Articles Review Article Review

The article discussed impact of recalls by producers of defective drugs and autos on the shareholders wealth and, thus, a market value of the firms. Losses of such character spill over to companies’ goodwill. These notorious losses regard not only the firm recalling its products, but an industry as a whole. Capital market penalizes each competitive firm even more than the direct costs of recall would. If we talk about drugs industry, where such recalls are not so frequent, we can see that any significant recall initiated either by the producer or by the Food and Drug Administration (FDA) results in a fall on market share of 6.5% within two weeks (Jarrell, Peltzman, 1985, p. 521). In fact, losses spill not only over the other products of the firm, but over other firms in the industry. That is why the goodwill effect is vital for producers of drugs. Auto recalls are more frequent and that is why they don’t affect the market value of the recalling firm to the same extent. The indirect costs of recalls in this sphere highly depend on the expectations: if the recall is close to being typical, then there will be no significant capital market response. Competitors lose during car recalls as well, which can be easily explained by spillover effect. To sum up, auto and drugs recalls have quite similar effect on the shareholders wealth, which can be explained by the spillover effect. Large goodwill loses imply large capital loses both by the recalling firm and its competitors. Per recall drug recalls are more costly (6 percent vs. 1.5. percent), but per year car recalls take the lead with about 1 percent (Jarrell, Peltzman, 1985, p. 536).
The article discussed two major questions which are: why are some recalls initiated by government and some by producers of cars; and what types of recalls involve more owner responses in repairing the autos in question. Neither GM nor the National Highway Traffic Safety Administration (NHTSA) benefits from initiating a recall. Any complaint of a customer must be investigated by one of the entities. The issue is what complains should each of them investigate first. Logically manufacturer tends to investigate those cases which may lead to the highest extent of liability. Government then is to investigate complaints that pose higher safety concerns and that are more costly to be identified. Manufacturers are reluctant to spend their budgets on these because their liability in case of defect would be minimal. Although the reasons for manufacturer to investigate a complaint may be different it tries to minimize potential costs either from liability for defects or from investigation itself. In general both entities have incentives to recall highly hazardous cars, and the system, due to the lack of resource, somehow cooperate with firms by letting them overlook initiated recalls. But at the same time NHTSA is more likely to initiate costly recalls that generate significant liability for firms. There are always other factors that distinguish recall initiators such, as number of vehicles recalled, makes year age, character of defects. NHTSA is more likely, for example, to recall older cars in large amounts (because owners have already suffered from the defects). Owners are more likely to respond to a recall if their costs are minimal. On the other hand, they are reluctant to travel far or to spend a lot of time to repair their car for free. In this case, manufacturer benefits, because it is not liable for a person’s refusal to make a recall. Of course, this issue is controversial and many factors affect the client’s willingness to respond to a recall such, as age of the car, character of defects, public disclosure of the recall, and potential losses. People are more likely to repair new domestic cars which are subject to hazardous effects.

References

Jarrell, G., Peltzman, S., (1985). The Impact of Product Recalls on the Wealth of Seller. Journal of political economy, 3, 512-536.
Nicholas G. Rupp, Curtis R. Taylor, (2002). Who initiates recalls and who cares? Evidence from the automobile industry. The journal of industrial economics, 2, 123-148.