MANAGERIAL REPUTATION AND CORPORATE-INVESTMENT DECISIONS

This review examines the incentives of managers to use investment choices as a tool for building their personal reputations or the reputation of their firms. These incentives come in three main forms: visibility bias, which encourages a manager to try to make short-term indicators of success look better; resolution reference, which encourages a manager to try to advance the arrival of good news and delay bad news; and mimicry and avoidance, which encourages a manager to take the actions that the best managers are seen to do, and to avoid the actions the worst managers are seen to do. These incentives imply a variety of investment biases. These include: secretly squeezing investment so that short-term cash flows look higher liquidating assets prematurely to reveal that they are worth a lot; undertaking unprofitable investments to try to seem like a firm with good projects available; undertaking investments whose outcomes will be resolved soon, to reveal that you are a good manager undertaking investments whose outcomes will be resolved in the distant future, to conceal the fact that you are a mediocre manager; avoiding profitable projects that have a high fisk of early failure, to protect short-term reputation; hedging on corporate account, to reduce reputational fisk; avoiding marginally profitable new projects, since investors will attribute low profitability to a lack of managerial talent; escalating bad projects, to avoid conceding failure; conforming to the decisions of other managers, to avoid seeming unreliable, or in order to be judged against a comparable benchmark; and deviating from other managers, in order conceal mediocrity. Reputation-building affects the firm's attitude toward risk, what projects it undertakes and terminates, whether it obtains resolution of project outcome early or late, and whether it chooses the same or different projects as industry competitors. Some researchers have developed models of reputation building with implications that seem consistent with recent allegations that U.S. business underinvests, avoids risk excessively, and is too conformist. However, taken as a whole, the theoretical and empirical research on this topic neither substantiates nor disproves these claims. It is possible that reputational concerns lead to the opposite effects: greater investment and less conformity. Many managers may feel that they do not want to implement the policies suggested here, because these policies often involve protection of the manager at the expense of shareholders. For example, a manager may feel that he should undertake a project with positive risk-adjusted NPV, even if the possibility of an early failure could put his reputation in jeopardy. There is an important moral question when the manager's interests are in conflict with that of the shareholders. However, the firm as well as the manager can benefit from a favorable reputation. A favorable firm reputation benefits shareholders who need to sell their shares, and can allow the firm to raise capital more cheaply. Thus, even a manager who puts current shareholders' interests before his own has reason to consider the effects of his investment choices on his firm's reputation. The sheer variety of possible ways of manipulating investment choices to influence reputation may seem bewildering. However, there is a simple way of evaluating the effect of a visible action on the firm's short-term reputation: watch the firm's stock price. Actions that are, on average, associated with rises in stock prices (such as divestitures, and increases in capital expenditures, advertising, and R&D) tend to improve the firm's reputation. Actions that are, on average, associated with decreases in stock prices (such as diversifying acquisitions) tend to reduce the firm's reputation. Of course, it would be foolish to design the firm's investment strategy solely to look good to the market in the short-run. Sometimes strategies that are unpopular in the long-run turn out to be the best. But at a minimum, a manager should be aware of how different investment choices will affect investors' perceptions of himself and his firm.