OCTOBER 2004

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The Court of Public Opinion

Reputation-Building, Corporate Governance, and the Media

Research by Luigi Zingales

The media plays a crucial role in shaping the public image of corporate managers, and in doing so can pressure them to behave according to social norms.

In April 1992, the Wall Street Journal published a full-page ad featuring a silhouette of the board of directors of Sears, Roebuck, and Co., with the title "The non-performing assets of Sears." The ad was paid for by dissenting shareholder activist Robert Monks, and identified all directors by name, claiming that they were responsible for the poor performance of Sears' stock. Greatly embarrassed by the ad and facing public scrutiny, the directors chose to adopt many of the proposals advanced by Monk. The market rewarded these changes with a 9.5 percent excess return the day the changes were announced, and a 37 percent excess return the following year, increasing shareholder value.

On March 8, 1988, all major U.S. television networks broadcast a tape of a Panamanian tuna boat, the Maria Luisa, killing hundreds of dolphins while fishing for tuna. Building on public outrage, many environmental agencies launched a boycott of tuna. On April 12, 1990, H.J. Heinz Company announced that it would only sell dolphin-safe tuna, and within hours, the two other largest tuna producers made a similar announcement. Managers were forced to bow to environmental groups.

Both examples demonstrate the wide-ranging influence of the media on corporate policy. In these examples, the media acts as a lever, but for two different groups-disenfranchised shareholders and environmentalists.

In the study, "The Corporate Governance Role of the Media," University of Chicago Graduate School of Business professor Luigi Zingales and Alexander Dyck of Harvard Business School find that the media can pressure corporate managers and directors to act not just in shareholders' interest but in ways that are "socially acceptable."

Traditional finance theories about "reputation" are based on the argument that managers do care about their reputation in the labor market, and will behave in ways that maximize shareholder value in order to receive better compensation in the future. From the authors' analysis emerges a broader notion of reputation, where managers also care about their public image and where the media plays a fundamental role in shaping this public image.

Using international data, Zingales and Dyck analyze the effects of a country's press on private sector responsiveness to environmental issues. They chose to focus on the environment because it is a popular issue in the press, and because creating environmentally-friendly policies is not necessarily related to maximizing shareholder value.

The results indicate that in countries where the media is more influential, companies exhibit greater environmental sensitivity.

"Only concerns about their public image would explain the responsiveness of corporate managers to environmental issues," says Zingales. "These policies have little or no impact on the wealth of their ultimate employers, the shareholders, and may actually be very expensive."

In regards to the tuna example, Zingales points out that some studies indicated that customers were not willing to pay a higher price for environmentally-friendly tuna. In fact, not even the environment benefited from dolphin-safe tuna fishing, because the fishing was moved to the South Pacific where it threatened other endangered species (dolphins not being an endangered species). The decision therefore was only made to please the public.

"A manager's relationship with the media is extremely important," says Zingales. "For example, Richard Grasso, head of the NYSE, was forced to resign mainly because of public opinion. You have to carefully manage your relationship with the press, because it might cost you dearly if you don't."

Channels of Media Influence

A person's reputation within a certain group encompasses all of the historical information about that person's behavior available to that group. Governments, firms, and interest groups generate an enormous amount of information that the media then process and selectively communicate. Hence, public reputation is very much affected by the media.

The broader the media coverage, the more likely the public will acquire the information. The more attention the country's media commands, the more likely this information will spread.

The Importance of the Press

Zingales and Dyck note that it is difficult to measure the influence of a country's press in exact terms. To address this issue, they use official statistics on a country's circulation of daily newspapers divided by the population, a measure referred to as "diffusion." A higher level of diffusion indicates a higher readership level, and thus a broader reach of the press. A more diffuse press is often also a more reliable press.

If higher diffusion of the press leads to a higher probability of exposing socially unacceptable corporate policies, the authors argue that it is more likely that managers will behave in an environmentally conscious way in countries where the press is more diffuse.

To determine private sector responsiveness to environmental concerns, the authors used an index developed in collaboration with the World Economic Forum and researchers from Columbia University and Yale University. In this measure, the five highest ranking countries were Switzerland, Japan, Germany, the United Kingdom, and New Zealand. The five lowest ranking countries were Venezuela, Indonesia, Greece, Columbia, and the Philippines.

The authors find a strong link between diffusion of the press and a country's private sector responsiveness to environmental issues.

Countries where the press is very diffuse also tend to be countries with higher GDP per capita and better law enforcement. The five economies with the highest readership were Hong Kong, Norway, Japan, Finland, and Sweden. The five countries with the lowest press diffusion were Kenya, Zimbabwe, Pakistan, South Africa, and Egypt. To disentangle the impact of the press from the effect of higher income per capita, however, the authors control for GDP per capita in their analysis, and still find a strong effect of the press.

Having established the importance of diffusion of the press, what factors determine the level of diffusion? Zingales and Dyck find that the ultimate determinants of press diffusion lie in the education level of the country's population, and its cultural and ethnic traditions.

An important factor impacting the level of diffusion of the press is the number of languages spoken in a country, which has a negative impact on the level of diffusion. If more languages are spoken in a country, the newspaper market will be more fragmented, making it more difficult for newspapers to acquire credibility.

On the subject of language, the authors point out that the power of U.S. and British newspapers to pressure managers transcends domestic borders.

"The importance of the Anglo-American press in the overall international corporate governance debate should not be understated," says Zingales. "People read the Financial Times and the Wall Street Journal not only because they are very good papers, but because they are written in English. This has the effect of promoting the Anglo-American model of corporate governance."

The authors find that a country's dominant religion has a significant impact on the diffusion of the press, mainly through its effect on education. Protestant countries, for example, have a higher diffusion of the press than Catholic countries.

Shifting the Debate

Previous research has focused on the legal and contractual aspects of corporate governance. Zingales and Dyck argue that the media also plays an important role in shaping corporate policy-a role that should not be ignored in any analysis of a country's corporate governance system. The media's role, however, also brings to the forefront the importance of social norms.

"The media plays a role as social enforcers, so they are going to push managers in the direction where public opinion wants them to go," says Zingales.

From a policy point of view, this is a mixed blessing. On the one hand, even countries with inadequate laws and malfunctioning justice systems can experience some of the benefits of better corporate governance if media pressure is sufficiently strong, and social norms support good governance. On the other hand, social values cannot be easily changed by legislators or by international policymakers. Hence, the extent of press influence may be largely outside policymakers' control.


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Luigi Zingales is Robert C. McCormack Professor of Entrepreneurship and Finance at the University of Chicago Graduate School of Business.

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