The Effects of Regulatory Investigation, Supplier Defect, and Product Age on Stock Investors’ Reaction to a Product Recall

Abstract

When a product recall is announced, the manufacturer’s stock investors estimate the costs of the recall to determine how much to penalize the firm’s stock price. Prior event studies have viewed these costs as manifest only in the downstream consumer market. We reason that this view is deficient. This article considers the costs of a recall as manifest in the nonproduct market (specifically, with the safety regulator) and the product market (i.e., with the upstream supplier and the downstream consumers). For each of these three stakeholders, we hypothesize one characteristic that proxies recall costs. We find that automobile recalls elicit, on average, stock investors’ reaction of −.22%, equivalent to a loss of $81 million. Whereas the duration of regulatory investigation negatively affects this reaction, the product age positively impacts it. Contrary to our hypothesis, whether the defective component is manufactured by a supplier or the recalling manufacturer does not matter.

Keywords: product recall, event study, stock investors' reaction, supplier defect, regulatory investigation