How firm reputation shapes managerial discretion

The modern marketplace is saturated with ‘ratings’ and ‘reviews’ of a firm’s products, services, and financial performance on platforms such as Google, Yelp, Bloomberg, and Facebook. While we know a great deal about how reputation improves a firm’s performance and that there are multiple dimensions of reputation, only recently have scholars begun to examine how reputation influences the behaviour of the firm itself.

Recent evidence has told us that reputation can also ‘raise the bar’ of stakeholder expectations to such a level that it increases the chance of disappointment. Findings include evidence that a product recall can particularly damage a reputable firm’s market value and that a university’s rule-breaking in athlete recruitment can hurt its fundraising efforts.

However, these findings point to the hazards of severe organizational crises or bad behaviour rather than the more commonplace challenges faced by most organizations, and most managers focus on avoiding such events rather than responding to them. How does reputation influence managers’ everyday decisions, then?

Herein lies the importance of managerial discretion. Managers’ behaviour is constrained by the extent to which they perceive that they have discretion in making certain decisions. As such, in a recent paper of ours, we argue that reputation shapes managers’ discretion focusing their attention on meeting stakeholder expectations. However, reputation and discretion both have distinct component parts.

A natural pairing of two reputation types and two discretion types

Building on decades of research across the organization sciences, we first emphasize that developing a reputation for some kind of outcome—such as superior financial performance or exceptional product quality—is distinct from developing a reputation for some pattern of behaviour—such as a tendency to prioritize R&D spending or to make investments according to free-market principles. Second, managerial discretion can be bifurcated in terms of ‘latitude of actions’—the range of strategic behaviours managers believe they are able to exhibit—and ‘latitude of objectives’—the range of organizational outcomes managers believe they are able to target.

In the first layer of our conceptual framework, we assert that because reputation leads to inertia in stakeholders’ expectations, the firm’s possession of an outcome-based reputation (eg, reputation for product quality) limits its latitude of objectives in pursuing outcomes that are inconsistent with that perceived pattern of outcomes. Conversely, the firm’s possession of a behaviour-based reputation (eg, reputation for ethical practices) limits its latitude of actions in employing means inconsistent with that perceived behavioural pattern (eg, the use of negative amortization mortgages that are profitable, but burdensome to consumers).

In the second layer of our framework, we contend that because stakeholders’ attention is focused on their top priorities, and because stakeholders have limited attention to devote to other non-prioritized aspects of the firm, we posit that the possession of one form of reputation expands the opposite form of discretion. That is, although a firm’s outcome-based reputation reduces managers’ latitude of objectives, it expands their latitude of actions. Stakeholders care less about the means that managers employ to achieve the outcomes they desire, so long as those outcomes are achieved. Also, although a firm’s behaviour-based reputation reduces managers’ latitude of actions, it expands their latitude of objectives. For example, as long as the firm is acting in the way that stakeholders want it to, such as prioritizing environmental stewardship or promoting ethical treatment of animals, those stakeholders will be less concerned about whether the firm achieves a certain outcome.

The third and final layer of our framework imposes a dual constraint by theorizing how firms will have the least amount of discretion when they possess both forms of reputation. That is, although the discretion enhancing mechanism of stakeholder inattention and indifference applies when the firm has only one form of reputation, the possession of both forms of reputation offsets these benefits, as stakeholders will come to have expectations about not only the ends the firm achieves, but also the means used to achieve those ends. This is exemplified by the case of Chipotle Mexican Grill. Chipotle had an outcome-based reputation for superior food quality and a behaviour-based reputation for local sourcing of ingredients and fresh preparation of food with minimal processing. When Chipotle came under fire for contamination of their food ingredients, their actions to rescue their ‘superior food quality’ outcome reputation were constrained by the behavioural reputation for local sourcing and on-site food preparation. Instead of taking dramatic steps to, for example, centralize their supply chain, standardize food handling, and ship food directly to restaurants, their reputation for how they handled food constrained them to half-measures such as ‘more food safety testing’ and ‘better training of suppliers and employees’.

Chipotle continues to languish and struggle to claw its way free of this predicament because it cultivated both outcome- and behaviour-based reputations that now constrain the discretion of its managers. If any lessons can be learned from this, it is that perhaps firms should take care to avoid being typecast even for ostensibly favourable outcome- and behaviour-based reputations; or, at least, not both at once.

Owen Parker is an Assistant Professor of Management in the Spears School of Business at Oklahoma State University and a guest contributor to the Oxford Business Law Blog.

Ryan Krause is an Associate Professor of Strategy and Schumacher Junior Faculty Fellow in the Neeley School of Business at Texas Christian University and a guest contributor to the Oxford Business Law Blog.

Cynthia Devers is The Lawrence E. Fouraker Professor in Business and Associate Professor of Management in the Mays Business School at Texas A&M University and an International Research Fellow at The Oxford University Centre for Corporate Reputation and a guest contributor to the Oxford Business Law Blog.