In January 2015, we published a report introducing a framework to enable analysis of the “legitimacy” of an institution by understanding its relationships with stakeholders. We used the banking sector as our test case given the recency of the Global Financial Crisis, but the framework can be applied to any industry or institution. Given this edition’s focus on “Order and Chaos,” we felt it would be relevant to revisit our previous work. This article is an excerpt from the report.


Earnings and valuation uncertainty – In a post Global Financial Crisis world, investors are questioning long-term earnings and valuation prospects for the banking sector. Tougher regulation, particularly on capital, liquidity and structure, are exerting pressure on the traditional banking business and clouding the outlook for investors.

A new framework – To better understand an evolving banking landscape, we offer a new framework based on the concept of “legitimacy”. Our framework is designed to help investors assess the quality of an institution’s relationships, as they convey a willingness to continue to engage with a bank – whether as a customer, shareholder, regulator, employee or community member.

Structure and application – We discuss the key elements of “legitimacy” and outline the steps and structure of the framework. We then provide an illustrative example where we assess the relationship between 1) Wells Fargo’s (WFC) corporate officers and non-management employees and 2) Wells Fargo and its consumer lending clients.

Investment implications – We believe that assessing “legitimacy”, or the quality of a bank’s relationships with key stakeholders, enhances investors’ analysis of factors that influence that bank’s valuation. Our legitimacy framework is not limited to the banking sector and can be applied broadly across other sectors and industries.

Background & Introduction to Legitimacy

While investors typically analyze a variety of financial statements and ratios to determine the relative attractiveness of a sector and individual institutions within it, starting from a different viewpoint may illuminate an otherwise less obvious set of opportunities. In this instance, it is the theory of legitimacy.

In a report titled Rethinking Legitimacy and Illegitimacy – A New Approach to Assessing Support and Opposition across Disciplines, Robert D. Lamb analyzes the concepts of legitimacy[1] and illegitimacy, discusses issues involved in measuring them in the real world, and introduces a new framework for assessing them in situations where the sources and dynamics of support of opposition need to be better understood. [2]

The legitimacy framework, developed by Lamb and published by Rowman & Littlefield and the Center for Strategic and International Studies (CSIS), originates in Lamb’s interest in understanding how gangs in Medellin, Colombia governed different neighborhoods. He examines legitimacy and governance where the unit of analysis is a gang instead of a state, and he studies how that affects the patterns of violence in particular neighborhoods. To address this, he designs a general framework that can be applied not just to gangs in Colombia, but to any number of situations where the dynamics of support, opposition and authority needed to be understood.

Lamb’s legitimacy framework is particularly interesting for investors given the need to understand the nature of a company’s stakeholders. Assessing legitimacy is helpful for – and in many cases similar to – assessing an organization’s governance structure. With this in mind, the legitimacy framework is helpful in understanding companies and the sources of friction in their business relationships. The focus of this report is on the global banking sector due to the reputational damage incurred in the Global Financial Crisis, but the framework isn’t sector specific. With modest modifications, it can be applied broadly across other sectors.

On the surface, it is easy to contemplate how detrimental regulatory fights, shareholder suits, high employee turnover, and poor client retention impact a particular bank’s earnings and returns. It would be virtually impossible to miss the differences in standard deviation of these two metrics over a five or ten year period – just eyeballing a long list of banks for business mix and credit acumen. Conducting a detailed analysis that involves quantifying the impact of each of these issues, however, is more difficult.

The legitimacy framework isn’t a silver bullet, but it does provide a way to begin the discussion. It is based on the quality of an institution’s relationships, as they convey a willingness to continue to engage with that bank – whether as a customer, shareholder, regulator, employee or community member. A bank with low quality stakeholder relationships may face more opposition and friction, and therefore more costs to overcome, than one with strong relationships.

Relationships and Long Run Costs

Relationships matter to the long-term profitability of any business. Strong customer relationships and stable supplier relationships save on costs of finding new customers and suppliers. A sour relationship with regulators can put an individual company under greater scrutiny or an entire sector at risk of more public oversight, increasing costs of doing business. Low worker morale harms productivity and increases turnover, recruitment and training costs. A greater degree of trust between businesses translates into lower costs for monitoring and enforcing business deals. A company with a reputation for harming the environment or local communities is likely to find opposition when expanding into new communities, or might face lawsuits stemming from past harms. Such risks can affect a company’s valuation in a future public offering or private sale. Strong stakeholder relationships can keep a business stable during inevitable rough periods.

These observations apply to the global banking sector as well as any other. Banking has long faced challenges with confidence and trust among its stakeholders, though this problem was magnified by the Global Financial Crisis. In the United States, for example, confidence in the banking sector declined by half after 2008, from 41% to 21 %, recovering to 26% only in 2013, still less than half its 2004 peak.  Retail, investment, and commercial banks worldwide have faced similar reputational problems. Risky behaviors and perceptions of breached trust have led to bank closures, tighter regulation, and in some countries prison time for executives.

One should not overstate the case. There is little hard evidence, beyond anecdotes, that poor relationships lead to poor returns on investment. Even banks with serious reputational problems can make money for their investors. However, a bank that manages stakeholder relationships particularly well might, all else equal, have a long-run financial advantage over its competitors. Harmful corporate behavior can trigger opposition from key stakeholders, needlessly increasing costs by having to defend lawsuits, pay fines, sell off assets, and rebrand. Poor relationship management can cost money that could otherwise be capitalized. And corporate leaders capable of managing complex stakeholder relations successfully might well be better managers overall.

For investors, assessing the state of a bank’s stakeholder relationships can help identify potential sources of opposition — and therefore potential costs and risks — as well as potential sources of stability. This information can be useful when deciding which banks have a more promising long-term outlook, all else equal.

The application of legitimacy to investing may be new, but legitimacy has been a topic of study for political theorists, sociologists, psychologists, anthropologists, and military historians for almost as long as those disciplines have existed. It is strongly associated with stability, because when people believe something has legitimacy they tend to voluntarily support it, morally and materially. But because legitimacy is not something that can be easily observed, measuring it has always been a challenge. It is our belief, however, that Lamb’s framework overcomes some of the challenges of previous attempts.

Assessing Support and Opposition

It is sufficient to define legitimacy concisely as a “worthiness of support,” as judged by a particular population (called “referees”). When something is considered legitimate, support is offered voluntarily. Having legitimacy, therefore, means support does not need to be purchased or coerced. That, in turn, reduces costs associated with sustaining one’s operations. By contrast, illegitimacy is a “worthiness of opposition” that tends to trigger resistance and thereby increase transaction and friction costs.

To see how these ideas apply to the banking sector, consider two fictional retail banks. Trusty Bank has loyal investors, a reputation for excellent customer service, high employee morale and low turnover, a history of cooperating with regulators and auditors, and good relations with community leaders in the neighborhoods its branches serve. Its policies are transparent, it keeps promises and complies with laws and regulations, its managers and staff treat people fairly and with respect, and it is responsive to questions and complaints it receives.

By contrast, Infidelity Bank has faced shareholder lawsuits, consumer complaints, high staff turnover, failed audits, legal fines, and community protests. Its policies are opaque, its staff are occasionally deceptive (at times illegally so), its employees are rude to each other, they discriminate against some of their customers, and the bank is generally unresponsive to complaints unless compelled by legal action or media pressure.

All else equal, which company is better managed? Which is likely to end up spending more money than necessary on legal fees, customer retention, marketing, staff recruitment and training, public relations, scandal management, arbitration, legal settlements, or fines? Which can be trusted to maximize shareholder value with minimal oversight?

In reality, the contrast between how different banks manage relationships with different stakeholders is not usually so stark. Some have happy customers but miserable employees while others face supportive regulators but hostile communities. Their relationships with each stakeholder group might be complicated: investors who make money but feel disrespected, or customers who are pleased with frontline service providers but infuriated by the company’s policies. Even within stakeholder groups there is likely to be a diversity of experience as well. A lower-income community might feel customer service is worse in their branch than it is in a more upscale neighborhood. The relationship with state regulators might be different from that with federal regulators. And individual stakeholders might like everything about the bank except one aspect — unethical behavior in a single division, or a perception that executive compensation and bonuses are excessive — that overshadows everything else and damages the relationship.

Using the framework in Rethinking Legitimacy and Illegitimacy, these complicated relationships can be assessed in a way that untangles stakeholder attitudes and behaviors that are likely to be costly to the bank in the long run    – a potential drag on earnings or a threat to stability – from those that are beneficial and costless.

After identifying the bank to assess, the first step is to identify the particular stakeholder group whose relationship with the bank one wants to better understand. These could be customers, employees, regulators, investors, community members or activists.

Each relationship then needs to be broken down into three levels and five dimensions.  The three levels are individual belief, group behavior, and the bank as a whole.

  • Belief. The first level measures the beliefs, opinions, or attitudes of individual stakeholders, usually through surveys, focus groups, or interviews. What are their perceptions of the bank?
  • Behavior. The second level measures the behaviors of the stakeholder group, using existing data, observation, and documentation. How do they act toward the bank?
  • Bank. The third level measures objective features of the bank, also using data, observation, and documentation but in some cases surveys, focus groups, and interviews of bank representatives as well. What does the bank do, and what is it like?

At each level, indicators for each of the following five dimensions must be identified:

  • Predictable. Can the bank be relied upon to do what it says and what people expect it to do? Is it transparent in how it operates? Are its commitments credible? [NOTE: Here it is necessary to identify the expectations, commitments, etc. that are most relevant to the banking sector specifically, i.e., those that, if not met, could adversely affect the relationship in the future. This is different for every sector.]
  • Justifiable. Does the bank act in ways that are consistent with the values of its stakeholders and the broader society in which it operates? Is its behavior consistent with its own values? [NOTE: Not all stakeholder and societal values are relevant to the analysis. Investors who care only about profits will value the bank’s governance differently from investors who care about social concerns. Therefore, it’s necessary to identify a few key values, the violation of which would be damaging.]
  • Equitable. Does the bank treat all stakeholders fairly? Are differences in treatment justified by differences in the stakeholders? [NOTE: In some situations, acting fairly toward certain groups could damage the bank’s relationship with a majority or elites; this analysis does not necessarily need to assume that liberal values are correct, only that it’s necessary to study relevant stakeholders in depth and in context.]
  • Accessible. Do the stakeholders have a reliable way to communicate with the bank, resolve issues, and influence operations or policies (at a level appropriate to their position)? [NOTE: Again, it is necessary to identify relevant indicators: accessible customer service is probably important while customer access to many corporate governance decisions is probably not. Similarly, the board need not have access to decisions about day-to-day operations barring a unique circumstance.]
  • Respectful. Does the bank treat the stakeholders with dignity and respect? [NOTE: Here is where cultural understanding is completely necessary.]

The risk of resistance or opposition to a bank’s operations tends to be higher the more the bank acts toward its stakeholders in ways that are unpredictable, unjustifiable, inequitable, inaccessible, or disrespectful. Studying these five dimensions across three levels, therefore, makes it possible to uncover potential sources of risk resulting from poor relationships.

Consistency between dimensions and across levels indicates the presence of legitimacy. If individuals say they consider the bank equitable and behave in ways that reflect such a belief (i.e., referring others in their community), and if the bank itself seems to treat its customers equitably, then there is little reason to be concerned the bank might be at risk, for example, of a discrimination lawsuit (this does not eliminate the risk of frivolous lawsuits, however). Inconsistency, by contrast, identifies a trouble spot. For instance, if individual customers say the bank is accessible but rarely call customer service to resolve an issue, then further investigation may be warranted. Perhaps on-hold times at the call center are unpredictable and occasionally excessive (i.e., the bank is accessible but unpredictable). In itself, that is not a reason to fear a risk to long-term stability. But it does suggest a potential trouble spot that is worth exploring further to determine if a competitive disadvantage exists.

A systematic assessment of the strength and sources of support or opposition can be as simple as a quick study of the five dimensions at the bank level or as comprehensive as an in-depth analysis of the bank’s relationships with all stakeholder groups. The choice depends on the time and resources available to the investor conducting the assessment. The Rethinking Legitimacy framework describes four types of assessments that can be made:

  • Rapid. This method uses only the bank-level indicators for the five dimensions. First, for each of the five dimensions, an investor should identify a set of indicators relevant to this bank’s relationship to the stakeholder group in question. The predictable indicator might include a look at expectations for timeliness, which are likely to differ from country to country. A culture whose religion forbids the charging of interest will have different justifiable indicators than others who have no such prohibitions. Then, using those research methods that are feasible, measure the indicators. Does extended observation suggest that managers treat employees equitably and respectfully? Do interviews with investors suggest they have some say over decisions they care about?

For those indicators deemed relevant, it is necessary to identify whether the bank’s performance on each is generally positive, negative, or neutral. (An even more sophisticated look would also determine whether they are improving or deteriorating.) The resulting analysis provides a useful and quickly generated qualitative picture of the bank’s relationship with one particular stakeholder group. Any negative indicators, or inconsistencies between indicators, suggest potential problem spots that are worth exploring in greater depth.

  • Multilevel. A multilevel assessment begins with a rapid assessment, but then adds the other two levels to the analysis: group behavior and individual belief. Just as in the rapid assessment, a set of indicators needs to be identified for each dimension at each level. Indicators for individual beliefs are reasonably straightforward — and measuring them is not more complicated than standard opinion surveys or interview methods. Group behaviors take a little more work, because it is necessary to think through what types of behavior would imply an underlying belief.

If employees don’t believe they are appreciated by management, they might tell that to an interviewer (a belief indicator) and a high turnover rate might also be evident (a behavior indicator). This suggests a problem. On the other hand, if employees tell the interviewer they are appreciated by management in the face of high turnover, there is a disconnect between belief and action, and that also suggests a problem worth exploring. Again, negative indicators and inconsistency between indicators (across dimensions and across levels) both suggest potential problem spots. (A simpler multilevel assessment reviews indicators for general support or opposition at just the three levels, without breaking them out by dimensions; see tables on pages 9 & 10).

  • Bilateral. A bilateral assessment offers a deeper level of analysis. In effect, it takes a multilevel assessment and reverses the actors, under the conclusion in Rethinking Legitimacy that legitimacy is a two-way street. In addition to studying, for instance, investors’ beliefs about the bank, their behaviors toward the bank, and the bank’s objective treatment of investors, this assessment studies the bank officials’ beliefs about the investors, their behaviors toward the investors, and the investor’s objective treatment of the bank’s officials.

There is some obvious overlap in indicators here. But this bilateral approach offers a much more detailed picture of the relationship and identifies some potential problem spots that might not be identified in a simple multilateral assessment. One side might have positive feelings about the other side, but the feeling might not be mutual. That is problematic not only because there is a negative indicator but also because one side seems oblivious to the problem, which is itself a potential problem.

  • Comprehensive. Finally, a comprehensive assessment is a bilateral assessment that is repeated for the rest of the bank’s stakeholders. If the multilevel or bilateral assessment focused on the bank’s relationship with regulators, then a comprehensive assessment would do the same analysis of the bank’s relationships with customers, employees, the community, relevant activists, regulators, and whatever other group whose relationship could complicate the bank’s current or future operations.

Each of these four approaches is more labor-intensive than the previous: a multilevel assessment is about three times as labor-intensive as a rapid assessment; a bilateral assessment twice as labor-intensive as a multilevel; and a comprehensive assessment four or five times as labor-intensive as a bilateral assessment. A mix is possible; for example, one can do a rapid assessment for more than one stakeholder group. And for many assessments, it might not be necessary (or possible) to do a comprehensive assessment. The amount of time and resources available limits how much can be done. The risk, however, is that the simpler methods have fewer layers of validation and are therefore more subject to investor bias.

Potential for Additional Applications

[In our original report, we applied] our legitimacy framework to the global banking sector in light of the reputational damage incurred by the Global Financial Crisis, but the framework has applications beyond banking. Indeed, our framework can be employed by investors across sectors to evaluate a company’s intangible assets. As noted in our ESG Essentials – A Guide for Investors report, intangible assets constitute a larger proportion of market value than in the past, and this shift from tangible assets to intangible assets introduces more variability and uncertainty into the assessment of overall value to shareholders.

As investors address this issue, they would be keen to consider the legitimacy framework in evaluating intangible assets – specifically those that are dependent on a company’s relationships with stakeholders. Customer relationships, brand names, corporate reputation and management quality are examples of intangible assets that can add or detract significant value based on the perception of legitimacy or illegitimacy, and investors must understand what drives these perceptions.

Directly quantifying the impact of legitimacy is not the goal. Instead, our legitimacy framework will enable investors to identify companies with a stronger capacity to manage relationships and greater prospects for long-term stability.


Michael Shavel is the Global Thematic Analyst at Cornerstone Capital Group. Prior to joining the firm, Michael was a Research Analyst on the Global Growth and Thematic team at Alliance Bernstein. He holds a B.S. in Finance from Rutgers University and is a CFA Charterholder.

Robert D. Lamb, PhD, is an expert on governance, international development, and conflict with an emphasis on analysis of intangibles, complex crises, informal processes, and hybrid political and economic systems. He is a nonresident senior fellow at the Center for Strategic and International Studies, where he previously directed the Program on Crisis, Conflict, and Cooperation, and is a nonresident research scholar at the Center for International and Security Studies at the University of Maryland.

Diane Glossman, CFA, spent 25 years as an investment analyst, working on both the buy- and sell-sides. Over the course of her career, she covered all aspects of banking and financial services industries, with research distinguished by it’s in depth coverage of banking technology and the international operations of US banks (visiting banks in over 60 countries).





[1] Legitimacy, according to many fields of study and practice, is something that induces voluntary support. It is therefore an important intellectual resource for decision makers. Because it cannot be observed, however, measuring and assessing legitimacy is difficult.

[2] Robert D. Lamb, Rethinking Legitimacy and Illegitimacy: A New Framework for Assessing Support and Opposition across Disciplines (Washington, D.C.: CSIS and Rowman & Littlefield, May 2014), available at