A 2005 statistical study published in the Quarterly Journal of Business and Economics analyzed the security prices of non-automotive recalls following the announcement of the product recall in the Wall Street Journal (WSJ).[1] [2] The study looked at a sample of 269 product recalls from 1984 through 2003 and reported the mean abnormal returns (MAR) for days surrounding the WSJ announcement date, or the event date. Because markets often know about the recalls the day prior to WSJ publishing (event -1), it was expected to see a reaction on this day as well, so long as the market had had time to react.
The results provide impressive evidence that product recall announcements have a meaningful negative effect on the common stock price of the responsible companies. Our MAR on the day prior to the announcement date (t = -1) is -1.11 percent, which is significantly different from zero at the 0.1 percent level. The MAR is -0.64 percent on the event date (t = 0), which is statistically significant at the 10 percent level. Approximately, 60 percent of the abnormal returns are negative on day -1 and 55 percent of the abnormal returns are negative on day 0. Pruitt and Petersons results closely parallel our own as they too report a large negative reaction to the recalls on both event day -1 and event day 0.
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Daily mean cumulative abnormal returns (MCAR) for
selected event days [show that], except for a slight downward drift on day -12, the MCARs are comparatively stable
during the pre-event period. The negative MCARs begin increasing over the
post-event period, hover around 3 percent from day 13 to 36, and decline toward
the end of the post-event period. The largest MCAR is -3.55 percent and
appeared on event days 19 and 20.[3]
While
some observers praised Mattel for voluntarily informing the CPSC of the product
safety problems found in its supply chain in 2007, others criticized the
company for not having done so quickly enough. As of September 2007, the CPSC
was investigating whether Mattel had issued its recall of Fisher-Price toys the
previous month in a sufficiently timely manner. The Associated Press reported
that month that Fisher-Price had been fined $975,000 in March for being too
slow to inform government officials that one of its Little People toys posed a
choking hazard. Fisher-Price had been fined in 2001 for similar reasons.
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The
CPSC requires companies to report, within 24 hours, any products that could be
harmful. According to the Journal, in a number of earlier recall cases, Mattel
had gathered information on potentially hazardous toys for several months
before reporting to the CPSC.[6]
Mr.
Pinner says Mattel doesn't buy product recall insurance because the coverage
doesn't pay for the biggest expense associated with a recall - loss of
market share. When there's a recall, ``you lose three things,'' he
explained. ``You lose the cost of the recall, which most large companies can
afford; the loss of the product; and you lose market share, because people
now have some concerns about your products.[7]
“If product recalls are handled properly, a company not only can keep damage to a minimum but also may find opportunities to reap unexpected benefits.” … Consider Saturn Corporation and Intel, “in both cases, senior managers quickly confessed their mistakes and sought to make amends with appropriate corrections. Both companies reacted strategically, focusing on long-term marketing implications, and both emerged stronger for the experience.”[9]
[1] “An Extension of Security Price Reactions Around Product Recall Announcements,” Quarterly Journal of Business and Economics, Summer-Autumn, 2005
[2] Automotive recalls are not included because the consistently high frequency of recalls in that industry suggested that their inclusion “would result in significant sample bias.”
[3] “An Extension of Security Price Reactions Around Product Recall Announcements,” Quarterly Journal of Business and Economics, Summer-Autumn, 2005
[4] Ibid
[5]I will not attempt to prove that reputation impacts CFP in this paper, other than to say that, according to Orlitzky, Schmidt, and Rynes’ meta analysis, “the findings with respect to [Corporate Social Performance] CSP operationalizations suggest that studies that used reputation indices as proxies for CSP showed the highest average correlation with [Corporate Financial Performance] CFP’.” [Corporate Social and Financial Performance, 2003] Therefore, since a product recall affects a company’s reputation, we would expect it to also be associated with changes in financial performance.
[6] KLD Mattel, 2007, p.22
[7] “Managing product recall risks no child's play for toymakers”,
Business Insurance, 2001
[8] Widmer,
Lori, “When Your Name Is at Risk”, November 2000, BNet Research Center
[9] N. Craig Smith, Robert J. Thomas, and John A. Quelch,
“A Strategic Approach to Managing Product Recalls,” 1996, Harvard Business
Review
[10] Amy K. Smith and Ruth N. Bolton, “An Experimental Investigation of Customer Reactions to Service Failure and Recovery Encounters: Paradox or Peril?,” 1998 Journal of Service Research

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