The Impact of Customer Capital on Firm Valuation: Brand Recognition vs. Key Employees

DOU, Winston Wei | 吉岩 | REIBSTEIN, David | WU, Wei

Key talents, such as executives and innovators, play a crucial role in driving a firm’s success and shaping public perceptions of its operations. However, such talents can also pose a risk to their firms. HKUST’s Yan Ji and his collaborators reveal that firms whose reputation rests more on the shoulders of leaders and innovators generate higher expected stock returns for shareholders. These firms, which include Tesla, Facebook, and Teavana, are more vulnerable to corporate liquidity issues and financial constraint shocks. In contrast, firms whose reputation relies more on pure brand recognition, such as Toyota, Microsoft, and Coca-Cola, offer lower expected stock returns in the long run.

The researchers set out to determine how customer capital systematically affects stock prices and which primitive forces shape the relationship between customer capital and stock returns. Customer capital, also known as brand loyalty, is one of a firm’s most important intangible assets. It helps to create entry barriers and durable advantages over competitors. “Developing and maintaining customer capital is essential for a firm’s survival, growth, profitability, and ultimately valuation,” the researchers explain.

To develop and maintain customer capital, firms must pursue innovation, dynamic management, and product differentiation, which depend primarily on the unique contribution of key talents. They must also focus on advertising, price-adjusted product quality, and market structure, which are based on pure brand recognition.

Firms whose customer capital depends more on key talents than on pure brand recognition may be more vulnerable to financial risk. “When firms are financially constrained, key talents are likely to leave,” warn the authors. The consequences may be severe. As customer capital relies heavily on the unique contribution of current key talents, “it can be taken away or seriously reduced with their departure.” This is known as the “inalienability of customer capital” (ICC). In contrast, pure brand recognition is largely immune to key talent turnover. Thus, during periods of heightened financial constraint risk, firms whose customer capital is more talent-dependent suffer more.

As well as developing a theoretical framework to explore the causal relationship between customer capital and stock returns, the researchers conducted extensive empirical analysis. Their first step was to construct a firm-level measure of ICC, capturing the degree to which a firm’s brand loyalty depends on key talents (compared with pure brand recognition). They drew their data from the world’s most comprehensive database of consumer brand perceptions. Next, they explored the interaction of ICC with financial shocks, considering a range of firms facing liquidity constraints.

Their findings are instructive. “Customer capital is less sensitive to financial constraint risk if it depends more on customers’ pure brand recognition,” report the authors, “while it is more sensitive to financial constraint risk if the contribution of key talents is essential.” This leaves shareholders in a difficult position. While retaining talent within firms can help maintain positive net cash flows, it can prove challenging when businesses are under financial pressure. At such points, “key talents may find it optimal to escape from a sinking ship,” say the authors.

Making a novel contribution, the researchers demonstrate the measurable impact that key leaders and innovators can have on the stock prices and financial performance of a firm. “The talent dependent customer capital that we investigate,” say the authors, “provides one of the most concrete and convincing examples of inalienable human capital.” The research also offers a stark warning for investors. “Shareholders are exposed to the risk inherent in the limited commitment of key talents.”