Cover-Up of Vehicle Defects: The Role of Regulator Investigation Announcements

34 Pages Posted: 27 Jun 2018 Last revised: 24 Aug 2018

See all articles by Soo-Haeng Cho

Soo-Haeng Cho

Carnegie Mellon University - Tepper School of Business

Victor DeMiguel

London Business School

Woonam Hwang

HEC Paris

Date Written: June 21, 2018

Abstract

Automakers such as Toyota and GM were recently caught by the U.S. regulator for deliberately hiding product defects in an attempt to avoid massive recalls. Interestingly, regulators in the U.S. and U.K. employ different policies in informing consumers about potential defects: The U.S. regulator publicly announces all on-going investigations of potential defects to provide consumers with early information, whereas the U.K. regulator does not. To understand how these different announcement policies may affect cover-up decisions of automakers, we model the strategic interaction between a manufacturer and a regulator. We find that, under both countries' policies, the manufacturer has an incentive to cover up a potential defect when there is a high chance that the defect indeed exists and it may inflict only moderate harm. However, only under the U.S. policy does the manufacturer have an incentive to cover up a potential defect with significant harm, if there is only a moderate chance that the defect exists. We show that the U.S policy generates higher social welfare only for very serious issues for which both the expected harm and recall cost are very high and the defect is likely to exist. We make four policy recommendations that could help mitigate manufacturers' cover-ups, including a hybrid policy in which the regulator conducts a confidential investigation of a potential defect only when it may inflict significant harm.

Keywords: product recalls, automotive industry, socially responsible operations, public policy

Suggested Citation

Cho, Soo-Haeng and DeMiguel, Victor and Hwang, Woonam, Cover-Up of Vehicle Defects: The Role of Regulator Investigation Announcements (June 21, 2018). HEC Paris Research Paper No. MOSI-2018-1295. Available at SSRN: https://ssrn.com/abstract=3200337 or http://dx.doi.org/10.2139/ssrn.3200337

Soo-Haeng Cho

Carnegie Mellon University - Tepper School of Business ( email )

Pittsburgh, PA 15213-3890
United States

Victor DeMiguel

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Woonam Hwang (Contact Author)

HEC Paris ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

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