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How to recover from a scandal

Datum:02 februari 2022
Sunset pollution
Sunset pollution

When a firm is publicly accused of illegal or unethical behavior, it threatens the firm’s reputation. Loss of reputation jeopardizes stakeholder support, impedes access to vital resources, and hurts stock prices. The stock of Volkswagen, for instance, dropped by over 30 percent in just a few days after the 2015 emission scandal hit the news. Sales of VW in the US that month dropped by 25 percent. The question is how can firms rehabilitate post scandal?

Research suggests replacing organizational leadership. Replacing a tainted leader with an outsider not linked to the firm is a costly corrective action that installs a watchdog— an individual not committed to the current management team. Yet, the labor market for talented leaders is extremely tight. Finding an outsider with the required credentials may thus be difficult. VW, for instance, replaced CEO Martin Winterkorn with the CEO of Porsche —a subsidiary of VW— in an effort to repair their public image. After the appointment, skepticism started growing about the actual determination of VW to substantively change. Critics argued that the new CEO had a very similar background and questioned the claimed extent of reform.

Regaining the trust of the public may not necessitate such grand one-off corrective actions. In an ongoing research project, we develop and empirically test for the orchestration of multiple corrective actions over time. We view rehabilitation as a process in which firms orchestrate multiple actions over time to form a compelling story of reform. We show that even actions that are relatively cheap and easy to implement —and ineffective when implemented in solitary— can be effective when combined and properly orchestrated. 

Our results show that orchestrating the response does not just involve selecting and implementing the appropriate actions. It also involves effectively sequencing and timing them. Specifically, we show that successful rehabilitation requires firms to first restore its damaged credibility. One way is by establishing ties to organizations with a high moral image and social approval, contra that of the scandal. For example, following an environmental scandal, firms may establish ties with an organization such as the Environmental Defense Fund. This creates the impression that the firm is willing to change. Yet, it merely introduces a possible agent of change. It is therefore important to subsequently communicate to the public the improvements made following the established tie. This to suggest that the new tie indeed led to improvements within the firm that will prevent the scandal from reoccurring. Key here is to leave sufficient time between estabishing a tie and claiming improvements for the public to perceive change to have been implemented. By first creating the expectation of change and after sufficient time for change to have been implemented claim that the undesirable behavior has indeed been corrected, firms can successfully regain lost reputation. However, when firms claim improvements before establishing such a tie, we find that the public perceives these claims as insincere. This may even lead to accusations of hypocrisy, further damaging the firm’s reputation.

With these insights, we caution regulators, investors, and watchdog organizations of the possibly misleading persuasiveness of reform efforts some firms may tell. Our data shows that while orchestrating corrective actions over time helps firms regain lost reputation, it does not necessarily lead to substantive changes within the firm. The claims made may not be implemented at all or to a lesser extent than claimed. Thus, while an orchestrated set of actions creates a compelling story of reform, in reality this may not be the case. 

Author: Guido Berends -