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Following Wall Street's lead can taint corporate reputations, study shows

Matthew Kraatz
Click photo to enlarge
Matthew Kraatz, professor of business administration, studied Fortune 100 corporations that joined a wave of downsizing from 1985 to 1994, weighing how the sweeping job cuts influenced their showing in Fortune’s annual rankings of most admired companies. 

5/30/2008

Jan Dennis, Business & Law Editor
217-333-0568; jdennis@illinois.edu

CHAMPAIGN, Ill. — Corporate reputations take a beating when scandals erupt, faulty products force recalls or earnings tumble, yielding sell-offs that leave investors jittery.

But new research by two University of Illinois business professors shows the polished image that companies spend millions of dollars to cultivate is so fragile that it can tarnish even when firms make moves with the blessing of powerful stakeholders such as financial analysts and the business community.

Business administrator professors Geoffrey Love and Matthew Kraatz studied Fortune 100 corporations that joined a wave of downsizing from 1985 to 1994, weighing how the sweeping job cuts influenced their showing in Fortune’s annual rankings of most admired companies.

The findings show companies that slashed staff fell more than a position in the next year’s rankings on average, even after accounting for financial performance. That trend held until downsizing became a virtually accepted business practice in the mid 1990s, according to the study, which will appear in the Academy of Management Journal.

Love and Kraatz say the drop is surprising because the magazine’s ratings are based on a survey of Wall Street analysts, who generally pushed downsizing to boost profits, and corporate executives who had sometimes led downsizing of their own firms.

“What we think is happening is that while analysts and executives pay attention to the numbers, they also say it matters how other stakeholders are treated, even if they support it or have done it themselves,” Love said. “When they see a firm downsize, they see a broken commitment to employees and that’s a sign of character that plays into their evaluation, too.”

Geoff Love
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The research by business professor Geoffrey Love and his colleague shows the polished image that companies spend millions of dollars to cultivate is so fragile that it can tarnish even when firms make moves with the blessing of powerful stakeholders such as financial analysts and the business community.

Kraatz doubts analysts and executives were aware that downsizing colored their view, and says the findings support earlier research showing corporations are judged based on the same standards as people.

“People ascribe traits to organizations and evaluate them as if they were people,” Kraatz said. “Some are trustworthy, reliable and credible. Others are opportunistic, self-interested and shifty.”

“That’s something managers need to be aware of. Even if there is a good business reason to do something like downsizing and it isn’t a moral issue to them, it could be evaluated that way,” he said.

Timing was a factor in how much image suffered, according to the study, “Character, Conformity or the Bottom Line: How and Why Downsizing Affected Corporate Reputation.”

Companies in financial peril were judged less harshly than already profitable firms that downsized to further boost earnings, according to the study, which accounted for company performance and stock-market reaction related to downsizing. Reputation also took less of a hit overall as downsizing became more commonplace.

Love says that because downsizing is so well accepted now, corporate images likely would still hold up if a new wave follows an economic slowdown that many fear could lapse into recession. But he says there are other moves that could leave a black eye.

“The interesting thing would be to think about business strategies that are relatively new and share some characteristics with downsizing, moves that serve one stakeholder but damage others,” Love said. “Outsourcing is one and off-shoring certainly comes to mind as an increasingly common action that might be viewed negatively.”

Love and Kraatz say a tainted reputation can be costly. Stock prices can slide if analysts take a dimmer view of companies. Potential customers and business partners also could be influenced, as well as government regulators.

“These findings point to a moral evaluation and to some extent an emotional evaluation,” Kraatz said. “Downsizing was viewed as an act of betrayal and opportunism where firms went back on their commitment. It casts worry, making people wonder whether the company might sell out some other constituency in the future to meet its goals.”

Editor’s note: To contact Geoffrey Love, call 217-333-2194, e-mail glove@illinois.edu.

Matthew Kraatz, 217-333-7994; kraatz@illinois.edu.