altered the firm’s reputation status. The

resultant changes in the firm’s reputation will, in turn, influence the interpretative

framework the stakeholder members use to interpret the firm’s subsequent actions.

We test the preceding two implications using a unique sample of Chinese publicly

listed firms that had experienced regulatory enforcement actions for securities fraud and

subsequently made contributions to the 2008 Sichuan earthquake relief efforts (hereafter

referred to as fraud-tainted donors). Being sanctioned for securities fraud is an obvious type

of reputation-damaging event for shareholders (e.g., Cowen and Marcel, 2011; Kang,

2008; Semadeni et al., 2008; Wiesenfeld et al., 2008). First, this type of corporate mis-

conduct ‘clearly violates normative expectations of ethical behavior’ (Cowen and

Marcel, 2011, p. 510) and is ‘seen as far more controllable than a mere lack of skill’

(Wiesenfeld et al., 2008, p. 239). As a result, shareholders are likely to make negative

imputation about the fraud-tainted firms’ incentives and behavioural tendencies, which

consequently damage the firms’ character reputation. Second, sanctions for securities

fraud are likely to adversely affect the firms’ future earnings due to their adverse effects

on the behaviours of different stakeholder groups and consequently weigh on sharehold-

ers’ assessments of a fraud-tainted firm’s capabilities. For example, research has shown

that customers tend to reduce their purchases of the goods/services provided by

firms with an unfavourable reputation (Deshpande and Hitchon, 2002; Ricks, 2005).

Furthermore, firms with a less favourable reputation have difficulty attracting high qual-

ity workers (Ashforth and Mael, 1989; Dutton et al., 1994) and investors (Hribar and

Jenkins, 2004; Kravet and Shevlin, 2010). Consistent with the above-mentioned dam-

ages in the fraud-tainted firms’ character and capability reputations, previous research

has documented that there is usually a significant decline in the stock prices of fraud-

tainted firms when these firms announce their fraud sanctions to the public (see Chen

et al., 2005; Janney and Gove, 2011; Karpoff and Lou, 2010).

After experiencing a reputation-damaging event, tainted firms often take positive

remedial actions (e.g., by re-examining the standards of conduct for their executives,

making substantive leadership and organizational changes, and engaging in corporate

social responsibility [CSR] activities) to gain favourable judgments from their

772 H. Shu and S. M.-L. Wong

V

C2017 John Wiley & Sons Ltd and Society for the Advancement of Management Studies