Business and human rights : human rights violations and the impact on firm’s reputation and financial performance

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Business and Human Rights:

Human rights violations and the impact on firm’s reputation

and financial performance

“A pretty face can’t hide the ugly truth”

MSc. Business Administration – Strategy University of Amsterdam

Name: Renée Paulina Adriana Corstens Student number: 10587985

First supervisor: Dr. M.K. Westermann-Behaylo Second supervisor: Arno Kourula Date: 12 January 2015

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Abstract

This exploratory and explanatory research examined the relationship between human rights violations, on the one hand, and firm’s reputation and financial performance, on the other hand. Moreover, this study considered how media attention and a corporate response impact firm’s reputation. A within-case analysis was used to understand the story of each specific instance of human rights violation, followed by a cross-case analysis to look for correlations in the cases. The main finding of the study is that the apparel industry, as compared to the oil and gas industry, might be more subject to potential reputational damage. This can probably be due to industry type, geographical differences, and media attention. Furthermore, the tone of media attention might be negatively directed towards a firm’s responsibility, but could be taken positively by a corporate response. Therefore, the present research supports the importance of a corporate response. While this study did not find support for the negative impact of human rights violations on financial performance, it nevertheless provided insights to further test the emerging theory in future quantitative studies. In addition, the findings provide valuable insights for managers to incorporate human rights due diligence into their strategic decision making.

Key words: Human rights violations, Reputation, Media attention, Corporate response , Financial performance and Globalization

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1. Introduction

In 2008, the lives of 69.000 people in Bodo, a town in the Niger Delta, were disrupted by two enormous oils spills by the oil company Shell (O'Gorman, 2013). Both spills lasted for a number of weeks before they were stopped and dealt with. Six years later, the major impact of Shells failure is still visible, especially in the fishing industry. Other global issues of today are, for instance, the poor working conditions in the apparel industry. Frequently, unless a tragedy occurs, little to nothing is done to persuade the public to defend the rights of the workers. Last year, hundreds of people died as a result of a fire in a fabric factory in Bangladesh (Burke, 2013).

The most worrying and grievous part of it is that the above scenarios are only some examples of indeed numerous stories where firms are causing harm to human rights. Ruggie (2008) argues that the roots of this predicament between business and human rights lie in globalization, as globalization created a governance gap between the scope and impact of economic forces and actors, on the one hand, and the ability of societies to manage the adverse consequences, on the other hand (Ruggie, 2008). Moreover, some developing countries lack the capacity to enforce national laws and regulations against transnational firms that are doing business in their country (Ruggie, 2008). Therefore, today’s challenge is to implement human rights’ responsibilities in everyday activities of businesses across industries through an appropriate management process (Leisinger, 2006).

Although the attention to human rights as a business issue has recently increased (Hamann, Sinhia, Kapfudzaruwa & Schild, 2009), it is only since the 90s that it has been incorporated into the international agenda (Ruggie, 2013). In 1998, the UN sub-commission on promotion and protection of human rights was established, which resulted in formulation of the Guiding Principles from UNHRC (2011) (Ruggie, 2007). These principles encourage firms to engage in human rights due diligence as a means of taking their responsibility more seriously (Ruggie, 2013). Basically, due diligence refers to the process whereby firms both ensure compliance with national laws and manage the risk of committing human rights violations (Ruggie, 2013). The framework is based on three core principles: the state duty to protect human rights violations by third parties including business; the corporate responsibility to respect human rights; and the need for more effective access to remedies

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(Ruggie, 2008).

However, these principles are not only a framework for voluntary corporate citizenship (Hamann et al., 2009), as the national and international law sector for human rights issues has also become more applicable to private sector firms (Hamann et al., 2009). As a result, human rights as a business issue become more important for firms, both from a moral and legal perspective. However, do firms nowadays respect human rights from a moral and legal point and what are the risks of non-compliance, for instance, for a firm’s reputation? While extensive research is available on the importance of positive reputation, the literature on reputation risk is scarce (Suomi & Järvinen, 2013). As positive reputation possesses the characteristics of intangible assets (Rose & Thomsen, 2004), it can therefore become a source of competitive advantage. For example, when a consumer buys an iPhone, the buyer not only pays for the product itself, but also for the brand. This reflects the monetary value of reputation. From the above, it can be concluded that it is crucial for managers to focus on keeping positive reputation closely associated with the firm (Keh & Xie, 2009). Thus, it is interesting to investigate the impact of reputational damaging events (Zyglidopoulos, 2001) and strategies to reduce this negative impact by, for example, corporate responses. Previous research indicates that acceptance of responsibility is the best response strategy when a firm is facing a crisis (Bradford & Garrett, 1995). Furthermore, Cuesta, Valor and Holgado (2012) state that reputation management is a powerful driver to incorporate human rights in the agenda, as the drivers for a better management are oftentime external.

Based on the assumption that customers esteem socially responsible firms (Levy, 1999), it could be argued that customers are less willing to buy from firms that behave in a socially and environmentally irresponsible way. As aptly phrased by Warren Buffet in his famous quote: “It takes 20 years to build a reputation and five minutes to ruin it”. Basically, this implies that negative publicity can damage reputation. This effect is due to the tendency of negative publicity to outweigh positive publicity in a customer's opinion (Mizerski, 1982). Furthermore, as the media like to report bad, rather than good news (Dennis & Merill, 1996), firms are more likely to receive negative media coverage. However, less is currently known about how consumers react to negative publicity (Aluwalia, Burnkrant & Unnava, 2000). Thus, the question is: if customers know from the media that the clothes they purchase are made in Bangladesh and that there are possible fatalities among the individual producers as a result of bad working conditions, why do customers still buy these clothes? How dramatic are

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indeed the effects of negative publicity?

To address the gap between the scarce body of literature about business and human rights and the effects of damaging events on reputation and financial performance, the present study will examine whether human rights violations are drivers for a firm’s reputation and financial performance. Therefore, this research will seek to provide an answer to the following research question:

How are human rights violations related to reputation and financial performance of oil, gas industry, and apparel industries of Africa and South America?

This paper will first review the literature regarding human rights as a business issue, reputation, media attention, corporate response and financial performance. Next, a conceptual model is introduced, which summarizes the theoretical propositions. The research methodology and analysis will be discussed next, followed by the discussion as well as the conclusion.

2. Literature review

2.1 Major concepts

Human rights refer to the “the fundamental freedoms of people to which all human beings are equally entitled” (Cragg, 2012, p. 5). Until recently, the promotion and protection of these rights have been seen as a responsibility of the state (Cragg, 2012). However, there is an ongoing debate regarding human rights as a business issue. The following section explains the developments and shifts regarding human rights as a business issue.

Human rights as a business issue

Since the 90s of the twentieth century, the attention regarding business and human rights has been rising (Ruggie, 2013). Some experts link this tendency to globalization (Ratner, 2001), which is forced by for instance the increased number of transnational corporations in developing countries (Shinsato, 2005). Some of these corporations have eroded the power of the state (Ratner, 2001). While, on the one hand, transnational corporations can stimulate growth in developing countries by creating jobs (Halabi, 1997), on the other hand, globalization can negatively impact societies through environmental abuse and human rights violations (Shinsato, 2005). For instance, transnational corporations have increased the rate of man-made environmental abuse and the attendant effects such as harm to human life

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(Shinsato, 2005), especially in the extractive and apparel industry (Ruggie, 2007). This can possible be due to the resource- and efficiency-seeking motives of firms that are operating in developing countries (Dunning, 1988). Furthermore, globalization has forced, for instance, the technologies in telecommunication, which makes it possible to show the world the deplorable working conditions of people in developing countries (Ratner, 2001).

Considering the developments outlined above, the discussion has emerged about the responsibilities of firms for respecting human rights. The question whether firms have this responsibility is the topic of a challenging and contested debate (Cragg, 2012). For instance, Cragg (2012) emphasizes three models to address these issues: the Legal Model, the Self- Regulatory Model, and the Drafts Norms Model. The first model states that firms have no morally-grounded human rights responsibilities beyond those set out by law in the country of their operation (Cragg, 2012). In other words, the obligation to respect human rights derives from the law and firms have to obey those laws (Cragg, 2012). Thus, it is the responsibility of the state to promote human rights and control non-compliance. This contention is in line with Muchlinkski (2001) who describes this view as the “the very foundation of human rights thinking” (p.32). However, the Legal Model has its limitations. As stated above, one of the consequences of globalization is an increase in transnational corporations in developing countries, where some of these corporations have eroded the power of the state. Cragg (2012) describes this as the increase in the so-called ‘government-like’ power of transnational corporations. More specifically, transnational corporations gained power to control conditions under which products and services are produced and distributed (Cragg, 2012). Consequently, the power of the government moved partially to the transnational firms. Therefore, Cragg (2012) introduces the second model: the Self-Regulatory Model. This model implies that human rights violations are voluntary and self-assigned. In fact, it means that transnational corporations have the right to choose their own human rights standards that fit their own conduct. Obviously, this view contradicts the fundamental and universal definition of human rights, since human rights are not voluntary.

The Drafts Norm Model has emerged as a response to the weaknesses of the first two models. Therefore, the intention of the third model is to understand both the scope and nature of human rights responsibilities of transnational firms and the state. While, on the one hand, it implicates that laws are an effective tool to ensure that firms seriously take their responsibility seriously, on the other hand, it takes into account that the government-like power of today’s firms have increased. However, it needs to be taken into consideration that the role of firms is

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to serve private, rather than public interests (Cragg, 2012). Despite the increase of this government-like power of firms, it differs from the power of governments (Cragg, 2012). Therefore, the idea behind the third model is that firms have a government-like role by giving priority to public interests in all aspects of their activities (Cragg, 2012).

Concerning the difficulties regarding firms’ responsibility and effects of globalization, in 2005, the UN assigned John Ruggie as a Special Representative of the Secretary General, which led to the formulation of the UN “Guiding Principles on Business and Human Rights” (2011) where obligations for firms are described to involve policies and procedures to protect and respect human rights due diligence (Ruggie, 2007). This concept highlights the steps that a firm needs to take to become aware of, prevent, and address negative human rights impact (Ruggie, 2007). This relates to the moral obligation to respect human rights as specified in the third model of Cragg (2012).

In addition to the question of the legal and moral obligation to respect human rights, the issue can also be approached from a motivational perspective. Cuesta and co-authors (2012) state that, in most studies, human rights issues are approached from a legal point, rather than from a managerial perspective. Furthermore, the authors argue that the motivation to comply with human rights needs to be bigger than the economic motivation alone. Waddock, Bodwell and Leigh (2007) argue that firms are still in the ‘inspiration stage’ of implementation of human practices in their management systems. More specifically, while firms have made formal commitments to comply with human rights, they have not processed a management system to ensure their compliance yet. However, relevant literature highlights several stories about firms that have incorporated human rights in their managerial practices after bad publicity (Graafland, 2004). For instance, after negative publicity about their business activities in Nigeria, Shell has changed their strategy. Specifically, Shell has re-conceptualized their strategy from a closed into an open organization that uses all kinds of instruments to repair the damaged relationship with the society. Currently, Shell is a leading firm in business ethics (Graafland, 2004). However, the motivator for Shell to change their strategy needs be taken into consideration. Therefore, the question remains whether the effectiveness of due diligence is dependent upon moral commitments (Fasteling and Demuijnck, 2013) or whether it is stimulated by external hazards, like, for example, reputational (Cuesta et al., 2012) and financial declines.

Basically, the economic motives to respect human rights can be approached from different perspectives. Traditional economic thinking assumes that the aim of managers is to

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maximize the value for shareholders (Friedman, 1962). Therefore, traditional financial logic assumes that social responsible activities are inconsistent with the above aim (Macke, Mackey and Barney, 2007). Moreover, traditional economic logic relates to the Legal Model of Cragg (2012). While the role of managers is to create as much value as possible, the role of the government is to protect human rights and to make sure firms obey the laws.

Conversely, there are business and society scholars that argue that firms have an obligation to society that go beyond value maximization (Mackey et al., 2007), which refers to the concept of due diligence. Mackey and co-authors (2007) illustrate the above contradiction from an interesting perspective. The authors distinguish between the so-called ‘profit-maximizing ethics’ (Windsor, 2001), which refers to the actions with a positive impact on a firm’s cash flow and the so-called ‘costly philanthropy’ (Windsor, 2001), which contains firms that engage in socially responsible activities, even if those activities reduce the present value of a firm. The model of Mackey and co-authors (2007) builds on the latter perspective and states that shareholders sometimes have interest beyond maximizing their firm’s value. This relates to the Drafts Norm Model, since this entails that firms have to place public interests above its own interests (Cragg, 2012).

In view of the above, the obligation to respect human rights can be approached from a both moral or a legal perspective. However, the added value for a firm to respect human rights can be both addressed from an economic or moral point of view. That is, is the motivator to respect human rights more dependent upon external risks rather than on moral commitment? To explore the effects of human rights violations on a firm’s reputation and financial performance, this study starts with an overview of the major constructs, followed by the underlying relations.

Human rights violations as incidents

This study investigates the potential damage of human rights violations on a firm’s reputation and financial performance. Two types of human rights violations will be further explored: environmental abuse and labor violations. Environmental abuse refers to, for example, water contamination or the destruction of natural resources. Labor violations include, for instance, child labor and discrimination (see Appendix A for further detail). Both types of actions are seen as human rights violations, as they damage in some way the ‘rights’ of people. In this domain, Poe and Tate (1994) differentiate between social rights, political rights, integrity of the person, and economic rights. Kinley and Tadaki (2003) describe human rights violations as follows: “corporate activities that affect human rights including in areas as criminal law,

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anti-discrimination, health and safety at work, environmental protection, and labor rights” (p. 935). Therefore, environmental and labor violations are seen as human rights violations. Prior research yielded contradictory results, since damage to environment causes a reputational decline, while damage to human life does not (Zyglidopolous, 2001). Therefore, it is interesting to consider both types of human rights violations.

Human rights violations are seen as events in which a group of individuals accuses a particular firm of a human rights violation (CHRD, 2013). There are a number of events that can cause reputational damage, such as, for instance, accidents, scandals, and product safety (Marcs & Goodman, 1991). Accordingly, human rights violations are comparable to accidents. For instance, Zyglidopoulos (2001) investigates the impact of accidents on a firm’s reputation. The author uses the following definition for damaging events: “discrete one-time undesirable or unfortunate events that happen unexpectedly in the life of a corporation and cause damage to any number or kind of stakeholders” (p. 420). According to Zyglidopoulos (2001), human rights violations are seen as accidents, since they involve discrete and damaging events causing harm to a specific group of victims. However, in this study, not all human rights violations are one-time events or happened unexpectedly. In relating research about business and human rights, human rights violations were classified as ‘incidents’ (see, e.g., Kaeb, 2008; Ratner, 2001). Therefore, in this research, human rights violations are

defined as human rights incidents. Zyglidopouls (2001) points out that while accidents can vary considerably, they

nevertheless share many common characteristics. This research used these characteristics to investigate the impact of human rights violations. The common characteristics include: accident severity (from now on incident severity), firms responsibility, complexity, and media attention (Marcys & Goodman, 1991; Perrow, 1984, Schrivastava, 1987). Unlike Zyglidopoulos (2001), this research will distinguish characteristics that can be specifically applied to the incident and to the impact of media attention. Hence, this study uses incident severity, company responsibility, and complexity for describing the human rights violation.

First, incident severity refers to the extent of the ‘damage’ caused by a particular event. Zyglidopoulos (2001) distinguishes two kinds of damage, namely, environmental damage and damage to human life. The former refers to harm to the environment, such as natural resources, the ecosystem, or the wildlife. The latter is about the people who were killed or injured as a result of an incident. Moreover, the extent of the incident is measured as physical abuse, which refers to the amount of people that were killed or injured as a

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consequence of the alleged allegation.

Second, responsibility refers to the responsibility that a particular stakeholder group can assign to a firm involved in a particular incident. The extent of the responsibility depends on the nature of the event and the bias of the particular stakeholders who have been impacted by the actions of the firm (Zyglidopoulos, 2001). A firm’s responsibility is inversely related to plausible deniability (Zyglidopoulos, 2001). This indicates the extent to which a firm can deny its responsibility.

Third, complexity refers to how easily the events that led to an incident are understood. This parameter varies considerably, as, for some incidents, it is relatively easy to figure out what has happened, whereas, in other cases, such estimation is very difficult.

Reputation

There is debate in the literature about definitions of corporate reputation. Brammer & Pavelin (2006, p. 436) use the definition of Fombrun & Shanley (1990), according to which reputation is defined as “a perceptual representation of a firms past actions and future prospects that describes the firm’s overall appeal to all its key constituents when compared to other leading rival’s, reflecting reputation as an organizational attribute associated with stakeholders’ perception of the firm” (p. 72).

Moreover, a more recent model called The Reputation Quotient (RQ) (Fombrun, Gardberg & Sever, 2000) is based on the concept of social expectations, as it takes into account the stakeholders’ expectations about the behavior of firms (Berens & Riel, 2004). Other concepts include corporate personality, which means the personality traits attributed to firms and trust, which refers to the perception of a firm’s reliability, honesty, and benevolence (Berens & Riel, 2004). The RQ-model illustrates the multifaceted nature of reputation (Rhee & Valdez, 2009) and consists of six central dimensions of corporate reputation, namely: emotional appeal, products and services, financial performance, vision and leadership, workplace environment, and social responsibility. These dimensions affect stakeholders’ behavior and the firm’s earnings and such effects vary across dimensions (Rhee & Valdez, 2009).

The RQ model relates to the concept of multidimensionality (Zyglidopoulos, 2001), meaning that a firm could be known as a good or bad performer on a number of issues, such as a reputation for innovation, social responsibility, or excellent quality. While, with regard to all of these issues, someone can judge the reputation as good or bad, in reality, however, one would be referring to different dimensions of reputation (Zyglidopoulos, 2001). According to

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the findings from Zyglidopoulos (2001) and the RQ model, it is possible for a firm to have a positive reputation for the quality of its products and a negative one for environmental pollution (Rhee & Valdez, 2009).

Media attention

Previous research highlights the relationship between media attention and reputation (Fombrun & Shanley, 1990; Wartick, 1992; Weinberger & Romeo, 1989). Therefore, this research used the construct of media attention as a moderator between human rights violations and reputation. According to this research, media attention refers to the tone (positive/negative/neutral/mixed), amount and extent of prestige of a broadcaster of publicity that a particular incident receives (Zyglidopoulos, 2001). Newspapers, articles, television, magazines, and radio broadcasts are examples of media publicity.

Corporate response

Prior empirical research used diverse criteria for the categorization of corporate responses (Dutta & Pullig, 2011). For instance, Dawar and Pillutla (2001) consider a firm’s response along the continuum of unambiguous support and unambiguous stonewalling. However, the authors did not specify the intermediate responses. Many empirical studies used a derivation of the response types of Benoit (1997), which are clear types of corporate responses and are easy to apply for managers. Benoit (1997) distinguishes the following main types: denial, evasion of responsibility, reducing offensiveness of event, and corrective action. These are comparable to the types that Bradford and Garret (1997) use in their study on the effective communicative responses: no response, denial, excuses, justification, and concessions. Meznar and Nigh (1995) reduce these types of responses to two: firms can use a ‘bridge’ approach, by accepting their responsibility and trying to solve the problems or, alternatively, firms can use a ‘buffer’ approach, i.e. try to distance themselves from any kind of responsibility and blame. A different terminology is used by Marcsus & Goodman (1991) who propose that firms can send accommodative or defensive signals to their stakeholders. For example, Coolcat (a retail company) has recently signed an accord for fire and building safety in Bangladesh (Volskrant, 2013). Therefore, as the company shows attendant signals to its stakeholders, Coolcat is said to use a ‘bridge approach’ (Marcus & Goodman, 1991).

The above example illustrates that Coolcat is willing to respect labor rights. The incorporation of a corporate response into this research is likely to provide insights whether firms give priority to public interests for their business activities and about their moral

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commitments to respect human rights. This study will thus consider whether firms show accommodative or defensive signals to their stakeholders.

Financial performance

Financial performance is variously defined in available literature. Relevant studies make a distinction between economic profit and accounting profit (Besanko, David & Shanley, 2000). This roughly captures the idea that the costs that appear in accounting statements are not necessarily appropriate for decision making inside a firm. Business decisions require measurement of economic costs that are based on the concept of opportunity costs. This means that the economic cost of deploying resources into a particular activity is the value of the best forgone alternative of those resources (Besanko, et al., 2000).

Another starting point is to look from different perspectives on the reasons of firms’ exist. On the one hand, the shareholders’ view claims that firms should maximize value for the shareholder (Friedman, 1962). In contrast to this view, Freeman (1994) argues that a firm should balance stakeholder and firms interests. A definition of performance could be that the managers should maximize the market value for the firm (Mackey et al., 2007). Market value is defined as the price of a firm’s equity multiplied by the number of its shares outstanding (Mackey et al., 2007). According to this definition, it could be mentioned that the manager’s role is to create as much value for the firm as possible.

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2.2 Relations

Human rights violations and reputation

A major assumption of the present study is that human rights violations, such as environment or health and safety issues, negatively influence a firm’s reputation. There are reasons underlying this assumption (Zyglidopoulos, 2001). First, the evaluators of firm’s reputation can react emotionally to the events in which firms, possible responsible for the particular event, are involved (Zyglidopoulos, 2001). For instance, one of the largest oil spills, Exxon-Valdez in 1989, had disastrous consequences for the nature and fishing industry (newsdossier, 2006). Nowadays, this disaster is still mentioned in many articles as one of the biggest oil disasters, which shows the potential of events to damage a firm’s reputation in the long term.

Second, events usually trigger an investigation of the causes of an event (Zyglidopoulos, 2001). Consequently, under the pressure of publicity, firms need to open their business operations to show their day-to-day activities. While this does not look particularly harmful in the first place, it nevertheless sheds light on the daily operations and irregularities of a firm (Zyglidopoulos, 2001). According to a post-accident point of view, this can be quite damaging for a firm’s reputation (Perrow, 1984). For example, the collapse of the fabric in Bangladesh in 2013 highlighted the horrible working conditions and irregularities (Trouw, 2014). Therefore, the BAF (Bangladesh Accord Foundation) will inspect 250 factories every month (Trouw, 2014), increasing this the worldwide concern about bad labor circumstances.

As defined in the previous section, incident severity, responsibility, and complexity are common characteristics of human rights incidents. Although it is known that every event is unique and might have unique effects, the common characteristics provide a good base for comparison. Therefore, these outcomes are used for the emerging theory. It is obvious that the greater the incident severity, the larger the damage for environment and/or humans. Consequently, the event might receive more (emotional) attention of potentially influential stakeholders (Zyglidopoulos & Phillips, 1998b), which could weaken a firm’s reputation. Additionally, incident severity can cause commotion in the supply chain as well. For instance, the collapse in Bangladesh showed deplorable working conditions of suppliers of big brands like Primark and H&M. A disturbance in the network might also have a negative influence on a firm’s reputation (Zyglidopoulos, 2001) and this sheds light on the daily activities and irregularities of a supplier.

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Conversely, Zyglidopoulos (2001) suggests that damage to the environment has a negative impact to reputation, while damage to human life has not. The negative role of environmental damage is also emphasized by Cohen (1991) who states that consumers will boycott, for reasons such as a firm’s bad environmental record. In addition, the case of Nike, a footwear company, provide empirical evidence that damage to human life does hurt a firm’s reputation. In 1997, the firm was the subject of critical media attention as a result of two commissioned reports that looked into the poor working conditions in Nike’s contract factories (Knight & Greenberg, 2002). These unfavorable labor conditions included low wages and long working hours. Nowadays, Nike still continues to fight back against possible attacks on its reputation (Smith, 2003). Considering this empirical evidence, it is interesting to see the difference in impact regarding damage to environment and/or human life. These findings lead us to formulate the following theoretical propositions:

Proposition 1: Incident severity with respect to environmental damage would negatively impact a firm’s reputation.

Proposition 2: Incident severity, with respect to damage to human life would negatively impact a firm’s reputation.

The second event characteristic refers to responsibility. It is obvious that events differ in the degree of responsibility. This relates to the sphere of influence mentioned by Leisinger (2006) who indicates whether firms can exert direct influence to the human rights violation. This study defines direct responsibility when the alleged allegation is committed by the firm itself and an indirect responsibility when another player in the value chain has committed an abuse allegation. However, both types of responsibilities might have an influence, since the sphere of influence extends beyond factory side (Leisinger, 2006). Hence, it can be assumed that the greater the responsibility that can be attributed to a firm, the greater the reputational damage. This underpins the following theoretical proposition:

Proposition 3: Both direct and indirect types of responsibility for an event are likely to weaken the reputation of a firm.

The third characteristic is complexity, which refers to how easy it is to trace the cause of an event. According to Marcus and Goodman (1991), the greater the complexity of an event, the easier it is for firms or persons to deny abuse allegations. Said differently, the

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greater the complexity of an event, the greater the benefit of the doubt for a firm or person (Zyglidopoloulos, 2001).

In case of complex situations, prior reputation of a firm could give the benefit of the doubt (Zyglidopoulos, 2001). Firms with positive prior reputation will tend to suffer less from reputational loss during a reputational crisis (Zyglidopoulos & Phillips, 2005). This relates to the Halo effect (Coombs & Holladay, 2006), which suggests that prior reputation might function as a shield protecting a firm from potential damage. This effect also works in the opposite direction for firms with a negative history. This effect, the Velcro effect, refers to the tendency for negative labels to stick to a firm due to a preceding negative history (Coombs & Holladay, 2006). Consequently, if the same incident was committed, a firm labeled under the Velcro effect will face a much greater reputational loss than a firm labeled with a Halo effect. The impact of a firm’s prior reputation is interesting to test in future research. The aspects discussed above lead us to formulate the following proposition:

Proposition 4: It is expected that less complex events will cause more reputational damage

compared to the events of greater complexity.

Media attention as a moderator between human rights violations and reputation

During a damaging event, firms have to deal with mass media (Rhee & Valdez, 2009). However, there is no consensus in the literature regarding the specific factors underlying this impact. The tone (positive/neutral/negative/mixed), amount and broadcaster are commonly used, since these factors can seriously alter the content of an event (Brammer & Pavelin, 2006) and the amount of people that are reached by the news (Rhee & Valdez, 2006). For instance, Weinberger and Romeo (1989) state that negative media attention has a negative impact on corporate reputation. This is due to the tendency that negative publicity outweighs positive publicity in a customer’s evaluation (Mizerski, 1982). Furthermore, the media prefers to report bad, rather than good news (Dennis & Merill, 1996). Therefore, firms are more likely to receive negative media coverage. However, less is currently known about how consumers react to negative publicity (Aluwalia, Burnkrant & Unnava, 2000). To get an insight into the impact of media attention regarding human rights violations on reputation, this study distinguishes negative publicity about the firm and industry. Additionally, Fombrun and Shanley (1990) find that all tones of media attention damage firms’ reputation; therefore, the amount of media attention can make a difference. However, the latter finding is not supported statistically (Wartick, 1992).

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Furthermore, the type of a news organization that publishes the human rights incident has an influence on a firm’s reputation (Rhee & Valdez, 2009). These authors state that when a more prestigious media organization publishes the damaging event, more public get informed about the event; consequently, more damage is brought to a firm’s reputation.

Proposition 5: Instances of environmental abuse or labor violations that received a prevailingly negative media attention are likely to have a negative effect on reputation. Proposition 6: Instances of environmental abuse or labor violations that received more media attention are likely to have a negative effect on reputation.

Proposition 7: Instances of environmental abuse or labor violations that received negative media attention regarding the entire industry are likely to have a damaging impact on other firms operating in the same industry.

Proposition 8: Instances of environmental abuse or labor violations that received media attention and were widely covered in leading news articles are likely to have a negative effect on reputation.

Corporate response as a moderator between human rights violations and reputation

In much scholarly research a corporate response appears to be crucial for reputational repair when firms are facing a crisis situation (Rhee & Valdez, 2009). Therefore, the question emerges whether a corporate response can weaken the negative impact of human rights incidents on a firm’s reputation. As defined in the previous section, there are many possible response types possible; however, there are two dimensions in which response strategies vary (Dutta & Pullig, 2011), namely: 1) the explanation about the crisis and 2) whether a firm ensures prevention of the crisis. The first dimension is likely to be crucial for a successful response. For instance, a denial of allegation can leave many questions unanswered and so cause misunderstandings that could probably weaken a firm’s reputation. Thus, a corporate response containing a high level of explanation could be seen as a firm that sends accommodative signals to its stakeholders. Dutta and Pullig (2011) propose that the assurance of prevention of a crisis largely depends on the type of the crisis. For example, a production firm can ‘justify’ its defects by saying that this is due to the fact that they are the first firm using this kind of technology, which caused these defects. If customers accept this strategy, it could probably weaken the damaging impact on a firm’s reputation. When relating this dimension to human rights violations, it could be argued that a firm that tries to prevent

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repetition is sending accommodative signals to its stakeholders.

In their investigation of the best corporate response to a crisis event, Bradford and Garrett (1995) found out that acceptance of responsibility is the best optimal communication strategy. Their research involves also other factors, such as customer expectations about the firm and consumer commitment to a brand, since this can influence the effectiveness of a communication strategy (Bradfort & Garrett, 1995). However, those factors are outside of the scope for the present research. Furthermore, Zyglidopoulos and Iqtidar (1998) suggest that the impact of damaging events for a firm’s reputation is reduced by accommodative signals which indicate an acceptance strategy as well. The above leads to formulate the following proposition:

Proposition 9: The corporate response, which includes accommodative signals, would reduce the negative impact for a firm’s reputation.

In addition to response, organizational age and industry type can also have an influence in the reputational repair of a firm (Rhee & Valdez, 2009). Previous research suggests that time is needed to build trust between organizations and environments (Perrow, 1986; Stinchcombe, 1965). According to the liability-of-newness theory of Hannah and Freeman (1984), older organizations have a benefit over younger organizations, since they have ‘accountability’ and ‘reliability’. This relates to the influence of a prior reputation of a firm, since the ‘Halo’ effect can reduce the negative impact of a damaging event. However, organizational age can also have a backside, as stakeholders have higher expectations of older organizations (Rhee & Valdez, 2009) and unexpected behavior will cause strong reactions from the media (Rhee & Valdez, 2009).

In addition, the industry can be distinguished as the amount of segments served by a firm, separated by distinct product attributes or specific customers’ demands (Rhee & Valdez, 2009). According to Rhee and Valdez (2009), specialists will be more legitimate and valued higher by the market audience than generalists. In other words, firms that serve specific market segments have an advantage over firms that serve a broader part of the market with regard to the ease of reputational repair (Rhee & Valdez, 2009). Thus, prior reputation and organizational age are not used as separate measures in the present study. However, it is interesting to consider the differences between apparel, oil, and gas industries.

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Human rights violations and financial performance

Over the last few years, firms have become more aware of the commercial and social risks regarding human rights violations (Muchlinski, 2012). For instance, the Bhopal disaster cost Carbide at least $270 million (Muchlinkski, 2012). This indicates that non-compliance with human rights results in at least financial damage. However, while the body of scholarly research on the effects of human rights violations is limited, there is some literature on the importance of social responsible activities. Mackey and co-authors (2007) point out that there is a positive relation between the strategic choices of firms to invest in social responsible activities and these firms’ market value. Therefore, it can be suggested that the damage of social responsible activities might be expensive.

The following case of Shell is used to look at empirical evidence to assume that environmental abuse impacts financial performance. Shell has been accused of being complacent in several areas of human rights procedures in Nigeria (Wheeler, Fabig & Boele, 2002). As a consequence, worldwide boycotts and sabotage attacks were arranged, which resulted in a reputational loss, disinvestment, and an associated fall in share price (Wheeler et al., 2002). Accordingly, it can be assumed that environmental abuse definitely results in performance loss.

Alongside with the possible damaging effect of bad labor circumstances on reputation, the conditions of employees are affected as well. Since good employee practices make employees more committed (Shen & Zhu, 2011), the risk of turnover and absenteeism is reduced. Another example of good employee practices is that improved employee satisfaction and equal salary systems help employees climb up an organization’s hierarchy ladder (Shen & Zu, 2011). These practices could result in more motivated employees, lower turnover, and improvements in product and process quality. All these outcomes contribute to financial performance.

However, many organizations today are still involved in irresponsible employee practices, which could have detrimental consequences. For example, an NGO report stated: “labor conditions in suppliers of Adidas were far from satisfactory with weekly working hours exceeding the legal limit by 150% on average, employees beaten up by security guards and deaths caused by heat stroke” (China labor Watch, 2010, p.; Lee, Lau & Cheng, 2013, p. 1861). Accordingly, it could be assumed that labor violations have a negative effect on the motivation and commitment of employees, which would result in a less efficient financial performance. Thus, the following two propositions can be formulated:

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Proposition 10: Environmental abuse is likely to have a negative effect on financial performance.

Proposition 11: Labor violations are likely to have a negative effect on financial performance.

Reputation and financial performance

The importance of a positive reputation is frequently described in the literature. For example, a positive reputation could lower the transaction costs of a firm (Rose & Thomsen, 2004). The Transaction Cost Theory (TCT) argues that a firm should select the governance form that minimizes costs. Costs are defined as the expenses associated to negotiating and writing contracts and those related to monitoring and enforcing contractual performance (Williamson, 1979). When employees and suppliers trust a firm, a good reputation could save these costs. Therefore, a favorable reputation benefits a firm, because the firm becomes more attractive to employees, customers, suppliers, and investors.

Furthermore, reputation shows characteristics of intangible assets (Rose & Thomsen, 2004). According to the Resource Based View (RBV), reputation could be seen as an important strategic asset (Dierickx & Cool, 1989). It also meets the RBV criteria of Barney (1995): a resource must be valuable, rare, inimitable, and non-substitutable. Peteraf and Bergen (2003) argue that reputation could be seen as an ex-post limit to competition, because it is imperfectly mobile and non-substitutable. According to these characteristics, reputation is a resource that is difficult to replicate for competitors, which could lead to a possible source of competitive advantage and superior returns.

From the advantages outlined above, it can be concluded that there is a positive relation between reputation and financial performance, which has also been attested in empirical research (Roberts & Dowling, 2002). Furthermore, Robert and Dowling (2002) show that firms with a relatively good reputation are able to sustain superior profit outcomes over time. In view of the above, it can be assumed that a good reputation improves financial performance of a firm. Moreover, the relation between reputation and performance also holds true in the opposite direction (McGuire, Schneeweis & Branch, 1990); therefore, a good financial performance could influence the reputation positively as well. While this relation is outside of the scope for the present study, it is interesting to explore it in further studies.

From the above, it can be concluded that extensive literature exists on the importance of a positive reputation. However, most of this research is focused on the potential damage on

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a firm’s reputation and financial performance; thus, studies on reputation risks are scarce (Suomi & Järvinen, 2013). According to the concept of multidimensionality (Zyglidopoulos, 2001) and the RQ model, it is possible that reputation has both positive and negative effects (Rhee & Valdez, 2009), as reputation pertains to several dimensions. However, intuitively speaking, a reputation loss will lead to damage in financial performance.

If an event occurs that can damage the reputation of a firm, stakeholders may react negatively towards the firm by lowering their quality of involvement, acting confrontationally towards management, demanding better contractual terms, and/or detaching from the firm (Rhee & Valdez, 2009). Wilson and Grimlund (1990) find that affected firms undergo difficulties with maintaining old clients and obtaining new ones. These implications may have a negative impact on financial performance and lead us to formulate the following theoretical proposition:

Proposition 12: It is probable that positive reputation would benefit financial performance of a firm, while negative reputation would weaken financial performance of a firm.

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3. Methodology

Chapter 2 explicated the theoretical propositions underpinning the present study. This indicated the general research strategy of relying on theoretical propositions emphasized by Yin (2009), which shaped the data collection and the analysis plan (Yin, 2009). In addition, Chapter 2 showed the limited amount of in-depth research related to incidents of human rights violations. In this context, choosing a qualitative approach is appropriate. Moreover, a case study provides an opportunity for an in-depth study of real-life events (Yin, 2009) helping thus to identify the underlying risk factors and specify the consequences of human rights violations for firms. This chapter introduces the research methodology used in this study and specifies how this methodology has guided data collection and the analyses aiming to investigate the theoretical propositions.

3.1 Grounded Theory

The data collection and analyses in this study followed the principles of grounded theory: i.e. a constant comparison by looking at similarities and differences of the issues at stake (Gephart, 2004 p.45). This research strategy was chosen due to the limited prior theory and research regarding the effects of human rights violations on firms’ reputation and financial performance. The process of comparison between the collected data, categories, and initial findings helps to shape ideas that eventually become part of the emerging theory. This refers to the iterative and inductive approach of grounded theory that is used to build a new theory while using theoretical sampling (Strauss & Corbin, 1990). This process indicated the selection of cases that were particularly suitable for extending relations and logic among constructs that are not representative per se.

Both exploratory and explanatory analyses were used to investigate the theoretical propositions. Thus, this research is, on the one hand, exploratory with regard to human rights violations, since scarce scholarly research is currently available in this domain and our study attempted to further investigate these under-researched phenomena. On the other hand, our study is also explanatory with regard to the reputation of a firm, as there has been related research on how accidents impact reputation and how this affects performance, (see, e.g., Zyglidopoulos, 2001). According to the explanatory analysis, it tried to provide in-depth

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explanations and interpretations regarding the influence of a damaged reputation on financial performance. By combining the two ways of analysis, this study attempts to build a new theory based on the existing theories of the causes and effects of reputational and financial damages.

3.2 Multiple-Case Analysis

A multiple-case analysis helps to study the phenomena of human rights violations in the real-world context. This type of analysis contains a process of theory building via recursive cycling among the data of the case, emerging theory, and extant literature (Eisenhardt & Graebner, 2007). Moreover, it investigates whether emerging findings are simply idiosyncratic to a single case or can be consistently replicated by several cases (Eisenhardt, 1989), which refers to the logic of replication (Eisenhardt, 1989b). In addition, both similar results (literal replication) and contrasting results (theoretical replication) are considered between the cases (Yin, 2009). According to this research strategy, the point is to compare and contrast several cases to find out the similarities and differences in how human rights violations impact a firm’s reputation and how media coverage and corporate response change this impact. Said differently, the case of human rights violations specifically focuses on environmental abuse and labor violations and brings this multiple case approach together. In the end, this research will look whether the expectations are met and the results provide empirical support for the theoretical propositions (see section 5.1).

3.3 Case selection

Since our aim is to predict phenomena based on empirical data, rather than to seek representativeness to achieve statistical generalizability, the cases for this research were carefully selected. According to Yin (1994), the idea behind theoretical sampling is to choose cases that are unusual, i.e. such that provide research opportunities. This relates to the approach of Eisenhardt and Graebner (2007) of ‘polar types’; these authors state that a researcher needs to look for extreme cases to observe contrasting patterns.

The setting of the present study involved the firms operating in oil and gas and apparel industries in Africa and South America. This was based on the data available in the CHRD database (see section 3.4). Therefore, the data of the present research were limited to those two sectors; previous research shows that human rights violations are observed in both sectors (Ruggie, 2007). All firms included in the CHRD databases committed one or more instances

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of human rights abuse between 2000 and 2013. Further selection criteria involved the database of Fortune magazine, which involves reputational data about large American firms. Therefore, the data for this research are limited to large American firms operating in the oil and gas or apparel industries in Africa or South America. Furthermore, the reputational ranking from 2000 till 2013 was explicated per firm, specifying which firms had fluctuations in their reputational ranking. Basically, this provides a starting point to look for patterns with regard to reputational ranking.

Following these criteria, the research selected the data of nine firms, categorized in pairs of three, into one research case (see Figure 2). The data of three firms were categorized as follows: two firms with environmental or labor violations and one firm without reported abuse. The control cases are based on the available data derived from the CHRD database. In doing so, it was possible to deal with the appropriate data limitations and follow the theoretical sampling approach (Eisenhardt & Graebner, 2007) providing a diverse set of cases.

The parallel approach of Thomas (2011) was used to study the events concurrently so that to compare the findings of firms that committed or did not commit human rights abuse. Moreover, it investigated the results of the three research cases; therefore, our research took into account both industry-specific and geographical differences. In the end, literal and theoretical replications were expected to show the pattern in the cases.

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3.4 Data collection

Data for this research were collected from four main sources: 1) qualitative data from the CHRD database; 2) reputational data from Fortune magazine; 3) financial data from firms; and 4) archival data, e.g. news articles and annual reports.

Human rights violations

First, the data of the Business & Human Rights Resource Centre (BHRRC) were used. This institution has documented allegations of human rights violations against over 5000 firms from 2000 to the present. Their aim was to show the impact of human rights violations worldwide. The coding of this database was directed by the University of Denver. The project team made a template to code the data collected by the BHRRC. This template makes the coding process more standardized, which effectively reduces the risk of an interpretation bias. Moreover, this database is the first one to be used for scholarly research regarding business and human rights.

Human rights violations are defined as a Corporate Abuse Allegations (CAA). Once coded, this information will form a large-N database on alleged CAA’s. The University of Denver started with coding of the CAA’s of the apparel industry in South America. The CAAs from the oil and gas and apparel industries in Africa have been coded by the present author and other Master’s (International) Strategy students from the University of Amsterdam. Appendix A presents a list of all possible abuse allegations that were measured, coded, and deemed relevant for the present research. The outcomes of the coding process are the base for the CHRD database.

Reputation

The reputational data were derived from Fortune magazine, the most commonly used publication in research about reputation. This list includes reputational data of the largest U.S. corporations. Since 1984, reputation has been measured by Fortune through surveying over 8,000 executives and industry analysts to rank firms in their respective industries along the following eight dimensions: innovation, people management, use of corporate assets, social responsibility, quality of management, financial soundness, long-term investment value, quality of products/services, and global competitiveness (Fortune, 2014). These dimensions reflect the multifaceted nature of reputation, just as illustrated by the Reputation Quotient. In doing so, the research involved all dimensions of reputation and did not measure, for

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example, the reputation for environment or financial performance separately.

The dimensions were involved in a questionnaire mailed every fall to the respondents, followed by e-mails, phone calls, and faxes. The responses were perceived by November and the highlights were presented in the January release of Fortune magazine (Zyglidopolous, 2001). Therefore, the fluctuation in reputational ranking was measured in the year the event happened and the year after.

In this study, it was assumed that Fortune executives and industry analysts have a general understanding of the market conditions in South America and Africa. However, it needed to be considered that people use different cognitive filters, for instance, to categorize events and situations (Fiol & Koyoor-Misra, 1997). Therefore, it can be expected that people differ in the evaluations of the damage incurred by an incident. For instance, industry type and geographical locations can make a difference, since people review and process information differently.

Media attention and corporate response

The information regarding media attention was mainly based on archival data such as news articles. The corporate response of a firm was coded in the CHRD database. Moreover, this research also considers the information derived from firm’s a website and other archival data.

Financial performance

Firms’ financial performance was considered in different ways. First, the research looked to the fall in stock price the day and day after the event was reported and the year the event happened. This approach was based on the methodology of event studies that measures the impact of an unanticipated event on the value of firms associated with that event (Agrawal & Kamakura, 1995). Stock prices were viewed as reliable indicators for a firm’s value (Agrawal & Kamakura, 1995). In the present study, the fall in stock price directly after the event was used as an indication of the possible relation between human rights violations and financial performance. The fall in stock price over the year when the event happened was used to more thoroughly investigate the relation between reputation and financial performance. The data regarding stock price are obtained via Yahoo Finance, a multinational U.S. Internet cooperation. However, it needs to be taken into consideration that ours is a qualitative study that does not employ statistical methods. Therefore, the evolvement of stock price provided at most an indication of what may have happened, rather than a base for building a theory.

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Therefore, we also looked into the content derived from the articles regarding financial performance. For example, fines and extra costs give information about possible financial damage.

In addition to the data provided by firms’ sources, the present study also employed sources from third parties. Therefore, articles from different news websites were used, for example, Sunday Times and BBC. Moreover, news articles of organizations like Oilwatch (a network of resistance to oil activities in tropical countries) were used to get an insight into the stories of different parties involved in an event. The use of both firm and third party sources enabled for triangulation that eventually led to more sound interpretations (Eisenhardt, 1989; Yin, 1984;). Moreover, this research tries to build a new theory, which makes it suitable to overlap data analysis and data collection (Eisenhardt, 1989). This flexibility of additional adjustment offers opportunities to advantage the uniqueness of a specific case (Eisenhardt, 1989).

3.5 Data analysis

Miles and Huberman (1984) propose that data analysis consists of three concurrent flows of activities: data reduction, data display, and conclusion-drawing-verification. Data reduction refers to the part of the process of analysis that sharpens, sorts, focuses, discards, and organizes the data in such a way that final conclusions can be drawn and verified (Miles & Huberman, 1984). In this research, a conceptual model, theoretical propositions, and criteria for case selection were used to focus on the boundaries for data collection. This is what Miles & Huberman (1984) call ‘anticipatory data reduction’.

The codes used in this research (see Appendix B) were derived inductively from the data and helped to manage the qualitative data (Miles & Huberman, 1984). A code was assigned to a section of text when it applies to one of the themes. Those themes were derived from the conceptual model and included the following: human rights violations (incident severity, responsibility, and complexity), reputation, media attention, corporate response, and financial performance. These themes were used to find patterns in the data (Miles & Huberman, 1984).

Coded text length varied from one word, a sentence, a couple of sentences, to pages. The process of coding was as follows: first, every article about the event was coded. Second, the codes were collected per theme. Subsequently, the amount of citations and words per theme were counted and expressed in a percentage of the total amount of words. The

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convincing citations are provided in chapter 4, since Pratt (2009) argues that it helps to present data both in the body of the paper and in tables. This relates to the second process of data display (see chapter 4).

The reputational ranking was based on Fortune magazine measured in both absolute and relative terms. An overview of the reputation is provided in Appendix D. A year of reputational decline could probably be declared by a CAA. To get an insight in the evolvement of reputational ranking, the common characteristics of human rights incidents, media coverage, and corporate response were coded. The constructs of media attention included tone, amount, and publisher. First, the tone of media attention was investigated by the following codes: positive/negative/neutral/mixed. The tone was coded both regarding the firm and industry. Next, the amount of words used for expression was counted to give meaning to the amount of media attention. Finally, the publishing institutes were summarized and counted (see Appendix E for an overview).

The corporate response had already been coded in the CHRD database. The possible responses were: denial, acknowledgement of allegation, justification of action, apology, and plan for change. This information derived from the database was extended by archival data, which distinguished accommodative and defensive signals. In addition, this research considered whether the human rights violation was involved in the CSR-report of that year.

As stated above, the financial performance was measured as the fall in stock price, both directly after the abuse allegation was being reported and the overall average stock price for that year (see Appendix F for the evolvement of the stock price). Both measurements of reputation and financial performance were based on the logic of time series (Yin, 2009), which indicates a match between the observed trend and a specified earlier trend. However, this research was based on qualitative measurements and the findings were not statistically controlled for other factors in the market. Therefore, the fluctuations in reputation and stock price suggested only an indication of a possible pattern. Besides these measurements, we also considered the content in the articles on financial performance. For instance, fines and extra costs were expected to give meaning to financial damage and, therefore, to financial performance.

The final step in the data analysis included making conclusions and verification. The aim of each research case is to investigate whether environmental abuse and labor violations hurt a firm’s reputation and financial performance. The theoretical propositions help to use the right data to find support for the theoretical propositions (Yin, 2009).

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3.6 Within-case and cross-case analysis

Within-case analysis involved a detailed write-up for the story about each single firm. Therefore, the data of every single firm were considered as a stand-alone entity to discover unique patterns (Eisenhardt, 1989). Furthermore, the similarities (literal replication) and differences (theoretical replication) between firms with the same allegation type (environmental or labor) were compared. Moreover, the outcomes per industry were combined and compared. This refers to cross-case analysis which provided the opportunity to generalize patterns across cases (Eisenhardt, 1989). Basically, cross-case analysis provided the opportunity to study data in many different ways, which limits the information-processing bias (Eisenhardt, 1989). Alongside with firm sources, this research also used third-party sources to minimize the information-processing bias.

In summary, on the one hand, the data of two firms with the same allegation were compared to the data of a firm that did not commit an allegation (see Figure 2). Totally, six allegations were studied and controlled by three cases without abuse, organized in three cases of data of three firms. On the other hand, the outcomes of these three comparisons were used to find patterns across the cases — for instance, the difference between the impact of environmental abuse and labor violations, industry effects, and impact of response for reputational repair.

Business and human rights : human rights violations and the impact on firm’s reputation and financial performance