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MOVING BEYOND FIRM BOUNDARIES: A SOCIAL NETWORK

PERSPECTIVE ON REPUTATION SPILLOVER

Tieying Yu *

Carroll School of Management

Boston College

Chestnut Hill, MA02467

Phone: 617-552-2731 Fax: 617-552-0433

Email: yuti@bc.edu

Richard H. Lester Department of Management

Texas A&M University

College Station, TX 77843-4221

Phone: 979-862-7091

Email: rlester@mays.tamu.edu

* Please address any correspondence to this author.

We would like to thank Albert A. Cannella Jr., David L. Deephouse, Javier Gimeno, Peter S. Ring, Metin Sengul and Guest Editors Michael Barnett and Andy Hoffman, for their helpful comments and discussions. An earlier version of this paper was published in the Best Paper Proceedings of the Academy of Management (August 2002).

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MOVING BEYOND FIRM BOUNDARIES: A SOCIAL NETWORK

PERSPECTIVE ON REPUTATION SPILLOVER

ABSTRACT

A change in an organization’s reputation has consequences and implications that

may go beyond that organization’s boundaries. Drawing on social network and

stakeholder research, we introduce the construct of reputation spillover to

examine the process in which a reputational crisis occurred to one organization

may spillover to other organizations that are either proximate or structurally

equivalent to the focal organization. We argue that this process occurs mainly

through the perceptions and reactions of stakeholders and is contingent upon the

network centrality of the focal organization, the network structure of the industry

and the past reputation of potential recipient organizations.

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INTRODUCTION

An organization’s reputation according to the resource-based view of the firm can

be valuable (Hall, 1992), rare, hard to duplicate (Mahoney and Pandian, 1992), and non-

substitutable. Research has shown that as an important source of competitive advantage

(Barney, 1991); reputation can provide information about expected future behavior of an

organization (Weigelt and Camerer, 1988). Organizations can use their reputations to

deter entry (Milgrom and Roberts, 1982), charge a premium price (Shapiro, 1983), or

enhance access to capital market (Beatty and Ritter, 1986). However, the past reputation

may no longer be a reliable predictor of an organization’s future behavior when a

disruptive event sharply ends what has institutionalized in stakeholders’ mind with

respect to their previous thinking of the organization. In this paper, we explore the

relationship between an organization under a damaging crisis and the potential

implications of that upon its other industry members. We propose that an organization’s

damaged reputation may have implications that go beyond its boundaries and affect

others.

Various definitions of corporate reputation have been proposed primarily

emanating from two streams of literature. An economics perspective argues that

particular attributes of an organization signal stakeholders as to the worthiness of that

particular entity (Milgrom and Roberts, 1982; Weigelt and Camerer, 1988; Clark and

Montgomery, 1998). This leads stakeholders to assign various economic choices to the

organization (Dollinger, Golden, and Saxton, 1997) which may result in differences in

organizational performance. An institutional perspective characterizes reputation as a

global impression representing how multiple stakeholders view the organization as a

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collective (Hall, 1992, Fombrun, 1996; Rindova, Williamson, Petkova, and Server,

2005). The “true” nature of an organization is identified through the sharing of

information among a diverse population of intermediaries, which allow stakeholders to

make assessments and judgments regarding their current and future interaction with a

particular organization (Pollock and Rindova, 2003). Our work tends to lend itself to the

collective nature of reputation however we recognize the economic implications. We, as

others before us, therefore define corporate reputation as “observers’ collective

judgments of a corporation based on assessments of the financial, social, and

environmental impacts attributed to the corporation over time” (Barnett, Jermier and

Lafferty, 2006: 34).

A shift may occur in an organization’s reputation as a result of an organizational

crisis. Such crises usually happen when there are widely publicized and damaging events

that lead stakeholders to re-evaluate their previous conceptions of an organization’s

capabilities. Zyglidopoulos and Phillips (1999: 335) define reputational crisis as “a

situation in which important stakeholders negatively re-evaluate their opinions and

beliefs about the firm”. Their work as others in the crisis and reputation literature

typically details the impact of a crisis upon an organization, its management and

consequences. However, we know of no work that examines how changes in a focal

organization under a reputational crisis influence others operating in the same industry.

To fill in this gap, we draw upon social network theory and stakeholder research

to argue that a reputational crisis creates an environment of high uncertainty and

ambiguity. Since many stakeholders do not possess sufficient information to

comprehensively evaluate the causes of a reputational crisis, or properly disentangle its

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impact on other organizations, we expect they will stereotype organizations based on

their proximity and structural equivalence to the focal organization under the crisis. In

this regard, the reputational crisis that impacts a focal organization may spread to others.

We call this phenomena reputation spillover1 (i.e. when the damage to one organization’s

reputation spills over to another). The effects of proximity and structural equivalence on

the likelihood of reputation spillover are contingent upon a number of factors. We expect

that the spillover effect is stronger when the reputational crisis originates from an

organization with high network centrality; operating in an industry with a centralized

network structure; and the potential recipient organization possesses an unfavorable

reputation.

A reputational crisis can be triggered by events such as accidents (Buchholz,

Evans, and Wagley, 1985; Marcus and Goodman, 1991; Perrow, 1984), scandals (Marcus

and Goodman, 1991; Sethi, 1977), or financial problems (Kent, 1993). Previous work

defines triggering events of a reputational crisis as “organizationally-based episodes,

which cause reputational damage and unfold through complex technological,

organizational and social processes” (Shrivastava, Mitroff, Miller, and Miglani, 1988:

285). A triggering event is the starting point of a reputational crisis and its nature can

arguably influence how the crisis unfolds, in general, and how stakeholders interpret and

react, in particular. Stakeholders here are defined as “any group or individual who can

affect, or are affected by, the achievement of an organization’s purpose” (Freeman, 1984:

25), including potential investors, customers, employees and suppliers.

1 A narrow version of reputation spillover has been examined previously (Mayer, 2006) as a function of a firm’s performance. In this view if a firm performs poorly in an exchange the result may be a spillover to its future business with negative consequences.

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The triggering events of reputational crises are usually infrequently observed

events with no ex ante expectations regarding when they might occur (Pearson and Clair,

1998). They can force the organization to diverge from established practices and

strategies (Meyer, 1982; Miles, 1982), make its future more uncertain (Shrivastava et al.,

1988), and even threaten its survival (Dutton and Jackson, 1987). The reputational crises

of our interest typically involve highly complex events (Dutton, 1986). We define the

complexity of a triggering event as the degree of uncertainty or ambiguity the event can

create for stakeholders when they evaluate the antecedents and consequences of a

reputational crisis. A plausible assessment of the impact of a complex event on an

organization’s reputation is difficult, because it could be the result of a number of failures

interacting in non-linear and unpredictable ways (Perrow, 1984). It is important to note

that a reputational crisis does not have to be complex to spread to other industry

participants. For example, if a manufacturing firm experiences a major accident or

product failure resulting from a certain production technology; other industry participants

using the same or similar technologies are likely affected as well. Indeed this is what

Bowen, Castania and Daley (1983) observed while investigating the Three Mile Island

incident. The spillover of this type of reputational crisis (entailing no uncertainties) is not

of interest here. Instead we are more intrigued by the reputational crisis in which the

consequences of the crisis on others are less well understood.

For conceptual clarity we limit our analysis to reputation spillover between

organizations operating in the same industry – thus basically limiting our analysis to

within-industry effects. However, we do recognize that the spillover effects of a

reputational crisis may jump industry boundaries and affect organizations in other

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industries as well. For instance, it may affect organizations operating in the same value

chain as the focal organization. Consider the Firestone debacle of 2001 where a series of

tire failures on Ford Explorers caused a number of injuries and fatalities (O'Rourke,

2001). Not only was the reputation of Bridgestone Firestone Corporation damaged, but

also (for a time) the Ford Motor Corporation. In addition, a reputational crisis may affect

organizations with the same organizational form as the focal organization (Yu, Sengul

and Lester, in press). An example is the crisis that revolved around the collapse of Enron.

This seemingly isolated business failure subsequently extended well beyond energy

trading to affect (to varying degrees) virtually all publicly traded companies (Hamilton

and Francis, 2003). Similarly, the Union Carbide accident at Bhopal affected

multinationals well beyond the chemical industry and the Indian market (Bowman and

Kunreuther, 1988).

As indicated in our definition of reputation spillover, this paper focuses on the

negative spillover effects that stem from a reputational crisis. In fact, as suggested by

prior research a reputational crisis might have positive effects on other organizations. For

instance, other organizations may take advantage of the focal organization’s misfortune

and attempt to capture a portion of its market share (Porter, 1980). Alternatively, a

positive change in one organization’s reputation might cast a halo on other organizations.

Although positive spillover effect warrants separate consideration in future research, it is

outside the scope of this study.

Our paper is organized as follows. First, we briefly review the research on social

network and stakeholder. Then we explain when, how, and why a reputational crisis that

occurs to one focal organization might spread and affect other industry participants. Next,

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we explore the contingencies that are likely to shape this spillover process. Finally, we

discuss the implications of our paper.

THEORETICAL BACKGROUND Interest in reputation research has grown in the past decade. Various studies have

suggested that reputation is an important source of competitive advantage (Barney,

1991). Most of the existing research views reputation as a firm-level construct. In fact,

this is just one way of defining it. King, Lenox, and Barnett (2002) suggested that

reputation could be a common resource shared by many organizations in the same

industry. Tirole (1996:2) went further by proposing that “the past behavior of a member’s

group conditions that group’s current behavior and can therefore be used to predict group

members’ behavior”. While a reputational crisis may occur initially at an “individual”

level, it is likely that stakeholders will evaluate its impact at the “group” level.

Consider the following event as an example. In October 2002, the U.S. Food and

Drug Administration (F.D.A.) rejected two hormone replacement therapy drugs from

Schering A.G. due to concerns over side effects. Subsequently, Schering A.G. lost more

than a quarter of its market value. In addition, the rejection of Schering’s new drugs

drew attention to, and raised further questions about, the safety of a wide range of

hormone replacement drugs. According to NDCHealth, a healthcare information services

company, orders for drugs in the same category decreased between thirteen and sixteen

percent for Pfizer, Solvay and Galen (Fuhrmans, 2002), even though they all claimed that

their drugs did not have the same side effect as Schering A.G. As this example reveals,

Pfizer, Solvay and Galen were all negatively affected by the reputational crisis that

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occurred to Schering A.G., mainly because stakeholders perceived them all as similar and

therefore sanctioned them without exceptions (Tirole, 1996).

In fact reputation spillovers have been studied previously at both the country level

(Cole and Kehoe, 1996) and the organization level (Yu, Lester and Sengul, 2002; Mayer,

2006). Compared with the earlier work, our study undertakes a different theoretical

angle. More specifically, we draw insights from social network and stakeholder theories

to explain the phenomenon of reputation spillover.

Applying Stakeholder Theory and Social Network Theory

In our conceptualization the key to a reputation spillover event is the

interpretation and reaction of stakeholders. Following Freeman (1984:25), we view

stakeholders as “any group or individual who can affect, or are affected by, the

achievement of an organization’s purpose”. Stakeholder theory development has largely

centered around two related streams: 1) defining the stakeholder concept and 2)

classifying stakeholders into categories and understanding their influences (Freeman,

1984; Carroll, 1989; Brenner and Cochran, 1991; Hill and Jones, 1992; Rowley, 1997;

Frooman, 1999; Post, Preston and Sachs, 2002).

Regardless of how scholars define stakeholders, there is a core idea underlying

the stakeholder theory. That is, organizations need to address a set of stakeholder

expectations; thus, in many aspects management choice is a function of stakeholder

influences (Brenner and Cochran, 1991). In fact, this notion has been substantiated by a

number of studies (Zuckerman, 1999, 2000; Podolny, 1993, 2001; Stuart, Hoang, and

Hybels, 1999; Benjamin and Podolny, 1999). Researchers have shown that the

perceptions or expectations of stakeholders are important in disciplining organizations to

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perform expected roles in the network. There seems little doubt that stakeholders are

instrumental to firm performance and survival, as their choices affect both the cost

structure and the pricing ability of the organization. When a reputational crisis occurs,

although the impact of one stakeholder might be small on its own, the aggregated

influences from the entire stakeholder set are likely to be considerably significant

(Rowley, 1997).

A reputational crisis creates uncertainty for stakeholders to ascertain its causes

and consequences. Since a complete assessment of a reputational crisis’s influence on

other organizations may entail comparing all the attributes of the focal organization with

all known attributes of other organizations, such an assessment is quite unlikely given the

imperfect information flow and the high costs of acquiring such information. To manage

this uncertainty, we propose that stakeholders may evaluate the impact of a reputational

crisis on a set of organizations based upon their perceived relatedness to the damaged

organization.

This then begs the question of what vehicles stakeholders utilize to evaluate the

relatedness between organizations. Social network research suggests two approaches to

analyze organizations’ structural similarities and patterns of relations (Brass, Butterfield,

and Skaggs, 1998; Burt, 1987). Focusing on the direct ties between actors (e.g. strategic

alliances between organizations), the first approach argues that similarity is a function of

proximity. Research has found that the more frequent the communication between two

organizations, the more likely that they will share similar evaluation of strategic issues

(Galaskiewicz and Burt, 1991). Thus, directly linked organizations will be more likely to

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resemble one another than indirectly linked ones. Interaction breeds similarity and that

similarity breeds interaction (Blau, 1977).

Focusing on the positions of actors in a social network, the structural equivalence

approach suggests that organizations compare themselves with, and adopt similar

attitudes and behaviors of, those others who occupy equivalent positions in the network

(Brass et al., 1998). Position here refers to a collection of actors who are similar in social

activity, ties, or interactions, with respect to actors in other positions. Since position is

based on the similarity of ties among subsets of actors, rather than their adjacency,

proximity, or reachability, actors occupying the equivalent position need not be in direct

or even contact with one another (Wasserman and Faust, 1994). For example, car dealers

in different cities occupy the position of “car dealer” by virtue of similar kinds of

relationships with automakers and customers, though individual car dealers may not have

any contact with each other, work with the same automakers, or serve the same

customers.

As two most important network properties, proximity and structural equivalence

are influential drivers of social contagion process. In our study, we use them as the

foundation of our theoretical framework to explain the phenomenon of reputation

spillover in the context of a reputational crisis.

A FRAMEWORK TOWARDS REPUTATION SPILLOVER

As we noted earlier, when a reputational crisis occurs, it can sharply end what has

become institutionalized in stakeholders’ minds. Consequently, stakeholders use various

societal, organizational and personal mechanisms to reinterpret the changing

environment. Since determining the impact of a reputational crisis requires accurate

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information, in situations of ambiguity stakeholders might find it difficult to differentiate

between individual organizations; thereby penalizing all organizations that are either

proximate or equivalent to the focal organization equally. Under such condition, although

the crisis only occurs to one organization, its negative impacts may spread to others as

well.

Reputation Spillover due to Proximity

The underlying logic of spillover by proximity is that communication is easier

when organizations are directly linked and it gets more difficult as they have many

intermediaries between them. Interorganizational ties serve as “pipes” through which,

information, resources, product and financial transactions are transferred between

organizations (Podolny, 2001). Direct contacts or alliances with other industry members

also offer the potential for organizations to create entry barriers and improve performance

through better information exchange (Dollinger, Golden, and Saxton, 1997; Ingram and

Roberts, 2000). Thus, to a certain degree, direct contacts breed strategic interdependency

between organizations.

Furthermore, direct contacts shorten the social distance2 between organizations.

When the communication between two organizations is frequent, they are likely to adopt

the orientations and values of each other (Galaskiewicz and Burt, 1991), and this effect

will be further enhanced or enforced by institutionalizing process within and between

them (DiMaggio and Powell, 1983). Hence strong and direct ties between two

organizations make them proximate (Coleman, Katz and Menzel, 1966). The closer the

relational contact, the more likely that the change in one organization’s disposition will

2 By distance we refer to path length of a network: the number of steps required to get from one organization to another.

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affect the other (Galaskiewicz and Burt, 1991; Borgatti and Everett, 1992; Wasserman

and Faust, 1994).

In sum, direct contacts drive organizations to more closely resemble one another,

which in turn evokes a similar schema for stakeholders to interpret their true

characteristics after a reputational crisis occurs. Therefore a reputational crisis is more

likely to spread to an industry participant which has direct contacts with the focal

organization.

Proposition 1: The likelihood of reputational spillover from an organization

under reputational crisis to an industry participant is positively related to their

proximity to one another.

Although no studies in the literature have explicitly examined the spillover of a

reputational crisis, there is some indirect support to our proposition. For instance,

Ferguson, Deephouse and Ferguson (2000) found that by establishing strategic alliances,

reputational information may spread through the interorganizational ties and over time

coalesce into a reputation for both partners as a whole. Simonin and Ruth (1998)

empirically showed that alliances allow consumers’ prior attitudes towards one

organization to spillover to the alliance partner. Finally, Uzzi (1997) demonstrated that

exogenous shocks may cause embeddedness to shift from an asset to a liability. Under

these conditions, social processes that increase network proximity combine with resource

dependency issues to increase the vulnerability of tightly connected organizations.

Reputation Spillover due to Structural Equivalence

The underlying logic of spillover by structural equivalence is that stakeholders

categorize firms based on perceived similarity in their core attributes (Holland, Holyaod,

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Nisbett, and Thagard, 1986; Rosch, 1978; Smith and Medin, 1981), even though there are

few, if any, direct contacts connecting them together. Research has shown that

organizations displaying similar core attributes (such as organizational mission, form of

authority, core technology, and general marketing strategy) are more likely to be treated

as belonging to the same category (Hannan and Freeman, 1984; Polos, Hannan, and

Carroll, 2002).

There are multiple core attributes that differentiate firms from one another.

Scholars such as Burt (1987) and White and Reitz (1983) use network position to derive

social homogeneity. They partition a network into mutually exclusive classes of

equivalent actors who have similar relational patterns (Wasserman and Faust, 1994).

Burt (1980) defined two actors as structurally equivalent when they have the same pattern

of ties to and from other actors. Structurally equivalent organizations are likely to be

perceived similar by stakeholders for a number of reasons. For example, they may have a

similar organizational structure and therefore undertake similar actions and responses

when facing changes in the environment (Borgatti and Everett, 1992). Furthermore using

each other as a frame of reference for subjective judgments, they may express similar

opinions even if they have no direct communication (Burt, 1987). As a result, Podolny

(2001:33) noted that the equivalent positions of two market actors provide an important

informational cue on which outsiders rely to make inferences about their underlying

quality. He termed this “networks as the prisms of the market”.

In sum, we expect that when stakeholders do not possess sufficient information to

disentangle the causes and consequences of a reputational crisis, they may penalize

organizations sharing the equivalent structural position as the focal organization. Note

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that in contrast to spillover by proximity, the spillover of a reputational crisis by

structural equivalence requires no direct connectedness between organizations.

Proposition 2: The likelihood of reputational spillover from an organization

under reputational crisis to an industry participant is positively related to their

structural equivalence.

Previous research on product differentiation provides indirect support for our

proposition (Gaspar and Massa, 2004). A key feature of product differentiation is that it

makes firms’ products less demand elastic and hence protects them from demand

fluctuation. In other words, firm specialization makes the focal firm less similar to other

firms and thus makes the information concerning other firms less relevant to make

inferences about the focal firm. Dissimilarity in market segments (or structural positions)

may increase a focal organization’s idiosyncratic volatility, but it reduces its chance of

being affected by industry-wide demand shocks (Gaspar and Massa, 2004).

Here, we would like to note that we do not claim that the processes that create

cognitive categories in the minds of stakeholders are mutually exclusive. Indeed,

categorization is a complex process involving multiple criteria (structural position,

strategic similarity, human-resource composition, etc.). We focus on proximity and

structural equivalent position because these two network properties are influential drivers

of social contagion (Burt, 1987, Galaskiewicz and Burt, 1991; Wasserman and Faust,

1994). Moreover, we do not claim that the two mechanisms of spillover take place in

isolation from one another. In certain cases, when firms are connected by direct ties

(proximity), they may also possess similar network positions (equivalence). These

nonlinearities do not invalidate our claims. However as a first step towards understanding

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reputation spillover, this study takes a focused approach and leaves such nonlinear

complexities for future research

Contingencies Surrounding the Spillover Process

Two mechanisms of spillover described above suggest how a reputational crisis

spreads from the focal organization to an industry participant(s). However, the likelihood

of reputation spillover is not uniformly symmetric. Below, we further suggest that the

influence of proximity and structural equivalence on the likelihood of reputation spillover

is contingent upon a number of factors. More specially, as indicated in Figure 1, we argue

that the effects of proximity and structural equivalent on the likelihood of reputation

spillover will be stronger when the reputational crisis originates from an organization

with high network centrality; operating in an industry with a centralized network

structure; and the potential recipient organization possesses an unfavorable reputation.

_________________________

Insert Figure 1 about here

_________________________

Network Centrality of the Focal Organization

Network centrality refers to an individual organization’s position in the network

relative to others. As one of the most important properties of network structure, network

centrality evaluates an actor’s prominence (Galaskiewicz and Wasserman, 1994), power

(Brass and Burkhardt, 1993) and status (Podolny, 2001). In other words, actors who are

the most important or the most prominent are usually located in the most central positions

within a network. Central organizations are associated with more stakeholders and

receive more public scrutiny than those periphery organizations (Fombrun and Shanley,

1990; Pfeffer, 1982). The extensive contacts of central organizations in the network,

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coupled with their power and social status, increase the availability of information and

inflate the public’s familiarity with them (Tversky and Kahneman, 1974).

Furthermore, in most cases, central organizations are also the organizations that,

through their social influence, power and control, affect and regulate the decisions and

activities of other organizations operating in the same network. They are more

representative of the acknowledged image of the entire network and they can easily

intensify the interests and increase the attentions on any particular occurrences including

a reputational crisis (Hoffman and Ocasio, 2001). Thus, when a central organization

undergoes a reputational crisis, information about this disruptive event is likely to spread

quickly in the public domain, which will greatly facilitate and accelerate the reputational

crisis spreading to others (Fiske and Taylor, 1991). Hence we propose that:

Proposition 3: The effects of proximity and structural equivalence on the

likelihood of reputation spillover are stronger when the reputational crisis occurs

to a central organization in the network.

Consider the following event as an example. In the mid-1980s, the F.D.A.

released the results of a study that showed an unusually strong link between a tampon

manufactured by Procter & Gamble and toxic shock syndrome (TSS) – a rare, life-

threatening bacterial infection (Behr, 1980). The cause of TSS seemed to stem from a

unique and innovative material used by Procter & Gamble (but by none of its rivals). In

response, Procter & Gamble began a recall of their product from store shelves.

Interestingly however, Tampax, the next largest rival in the product category, also began

to experience declining market valuation, even while their product was recording record

revenues (Metz, 1980). Arguably, had the crisis struck not Procter & Gamble but a much

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smaller organization, rivals would probably not have faced the same generalized and

negative reactions.

Network Structure of the Industry

If we view the industry as a network of strategically interdependent organizations,

then the information cues used by stakeholders to derive similarity between organizations

are, at least in part, a function of network, i.e. industry, structure. Network structure

refers to the density of ties among organizations and the aggregate structure created by

these ties (Wasserman and Faust, 1994). Previous research suggested that understanding

the structure of a network is important to mapping the spread of practices and their

prevalence (Davis and Greve, 1997). Different network structures can be identified by the

pattern of connections among members. Based on these patterns one can identify three

archetypical network structures.

The first archetypical structure is a centralized network,3 in which most or all

peripheral organizations are connected to a central organization (Figure 2(a)). This

scenario roughly resembles a monopoly industry, such as the diamond industry and the

computer operating system industry, which are largely dominated by single organizations

(for example, DeBeers and Microsoft, respectively). The second structure is scale-free

networks, which are characterized by a few disproportionately important (i.e. connected)

members (or hubs) (Figure 2(b)). A scale-free network, like a centralized network, has

many peripheral actors. But it also includes certain organizations with disproportionately

large numbers of links to other organizations. Biotechnology, broadcast media and

3 It is important to note that the concept of network centrality focuses on an individual organization’s location within a network. So it is an organization-level construct. By contrast, the notion of a centralized networkscaptures how a network is structured based on the density of ties among all member organizations, so it is a network-level construct.

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refining industries are typical examples of this type of network. Finally, in distributed

networks, all organizations are connected to few others and there are no

disproportionately important organizations (hubs) in the network (Figure 2(c)). Most

members in a distributed network have approximately the same number of links to others.

Characterized by high differentiation and lack of significant scale economies, industries

such as restaurants, health clubs and beauty salons are examples of distributed networks.

_________________________

Insert Figure 2 about here

_________________________

These three archetypical network structures differ in density of ties among

member organizations. As displayed in Figure 1, one highly connected organization

(central organization) is very prominent in centralized networks while the importance of

highly connected organization(s) becomes less influential in scale free networks and even

less so in distributed networks. Notably, the existence of highly-connected organizations

sharply reduces the distance between, and thereby increases the proximity of, any two

organizations in a network.

Now assume that a reputational crisis randomly occurs to an organization in an

industry network. We expect that the ease and magnitude of its spillover depends upon

the density of the network structure. In particular, we expect that the reputational crisis

will spread most readily and with the largest magnitude in a centralized networks

followed in decreasing order by scale-free and distributed networks, due to the

differences in average proximity of any two organizations in these networks structures.

Indeed, our analysis reflects the thoughts of Paul Baran approximately four decades ago

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that a distributed communication system is the least likely to be affected by, and hence

most likely to survive a nuclear attack (cf. Barabasi, 2002). Therefore we propose:

Proposition 4: The effects of proximity and structural equivalence on the

likelihood of reputation spillover are the strongest when the reputational crisis

occurs in an industry with a centralized network structure followed in decreasing

order by scale-free and distributed networks.

Past Reputation of Other Industry Participants

Reputation of an organization is the overall estimation in which the organization

is held by its various constituents (Fombrun, 1996) and in essence reflects what

stakeholders think and feel about the organization. Reputation is said to be favorable or

positive when the organization is highly esteemed, worthy or meritorious, which implies

a good name and high regard (Dollinger, Golden and Saxton, 1997; Mahon and Wartick,

2003). There are at least two reasons to expect that the spread of a reputational crisis’s

negative impacts will be blunted among organizations with favorable reputations, or

accentuated among those with unfavorable reputations.

First, reputation tends to be sticky. While it is true that following a disruptive

event past reputation might no longer be as reliable as it was before, it is not easily

substitutable and still carries valuable information about the organization (Williams,

Schnake, and Fredenberger, 2005). When the environment changes disruptively, people

tend to rely on historical categories and old cognitive schemas to navigate the new

situation (Reger and Palmer, 1996). Second, as an asset, reputation can be used in a

defensive manner, allowing an organization to preserve its market position when

challenged (Clark and Montgomery, 1998). This is known as “the reservoir of goodwill

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hypothesis”, according to which organizations with favorable reputations will receive the

benefit of doubt from stakeholders when faced with sudden economic or political shocks

(Jones, Jones, and Little, 2000; Bostdorff and Vibbert, 1994). Finally, in the process of

acquiring positive reputation, it is likely that certain values become somewhat

institutionalized within an organization. Consequently, stakeholders may defend the

organization when it is threatened because of its historical contribution, role in the social

fabric of the community, and value as a symbol (Selznick, 1957).

Taken together, subsequent to a reputational crisis, “information that is perceived

to be consistent with existing definitions will not be revisited, because it is perceived as

credible. Organizations with negative reputations will incorporate negative attributes

more readily and those with positive reputations are more apt to resist assimilation of the

stigma” (Fiol and Kovoor-Misra, 1997: 150). Therefore, the influence of a reputational

crisis on an industry participant may be evaluated quite differently by stakeholders

depending upon the organization’s reputation.

Proposition 5: The effects of proximity and structural equivalence on the

likelihood of reputation spillover are weaker when the potential recipient

organization has a positive reputation.

DISCUSSION

In this paper we propose a new theoretical construct—reputation spillover—to

examine the process by which a reputational crisis may spread to others operating in its

industry. Overall our study makes the following contributions. First, it increases our

understanding of reputational crises—a phenomenon that has been significantly

understudied in the literature. Second, we explicitly examine the importance of

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stakeholders in disciplining market patterns. The central argument of our study is that

other organizations may be affected by a focal organization’s reputational crisis, not

necessarily because they have the same “bad genes” as the focal organization, but

because they were perceived structurally equivalent or proximate to the focal

organization by stakeholders.

Our study offers several directions for future research. First, an organization’s

reputation may be multidimensional (Fombrun and Shanley, 1990). Consequently, the

triggering event of a reputational crisis may have different impacts on different

dimensions of an organization’s reputation. For example, differentiating between several

components of reputation (product quality or innovation, management integrity, and

financial soundness) Dollinger, Golden, and Saxton (1997) empirically demonstrated that

when one component of organizational reputation was tarnished, others were not equally

affected. This addresses an intriguing research question, how will rival organizations

decide whether a reputational crisis can spill over to them when the reputational crisis

influences multiple aspects of a focal organization’s reputation? Interestingly as well, will

they react?

Second, empirical research on reputation spillovers can be pursued both

quantitatively and qualitatively. One avenue to trace the occurrence of reputation

spillovers is to use stock market data, which is assumed to reflect investors' expectation

of future cash flows. More specifically, using financial event history analysis, an analyst

can examine how the drop of one organization’s stock due to a reputational crisis affects

the stock prices of other organizations. Researchers can also use well established

measures in the social network analysis such as network distance (the measure of

23

proximity), structural equivalence and network centrality to empirically test our major

propositions (Please see Wasserman and Faust, 1994 or UCINET manual for a detailed

description of these measures). Alternatively, an in depth qualitative analysis of an

observed reputational crisis can also be efficiently used to study reputation spillovers.

Timely and thorough qualitative data may allow the researcher to describe the sequence,

frame the story, depict certain patterns of behavior and descriptively bring context into

account.

Third, we believe it would be interesting to sort out the distribution of

stakeholders’ valuations and to consider how this distribution affects the likelihood of

reputation spillover. In this paper, we assumed that a dominant opinion about the

reputational crisis would emerge among stakeholders. In certain contexts (e.g.,

institutional consolidation), we believe this assumption is reasonable. However,

heterogeneity among stakeholders is prominent in many settings. For instance, it has

been shown that while most financial market participants are exposed to the same

information sources, how they make decisions based on this shared information depends

on their own prior experience (Shiller, 1995). Further, different stakeholders may have

different degrees of separation from industry interests as well (i.e., some stakeholders are

truly impartial, while others may be biased for self-interested reasons by industry

concerns), which might affect how they play out their roles. Thus, for future research, it

is important to analyze to what extent perceptions of stakeholders vary, and how a

diversity of stakeholder perceptions affects the likelihood of reputation spillover.

Practical Implications

24

Our research is directed at providing some practical foundations from which

managers can make decisions when facing reputational crises from one of it rivals. Our

hope is to assist mangers, both reactively and proactively.

Reactively, we add to the crisis management literature by highlighting the

likelihood that any organization is at risk for a negative impact aimed at its reputation

based upon the actions of others in its competitive environment. According to traditional

economics research, when a rival was hurt by a reputational crisis, organizations should

always capitalize on its misfortune and engage in aggressive competitive strategies to

improve their market share. However, this reasoning might not hold true when the

potential for reputation spillover exists. If the likelihood for reputation spillover is high,

actions of any organizations are bounded not only by market-level (i.e., market size,

dominant designs and regulations) and firm-level (i.e., production resources, capacity and

managerial know-how) constraints, but also by the constraints imposed through the

interpretations and reactions of stakeholders as to their perceived relatedness to the focal

organization. Managers should be adept at understanding this risk of being “tarred by the

same brush” and through this awareness be prepared to defend its own reputation. It is

unlikely that a manager can predict with any certainty the crisis implications of a rival

and the spillover potential for themselves. However, having some basic guidelines on

responses should be a priority. It appears critical that organizations understand the

importance of stakeholders and the roles they may play in various industry contexts.

Proactively, we highlighted the concept that managers must not only manage their

own reputation, they must be cognizant of those in their immediate competitive

environment through active screening of that environment. At any given moment, the

25

opportunity might present itself to manage a reputational crisis, not so much of its own

doing but from a rival. To respond managers should have protocols which can be

launched immediately. These protocols should cover various aspects such as marketing

and public relations, legal and technical considerations. Development of those protocols

should be a high priority for any organization, because when reputational spillover

occurs, managers that are prepared to respond will fare considerably better than those

who do not, both in the short and long term.

26

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Figure 1 A Framework of Reputation Spillover

Proximity Structural Equivalence

Network Centrality of the Focal Organization

Network Structure Past Reputation of the Recipient Organization

Likelihood of Reputation Spillover

35

Figure 2 Three Archetypical Network Structures

(a)

(b)

(c)