Does a Firm's Product-Recall Strategy Affect Its Financial Value? An Examination of Strategic Alternatives During Product-Harm Crises

Yubo Chen, Shankar Ganesan, & Yong Liu
Journal of Marketing
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Executive Summary
Product-harm crises often result in product recalls that can have a significant impact on a firm’s reputation, sales, and financial value. In managing the recall process, some firms adopt a proactive strategy in responding to consumer complaints, while others are more passive. In this study, the authors examine the impact of these strategic alternatives on firm value using Consumer Product Safety Commission recalls over a 12-year period from 1996 to 2007. The study covers a broad range of product categories, from toys, to other children’s products, to electronics, to household products, to sports and recreation products, to outdoor products, and to other consumer specialty products. Using the event study method, the authors show that regardless of firm and product characteristics, proactive strategies have a more negative effect on firm value than more passive strategies. An explanation for this surprising result is that the stock market interprets proactive strategies as a signal of substantial financial losses rather than as a signal of socially responsible actions. When a firm proactively manages a product recall, the stock market infers that the consequence of the product-harm crisis is sufficiently severe that the firm had no choice but to act swiftly to reduce potential financial losses. The authors find that, in general, proactive strategies tend to be used more often by firms that are less reputable. Overall, the study suggests that during product recalls, the stock market uses the firm’s choice of particular recall strategies to assess the potential impact of the recall. The results also point to multiple and often contradictory interpretations of socially responsible corporate policies by the stock market. From a public policy perspective, these findings indicate a possible stock market failure in governing corporate behavior. Specifically, during a product-harm crisis, the stock market does not seem to reward corporate socially responsible behavior. The authors suggest that information asymmetry between the firm and investors can be an important reason for this failure. They suggest that appropriate regulatory measures should be taken to aid communication and information exchange, thus rewarding corporate social responsibility and increasing market efficiency and social welfare. From the firm perspective, this study suggests that when dealing with product recalls, firms need to be sensitive to how investors may interpret a proactive strategy and communicate effectively the rationale of their strategies so that the stock market will not “stereotype” the situation as just another case of severe product hazard and significant financial loss. In addition, this study recognizes the importance of firm reputation in reducing the need for a proactive approach, thus buffering the negative effect of product-harm crises. Finally, the study discusses implications for the investors. Investors are increasingly focusing their attention on socially responsible investing and incorporating the value of responsible corporate policies into their evaluation of firm value. This study posits that some seemingly social responsible corporate policies might be driven by other factors, such as the effort to reduce potential financial losses. Thus, investors need to be cautious when evaluating firms’ strategic initiatives and how such initiatives may be related to financial outcomes.

Biography
Yubo Chen is Assistant Professor of Marketing in the Eller College of Management at the University of Arizona. He received his PhD in Marketing from the University of Florida. His research investigates how social influence is changing the landscape of marketing strategy and how to use market force to address social and developmental issues, such as sustainability and corporate social responsibility. He has published articles in leading academic journals, such as Management Science and Marketing Science. Professor Chen is a recipient of various college- and university-level teaching awards and recognitions.

Professor Shankar Ganesan is Office Depot Professor of Marketing in the Department of Marketing in the Eller College of Management at the University of Arizona. His research interests focus on the areas of interorganizational relationships, buyer–seller negotiations, service failure and recovery, and new product innovation. He is the author of several articles that have appeared in leading academic journals, including Journal of Marketing Research, Journal of Marketing, Journal of Retailing, Journal of Personal Selling and Sales Management, Journal of Academy of Marketing Science, Journal of Applied Psychology, Organizational Behavior and Human Decision Processes, and MIT Sloan Management Review. Professor Ganesan has received numerous awards and honors for his research and teaching, including the American Marketing Association’s Louis W. Stern Award for the Best Article on Marketing Channels and Distribution, the Robert D. Buzzell/Marketing Science Institute Best Paper Award from the Marketing Science Institute, the American Marketing Association’s Best Dissertation Award, the Craig and Lauri Forte Excellence Award, and the Eller College BPA Student Council’s Faculty Appreciation Award for teaching. He has also received awards from Journal of Marketing and Journal of Retailing for being an outstanding reviewer on the editorial review board. He teaches sales management to the undergraduate students, customer relationship management to the graduate business students, seminars on marketing strategy and research methods to the doctoral students, and customer value module to the executive graduate business students. Before his academic career, he worked as a sales manager for a computer company in India.

Yong Liu is Assistant Professor of Marketing in the Eller College of Management at the University of Arizona. He received his PhD in Marketing from the University of British Columbia, Canada. His research interests include the effects of information and social interactions in the media and entertainment markets, positioning strategies for business and nonprofit organizations, and managing product-harm crisis. His research has been published in journals such as Journal of Marketing, Marketing Science, Journal of Public Policy & Marketing, Marketing Letters, and Journal of Cultural Economics. Liu has served on the editorial review boards of Marketing Science (2002–2005, 2005–2007) and the Canadian Journal of Administrative Sciences (2009–current). He was selected as a Marketing Science Institute Young Scholar in 2007 and was a fellow at the Center for the Study of Popular Television at the S.I. Newhouse School of Public Communication, Syracuse University.

Journal of Marketing, Volume 73, Number 6, November 2009
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Yubo Chen, Shankar Ganesan, & Yong Liu
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