Reputation plays a big role in economic models and in the business world. If not for the proper functioning of reputation markets, competition and the invisible hand could not perform many of their wonders.

Reputation matters because of asymmetric information. Stakeholders cannot directly observe the abilities and intentions of companies and businesspeople, and so stakeholders rely on observable past actions as cues to evaluate how companies are likely to behave in the future. Over time, companies and businesspeople who offer superior quality and do not sucker-punch their partners will develop good reputations. By contrast, companies and businesspeople who get caught misbehaving will suffer reputational losses: their stakeholders will think less highly of them, and they will lose future business opportunities. This idea may sound trivial, intuitive, and obvious—unfortunately, in many cases reality is messier and more complex.

Many markets for reputation are too noisy.[1] Stakeholders often overreact to some types of behavior and under-react to others. Some of it is due to lack of information and judgment biases on the part of the stakeholders. Some is due to the companies’ own actions. Most large companies are busy not only perfecting the quality of their products and services, but also trying to influence the market for reputation. They do it by using advertising, public relations, marketing, and many other avenues designed to change stakeholders’ perceptions of them.

The embarrassing blunder that the accounting firm PricewaterhouseCoopers (PwC) suffered last Monday is a good example. Tens of millions watched it live, and many more watched the 3-minute video clips of the terrible ending to the 2017 Oscars, when Warren Beatty and Faye Dunaway were handed the wrong envelope and announced La La Land as the winner for best picture, only to discover moments later that the winner was actually Moonlight.

Pundits and commentators have no doubt that PwC, the accounting giant that has been counting the Academy’s votes for 80 years, will suffer an enormous hit to its reputation from the Oscars debacle.

The reason is obvious: PwC found itself in the spotlight. Everyone who watched the Oscars or read about mishap the day after can understand what went wrong and how devastating the outcome is for the reputation and respectability of the annual awards ceremony.

But wait! How big is the mistake here, really? Isn’t it a reasonable human error? Chances are that it was all done bona fide. Nobody in PwC put the wrong envelope in Beatty’s hands because they wanted to cut costs or defraud the public. These things happen. But in the market of reputation, the hits you take are often not correlated to the level of negligence, malice, or criminal intent.

Let’s look at the other kinds of 'blunders' PwC has experienced in the last decade; you may be surprised by what you see. Five months ago, the accounting firm settled a $5.5 billion lawsuit that was brought against it after the collapse of Taylor Bean & Whitaker Mortgage Corp. and Colonial BancGroup in 2009. PwC, as Colonial’s auditor, was accused of failing to detect the fraud in Taylor Bean that ultimately brought down both companies.

If the details of this lawsuit look shocking, it is probably because you haven’t been following news reports about PwC in the last few years. Here are a few more examples:

In 2007, the firm agreed to pay $230 million to settle a class action lawsuit regarding the Tyco International accounting fraud. In 2015, PwC had to end its 32-year relationship with the U.K. retail giant Tesco after it was revealed that Tesco overstated its profits by as much as 263 million pounds (PwC was Tesco’s auditor).

And there were many more cases, some of them having to do with PwC’s consulting business. In 2014, for instance, PwC’s Regulatory Advisory Services unit was fined $25 million by the New York Department of Financial Services and suspended for two years from accepting consulting work at financial institutions regulated by the NYDFS.

The firm agreed to the fine and suspension to settle allegations by the New York regulator that the company had altered (or 'whitewashed') a report regarding the Bank of Tokyo-Mitsubishi’s compliance with anti-money laundering laws. The bank had been suspected of violating U.S. money laundering laws by processing $100 billion worth of payments to individuals and companies in countries subject to economic sanctions like Iran and Sudan. Under pressure from BTMU executives, the regulator alleged, PwC removed language and information that referred to the bank’s improper deals and its attempts to hide them from a review it sent to regulators.

Last year, a U.S. federal judge rejected PwC’s bid to dismiss a $3 billion lawsuit brought against it following the bankruptcy of MF Global—the hedge fund that was managed by former New Jersey Governor and Goldman Sachs executive Jon Corzine and collapsed in 2011. The company is currently being sued by MF Global’s plan administrator for allegedly providing bad accounting advice that—according to the lawsuit—had been one of the major causes of MF Global’s collapse. The trial is scheduled to begin on Monday, March 6.

Crucial to MF Global’s case is the portrayal of PwC (and other auditing firms) as public watchdogs—a definition which PwC has resisted before. In a letter to the court last month, PwC requested that MF Global’s plan administrator be precluded from referring to its role in the U.S. financial markets as a 'public watchdog.' On Friday, the court agreed and barred MF Global from arguing that PwC had a public watchdog role.

The definition relies on a previous Supreme Court ruling, in the 1984 case United States v. Arthur Young, which determined that accounting firms have a 'public watchdog' role that mandates they remain completely independent from clients.

One would think that after such a string of scandals you would often come across headlines in the New York Times, the Wall Street Journal and other major newspapers similar to the ones that followed the Oscars debacle. But no. In 2016, PwC was ranked among the top 10 most valuable brands in the world, apparently not suffering reputational setbacks for all of these major blunders. In the reputation market, it turns out, companies can handle, manipulate, smother, and even kill the truly catastrophic frauds and failures.

As Ryan Grim noted in The Huffington Post, the media often prefers to focus on public flubs like the Oscars than, for instance, Section 199—an obscure corporate tax break worded by a PwC accountant, George Manousos, during a stint at the Treasury Department under President George W. Bush. Manousos has since returned to PwC as a partner, and now advises clients on how to best use Section 199. He is the leading authority on Section 199, a distinction he makes sure to stress in his meetings with government officials, he told Grim.

The reason PwC may suffer a major reputational loss following the Oscars is because the ceremony is highly visible and the error is simple to understand. Most cases are not visible and very complex. When a company fails and there are questions surrounding its auditing, two things play out in the medium and long-term: the first is that after a couple of weeks or months, press coverage moves on to the next story; and the second is that the complexity drives most people to lose interest.

After the media loses interest, the regulators who are charged with investigating and dealing with the scandal or introducing reforms are left without significant scrutiny, and a new dynamic starts to evolve: this is the moment when PwC or any other big company that is involved in a scandal will bring out their hired experts, lobbyists, and lawyers and start the war of attrition. In most cases, it will end with nothing and in other cases there will be a watered-down settlement. Regulators move forward, the media is not there anymore, and politicians don’t see an opportunity to get attention. Therefore, reputation is salvaged.

Add to that multimillion dollar marketing and PR budgets, ads in newspapers, conference sponsorship, donations to genuine philanthropic causes, and huge corporate social responsibility divisions. Together, this reputation army will make sure that the company’s reputation is restored more often than not.

In monetary terms, PwC spends about $2 million on lobbying in the US each year. In the UK, the Big Four (the four biggest global accounting firms, which includes PwC) donated almost 2 million pounds’ worth of services to political parties from 2009 to 2012. The actual terms in which PwC is lobbying in the U.K. are more revealing: four years ago, the British newspaper The Independent found out that PwC was quietly bankrolling 'The Corporate Reporting Users Forum,' an organization that was trying to block accounting reforms.

These tools are not only efficient against scandals, but also against reforms. On March 2011, more than two years after the financial crisis of 2008-2009, a report by the U.K. House of Lords called for a 'detailed investigation' of the Big Four 'with a view to an inquiry by the Competition Commission so that all the interrelated issues surrounding concentration, competition and choice can be thoroughly examined in depth and in the round.'

The report found that the Big Four’s dominance limited competition and choice, that the communication between auditors and regulators was weak enough so as to make the financial crisis even worse, and that audit standards were slipping. The report spared no words. While it acknowledged that 'there was no single cause of the banking meltdown of 2008-09,' it still concluded that “the complacency of bank auditors was a significant contributory factor. Either they were culpably unaware of the mounting dangers, or, if they were aware of them, they equally culpably failed to alert the supervisory authority of their concerns.”

Hence, more than two years after onset of the financial crisis, which was arguably an excellent opportunity for structural reform, the U.K. had not even begun any reform efforts. Needless to say, there are no such reform efforts across the Atlantic, where the crisis started, either. Eight years after the calamity and subsequent bailouts on Wall Street, the role of the auditors—and the Big Four in particular—has never been fully investigated by regulators and legislators, nor the media.

The lesson (not the moral) is simple: if we want to better understand when markets work and when they fail, we should have a better understanding of the way reputation works, especially the way large players in the market manipulate reputation using complexity and a crowded media agenda, and how the public’s lack of interest is translated into a lack of regulatory urgency.

PwC’s Oscars blunder is a good opportunity to look at the cases where PwC and the other Big Four really failed, at times when there was a good reason for their reputation to be clobbered.

The financial crisis of 2008 might be a good starting point. The MF Global trial, which will start on Monday, is another one. One would hope it receives even half of the media coverage the Oscars blunder received.

This post was originally published on – the blog of the Stigler Center at the University of Chicago Booth School of Business.


[1] See Roy Shapira, Reputation Through Litigation: How the Legal System Shapes Behavior by Producing Information, 91 Washington Law Review 1193 (2016); Roy Shapira, A Reputational Theory of Corporate Law, 26 Stanford Law & Policy Review 1 (2015).