The Value of Reputation in Corporate Finance and Investment Banking (and the Related Roles of Regulation and Market Efficiency)

14 Pages Posted: 3 Jan 2011

Date Written: December 23, 2010

Abstract

This article explores the roles of reputation, efficient capital markets, and capital market regulation in preserving and creating economic value. Each of these three mechanisms serves as a substitute for the other two, with each playing a role in maintaining the credibility and reliability of markets.

While efficient markets and effective regulation are market-wide phenomena that affect all firms, reputation is a firm-specific corporate asset. Companies develop reputational capital by treating customers and counterparties fairly (while forgoing the temptation to achieve short-term profits at their expense). At the same time, companies seeking access to the capital markets but lacking a reputation must typically employ reputational intermediaries. Investment banks, credit rating agencies, accounting firms, law firms, and organized stock exchanges have all served as reputational intermediaries at various times during the last 200 years.

One contributor to the recent financial crisis was a kind of experimentation by some reputational intermediaries with an opportunistic and two-tiered “customer differentiation” strategy in which some customers were treated very well, while others were treated with little or no regard for their legitimate expectations as to how they would be treated. This strategy has proved to be a failure, imposing significant costs on those organizations as well as their customers. The available substitutes for reputation, capital market effciency and effective regulation, did not provide sufcient offsetting protection for investors.

While the two-tiered “customer differentiation” strategy has failed, the central message of the economic theory of reputation remains intact. This message is that a company's reputation is a valuable asset that must be preserved to ensure the future of the organization. For all financial intermediaries that rely heavily on their reputations when selling their products and services, the author recommends large and continuous investment in maintaining those reputations. For investment banks in particular - a group whose reputations have held up reasonably well - the author suggests that they continue to view their role as reputational intermediaries as a core part of their businesses.

Suggested Citation

Macey, Jonathan R., The Value of Reputation in Corporate Finance and Investment Banking (and the Related Roles of Regulation and Market Efficiency) (December 23, 2010). Journal of Applied Corporate Finance, Vol. 22, Issue 4, pp. 18-29, 2010. Available at SSRN: https://ssrn.com/abstract=1733798 or http://dx.doi.org/10.1111/j.1745-6622.2010.00299.x

Jonathan R. Macey (Contact Author)

Yale Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States
+203-432-7913 (Phone)
+203-4871 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
6
Abstract Views
1,072
PlumX Metrics