Kanye West and Adidas: When celebrity endorsements go wrong

The reputation or public behaviour of celebrities who are also collaborators and ambassadors of businesses can have a direct impact on a company's share value.

After months of speculation and increasing public pressure, Adidas ended its successful seven-year partnership with Kanye West (now known as Ye) over anti-Semitic comments. It was something the megastar had been agitating for as he wanted more creative direction and a bigger slice of the revenue pie. Now Adidas will end all production of Yeezy products including royalty payments.

On Morningstar equity research numbers, the immediate impact is expected to hit Adidas' fourth-quarter net income by $AUD 389 million. Moreover, the impact could be higher as it was expected that Adidas would continue to sell the items that were already in the Yeezy pipeline, but this is not to be the case.

While the decision to end the Yeezy deal was no doubt painful for Adidas, it was necessary, and Morningstar's analysis shows a low risk of financial distress for the business. Historically, Adidas has operated with more than $AUD1.555 billion in cash and little or no debt on its balance sheet, and we anticipate that this will continue to be the case.

Working with celebrities is a double-edged sword, if they align well with your brand values, they can leverage their profile to a company's benefit, but the risk is the brand ambassador gets cloaked in controversy and the brand becomes guilty by association.

Controversy surrounding celebrity fallouts are not new. However, approaches taken can vary. Dior maintained ties with Jonny Depp despite challenging personal affairs resulting in court appearances. However, once these proceedings ended and Depp won the defamation lawsuit he was re-signed.

Ultimately it depends on circumstances, the frequency of controversial events, the extent of misalignment between the individual and the company and severity of material risks. However, there are some lessons from a governance perspective we can take from the Adidas/Ye case, particularly for listed businesses.

Notably, it could serve businesses well if better disclosure was provided to stakeholders behind such endorsements. The information on Yeezy's sales and profitability is limited at best. Royalty payments are also not disclosed. Adidas is expected to provide more information when it reports its third-quarter results on November 9.

A company's reputation is intrinsically aligned to its value, whilst it is intangible, studies pulled by Investor Relation's consultancy Financial Corporate Relations estimates that the value of reputation can be materially significant (in excess of 30%) of a company's market value.

Another example is Peloton/Chris Noth collaboration on the Sex and City reboot, And Just Like That.

Notwithstanding the 5% dive in Peloton's stock price when Noth's character Big died after suffering a heart attack while riding the bike, the company, did turn the situation around, filming an advertisement showing Noth was alive and well. However, Pelton eventually severed ties with the actor after accusations of sexual misconduct against Noth came to light.

How well a company responds to such issues can have a positive or negative swing factor of millions of dollars.

As we live in a 24-hour news cycle, the sharing of information doesn't sleep which means companies have to act swiftly to manage issues in real-time. Reputational risk is a major corporate governance consideration. It involves anything that can harm the way a company is perceived by its stakeholders whether they be shareholders, employees, or customers.

Therefore, it's no surprise that management of reputational risks are firmly on company's corporate governance agendas. Management of reputational risks are particularly pertinent in today's world as investors increasingly put money where their values lie, evidenced by the growing allocation of capital into investments that take into account environmental social and governance (ESG) attributes.

Company management of controversial issues like Ye's are important. Too slow to respond or responding poorly can have seriously negative financial impacts. The risks are falling share prices, loss of customers and the all-important social licence to operate.

Although Adidas took a hit to its bottom line, the business has also sent a clear message that they will not tolerate such behaviour, it is not aligned to its company values, and it disassociates Adidas from these comments and person. Ye does not speak for them.

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