How Inductive and Deductive Generalization Shape the Guilt by Association Phenomenon Among Firms: Theory and Evidence

Abstract

This study advances and tests the notion that the phenomenon of guilt by association-- whereby innocent organizations are penalized due to their similarity to offending organizations-- is shaped by two distinct forms of generalization. We analyze how and why evaluators’ interpretative process following instances of corporate misconduct will likely include not only inductive generalization (rooted in similarity judgments and prototype-based categorization) but also deductive generalizing (rooted in evaluators’ theories and causal-based categorization). We highlight the role and relevance of this neglected distinction by extending guilt-by-association predictions to include two unique predictions based on deductive generalization. First, we posit a recipient effect: if an innocent organization falls under a negative stereotype that causally links the innocent firm with corporate misconduct, then that innocent firm will suffer a greater negative spillover effect, irrespective of its similarity to the offending firm. Second, we also posit a transmission effect: if the offending firm falls under the same negative stereotype, then the negative spillover effect to other similar firms will be lessened. We also analyze how media discourse can foster negative stereotypes, and thus amplify these two effects. We find support for our hypotheses in an analysis of stock market reactions to corporate misconduct for all U.S. and international firms using reverse mergers to gain publicly traded status in the United States. We discuss the implications of our theoretical perspective and empirical findings for research on corporate misconduct, guilt by association, and stock market prejudice.