Corporate Social Responsibility and the Impacts of Product Recall
Strategies on Firm Value
Shao-Chi Chang
Institute of International Business National Cheng Kung University No. 1, University Road, Tainan, Taiwan
E-mail: schang@mail.ncku.edu.tw
Heng-Yu Chang*
Institute of International Business National Cheng Kung University No. 1, University Road, Tainan, Taiwan
E-mail: r6897102@mail.ncku.edu.tw
_____________________
*Correspondence to: Heng-Yu Chang, Institute of International Business, College of Management, National Cheng Kung University, No. 1, University Road, Tainan, Taiwan. E-mail:
r6897102@mail.ncku.edu.tw
The authors wish to thank Chung-Hui Tseng for helpful comments and suggestions. Seminar participants at the 2012 Academy of Management Annual Meeting provided many valuable comments.
Corporate Social Responsibility and the Impacts of Product Recall
Strategies on Firm Value Change
Abstract
Although a firm may intend to convey positive signals by voluntarily recalling the products, prior evidence show voluntary recalls do not experience better abnormal returns than involuntary recalls. This paper investigates the influence of corporate social responsibility (CSR) on stock market reactions to the announcement of voluntary and involuntary product recalls. We argue that a voluntary recall may be associated with greater information uncertainty than involuntary recalls because it involves various incentives and the latitude in recall process allows a firm to act strategically. The engagement in CSR activities certifies the information conveyed by voluntary recalls, and reduces the information uncertainty for investors, and the effect is expected to be stronger for voluntary recalls. Our empirical evidence suggests that firms with good CSR performance receive significantly greater firm value change than those with poor CSR performance upon the announcements of voluntary recalls. On the contrary, the effect of CSR is not significant for involuntary recalls. In addition, we find the effect of CSR is mainly driven by the engagement in technical CSR activities. The evidence suggests that the important contingent effect of CSR in investors' perception of product recall announcements.
Corporate Social Responsibility and the Impacts of Product Recall
Strategies on Firm Value
1. Introduction
A common consequence for firms that experience product-harm crises is the
initiation of large-scale product recalls. Prior research had shown consistent evidence
that product recall announcements are associated with serious firm value loss (Ahmed,
Gardella and Nanda, 2002; Hoffer, Oruitt and Reilly, 1988; Jarrell and Peltzman,
1985; Pruitt and Peterson, 1986). Nevertheless, the financial impacts of product
recalls can greatly vary for individual firms. For example, Target Corp. recalled
185,000 Firestreet toy scooters on August 17th, and this action incurred an
approximate $1.6 billion share value loss in the wake of the national recall. In contrast,
Johnson and Johnson experienced a firm value increase by around $5.1 billion when it
recalled hepatitis B test kits on January 10th, 2006. As demonstrated in the above
examples, product recalls may be associated with heterogeneous valuation impacts
across different announcing firms.
Product recalls can be voluntary or involuntary. A normative recall process is
that after receiving information of an actual or potential product hazard, firms can
(Mullan, 2004). Some firms may even announce recalls with supplemental consumer
welfare. Nevertheless, firms may refute any responsibility for a defective product, and
likely delay the recall process (Siomkos and Kurzbard, 1994). The government
agency will then decide whether to issue a mandatory recall which generally requires
a lengthy legal process and detailed investigation of the information available
regarding the hazardous product. Once a mandatory recall is enforced, there is little
room for a firm to manage the recall process and thus involves less uncertainty on the
information contents of recall announcements because the investigation process in
mandatory recalls provides information on the nature and details of the hazard
products, and attracts media coverage. Accordingly, a mandatory recall may signal a
low-quality producer of the recalling firm because they have little incentive to
self-monitor product quality (Rupp, 2001).
Relative to a mandatory recall, the information contents of a voluntary recall
are not as straightforward. Firstly, voluntary recalls can be motivated by various
reasons that may yield very mixed perception. Prior research suggests that managers
may voluntarily recall products in order to reduce consumer blame and demonstrate
concern for consumers for maintaining their future purchases (Siomkos and Kurzbard,
1994; Laufer and Coombs, 2006). In addition, voluntary recalls can be motivated to
inspections, sending a signal to consumers that they are diligent in solving quality
issues (Hora, Bapuji and Roth, 2011). However, voluntary recalls may sometimes be
perceived as negative signals. Chen, Ganesan and Liu (2009) argue that rather than a
positive message, a proactive recall strategy may be interpreted as a signal of
sufficiently severe product defects so that it forces the firm to act swiftly to deal with
a recall on account of pending worse financial consequences. Thus, a voluntary recall
per se does not necessarily result in better impacts.
Moreover, the recall process may further complicate the interpretation on
signals of voluntary recall announcements. A voluntary recall generally occurs early
in the process, and the recall decisions may involve only internal investigation by the
recalling firms. In addition, voluntarily recalling firms are not allowed to release their
own information before announcements from government agencies (Chen et al., 2009).
As a result, the voluntary recall announcements may have greater information
uncertainty for investors in evaluating the potential direct and indirect damage and
costs to the recalling firms.
The empirical evidence shows that the financial impacts of different product
recall strategies are inconclusive. Davidson and Worrell (1992) investigate
non-automobile product recalls and find no significant difference between voluntary
period. Rupp (2001) documents very similar evidence in automobile industry, and
further find the results are independent of the hazard composition. Chen et al. (2009)
even report that proactive recalls generate significantly more negative stock market
reactions than passive recalls. Apparently, the positive information that firms hope to
convey through voluntary recalls is not necessarily recognized by investors.
In this paper, we argue that how messages of product recall strategies are
perceived by investors is contingent on the performance of corporate social
responsibilities (CSR) of the recalling firms. In an environment with limited available
information, outsiders will go beyond the disclosed information and search for other
signals or proxies in their interpretation of the disclosed messages. The engagement in
CSR activities serves an important role of certifying the credibility of information.
Prior studies have shown that firms with good CSR performance not only disclose
greater amount of information (Gelb and Strawser, 2001), but also have better
information quality (Raiborn, Butler and Massoud, 2011) and greater information
transparency (Dhaliwal et al., 2011). Moreover, better socially responsible firms have
greater reputation and are less likely to act opportunistically toward their stakeholders
(McWilliams and Siegel, 2001; Siegel and Vitaliano, 2007; Shleifer, 2004). In
product markets, the research has found that firms with more CSR engagement earn
more favorable stakeholder attitudes and behaviors (Peloza and Shang, 2011;
Stanaland, Lwin and Murphy, 2011), and are more able to sustain the competitive
advantage among rivals (Branco and Rodrigues, 2006; Wang and Bansal, 2012).
Godfrey, Merrill and Hansen (2009) argue that CSR activities lead to positive
attributions by offering an insurance-like protection when a firm suffers a negative
event.
This study investigates the impacts of product recall strategies on financial
performance by focusing on the contingent effect of CSR. We hypothesize that CSR
plays an important role in stock market responses to product recall announcements.
Because CSR performance certifies a firm’s reputation and credibility, the
information content of product recall announcements made by high-CSR firms is
expected to be of greater quality, and the conveyed signals be more positively
received by outsiders. In contrast, the information of recall announcements from
low-CSR firms is not as trustworthy as that from high-CSR firms. It may create
greater uncertainty and doubts about the true motives of the announcing firm, and
convey messages to outsiders that are very different from what the announcing firm
intends to deliver.
Moreover, the influence of CSR is expected to be heterogeneous for different
recalls than involuntary recalls. Because voluntary recalls are associated with greater
information uncertainty, investors may have to rely more on CSR ratings of the
recalling firms in interpreting the disclosed information and evaluating the impacts
associated with the voluntary recall announcements. Therefore, voluntary product
recalls by high-CSR firms are more likely to deliver positive signals by convincing
investors that the recalls are made for ensuring product safety and maintaining
consumers’ confidence. In contrast, voluntary recalls by low-CSR firms may be
perceived as an intention to hide the severe product hazard and financial damage as
argued in Chen et al. (2009). As a result, CSR ratings are expected to be positively
related with firm value change for voluntary product recall announcements. However,
the effect of CSR for involuntary recalls may be different. Because mandatory recall
decisions are reached after a detailed and lengthy government investigation and legal
proceedings, the information about the hazard defects, degree of safety concern and
the firms’ corrective plan is more certain and available when announcing the product
recall decisions are made. In addition, in mandatory recalls firms have little room to
manage the recall process. Therefore, the information uncertainty for investors in
involuntary recalls is expected be not as severe as voluntary recalls, and the function
CSR is a set of heterogeneous firm actions (Godfrey et al., 2009). The effects of
different CSR activities on stock market reactions to product recall announcements
may not be similar. To provide finer evidence, this study further tests the effects of
different CSR activities on the financial performance of product recall strategies.
Based on the targeted stakeholders, the literature has classified CSR into technical
CSR (TCSR) and institutional CSR (ICSR) (Mattingly and Berman, 2006; Godfrey et
al., 2009). TCSR activities tie more closely to firm operation, including product
quality and safety, corporate governance mechanism and employee relations, and
mainly interact with primary stakeholders who have strong power and direct interest
in business operation. On the other hand, ICSR activities emphasize the relationship
involving environment and community concerns with outside stakeholders who often
lack power and urgency to enforce shareholders wealth (Mattingly and Berman, 2006;
Parmar, Freeman, Harrison, Wicks, Purnell and de Colle, 2010). With different
focuses, TCSR and ICSR may have dissimilar effect on the consequence of product
recalls. Emphasizing aspects in business management, TCSR engagement reduces the
possibility of opportunistic behaviors toward other stakeholders in the business
operation and product quality. In addition, with the needed power and interests,
primary stakeholders have strong incentive to monitor the business operation. The
information transparency for not only primary stakeholders, but also other
stakeholders because the power and interest of primary stakeholders make their
actions credible signals on the information quality. Therefore, when announcing
product recalls, the impacts of TCSR performance is expected to be more important
than ICSR in influencing investors’ estimation on the financial impacts of product
recalls.
This study contributes to the literature by linking CSR with the financial
performance of product recall strategies. While firms may attempt to convey positive
signals through voluntary product recalls, we argue that how well investors are
convinced by the signals is contingent on the CSR performance. Due to information
uncertainty, voluntary recalls per se may not be enough to convince investors of the
good motives without other credible information, such as CSR performance. Our
arguments also suggest that the ignorance of CSR performance may help explain the
reason why previous studies find voluntary/active management in product recalls does
not necessarily experience better responses from financial market (Davidson and
Worrell, 1992; Chen et al., 2009). In addition, Cheah, Chan and Chieng (2007) find
no significant effect of CSR on the abnormal returns of pharmaceutical product recall
announcements in both the US and US markets. Our study suggests that the
CSR on different product recall strategies. To the best of our knowledge, our work
represents the first paper that provides an integrative perspective of CSR and investors’
perception on the financial impacts of product recall strategies. Besides, this paper
shows that not all CSR activities are equally relevant to the value assessment of the
financial market during product recall events. The CSR activities that are more
directly linked to the nature of corporate decisions have stronger impacts. Therefore,
to better understand how CSR influences the consequences of corporate events, it is
important to distinguish the heterogeneous characteristics of CSR activities.
In the next section of this paper, we provide the theoretical arguments for the
proposed hypotheses. The data and methodology are in section 3. The empirical
results are presented in section 4. The discussion and future research are provided in
section 5.
2. Literature Review and Hypotheses Development
Product recall events have been prevailing for decades due to the upsurge of
product safety consciousness and awareness, and in particular have the potential to
damage long-developed brand equity, destroy a firm’s reputation, blow up consumers’
2009). The substance of recalls can either be for product replacement, withdrawal, or
be for simply repair or examination on an available product. Siomkos and Kurzbard
(1994) propose four types of corporate responses to a product-harm crisis: denial,
involuntary, voluntary and super-effort recall strategies that make up the so-called
company response continuum. In a recall event, consumer attitudes toward different
types of product recalls can show a great variation because the information content
that a firm intends to convey through recall announcements may not be correctly
received. The uncertainty in interpreting the information disclosed in product recall
announcements may thus result in heterogeneous financial impacts. Given the
potentially destructive fallouts for firms involved, a firm’s success in dealing with a
product recall event may hinge not only on the type of responses that a firm
undertakes, but also how well the intended message can be received by the outsiders.
2.1 CSR and Product Recall Announcement Effect
Corporate social responsibilities are actions that appear to advance social good,
beyond the interests of the firm, and can play an important role to enhance
competitive advantages to an extent that capture value for firms through participation
in social activities (McWilliams and Siegel, 2001 and 2010). The value of CSR often
(Feddersen and Gilligan, 2001; McWilliams and Siegel, 2010). CSR thus associates
an informational relevance with a form of corporate goodwill or moral capital to
outside investors, especially when negative events occur (Godfrey et al., 2009). The
messages from social activities of a firm are germane to how investors evaluate the
sustainable benefits in preserving economic value (Godfrey, 2005).
A firm's CSR performance conveys positive information on the extent of the
firm concerns the interest of various stakeholders. Prior studies suggest that a socially
responsible firm is less likely to conduct opportunistic behaviors. For example, Chih,
Shen and Kang (2008) find that a firm with social responsibility does not conceal
unfavorable realized earnings outcomes to myopically increase current profits, and
thus less inclines to conduct earnings management that distorts investors. Firms
committed to CSR emphasize the quality of their publicly available financial
information and aim at nurturing future relationships with stakeholders. Shleifer
(2004) interprets that because ethical norms evolves and promotes social cooperation
with a strong commitment to social responsibility that reduces the likelihood of
opportunistic earnings manipulation, firms with social responsibility accordingly
would not selfishly abuse public trust, and function more efficiently.
Firms actively engaging in CSR generally have better financial transparency
undertaking CSR are for stakeholder engagement. Firms with good CSR performance
appear to provide more extensive disclosures than legitimate requirements, and such
manner convinces investors to believe in their disclosure quality and transparency.
Dhaliwal, Li, Tsang and Yang (2011) find that voluntarily communicating financial
information with investors can increase their awareness of a firm’s existence and
further reduce their risks because the financial disclosures are informationally
value-relevant for investors to decide the investment horizon on a firm.
To product markets, CSR is found to be important in serving a certification role
on verifying the information content about a new-launched or an in-the-market
product. Siegel and Vitaliano’s (2007) argue that both the credence (ex. mutual funds)
and experienced (ex. advertising) services involve a high degree of information
asymmetry between buyers and sellers, which cannot be readily evaluated prior to
purchase. CSR, as a positive signal regarding a firm’s reputation, assures the future
value of credence and experienced services. Because consumers rely heavily on the
firm’s reputation for quality, CSR presents to convey relevant information for
consumers to gauge their purchase behavior. Peloza and Shang (2010) also point out
that CSR provides product-related benefits in terms of quality insurance because it
generates certain form of social and environmental good that maintains stakeholder
CSR is found to have a significant effect in reducing negative shocks. Janney
and Gove (2011) find that CSR initiatives partially buffer a firm against a
wrong-doing event and enhance overall corporate reputations from scandal
revelations. CSR initiatives as observable behaviors would benefit the firm by
differentiating it from its peers and competitors for long run. Because the market
reactions to backdating scandal are influenced by prior CSR initiatives pertaining to
good governance, the impact of firms’ wrong-doing events is more likely to
ameliorate investor concerns. Godfrey et al. (2009) argue that CSR is crucial in the
corporate risk management policy. When firms face negative events, the
"insurance-like" characteristic of CSR can lead to positive attribution from
stakeholders who then temper the unfavorable evaluation and sanctions toward firms.
The moral capital resulting from CSR investment can mitigate the negative impacts of
product recalls, and thus help reduce the loss of firm value.
Based on the arguments stated above, we argue that CSR performance may
alleviate the negative information of a product recall announcement. Managers
engaging in CSR activities may send strong signals that the firm is careful about
social or moral desires to create potential value for stakeholders. Reciprocally,
stakeholders interpret the signals from such moral capital to temper the possible harm
the announcements of product recalls, firms with better CSR performance are more
likely to convince investors that the product recall is primarily motivated by
maintaining shareholders' welfare, rather than opportunistically hiding the substantial
financial losses. Therefore, we propose the following hypothesis:
Hypothesis 1: A firm’s CSR performance positively relates to abnormal stock returns upon the announcements of a product recall.
2.2 The Contingent Effect of CSR on Product Recall Strategies
A product recall can be voluntary or involuntary. In the formal product recall
process, a firm has the obligation to report safety issues to the government agency
when they receive consumer complaints or distribution channel member notices. As
long as the impact of the reported product is investigated, the recalling firm may
voluntarily make an official recall announcement jointly with the related government
agency. Nevertheless, a firm may disagree with the agency’s decision on a warranted
recall and thus the government agency needs to decide whether to impose a
mandatory (i.e., involuntary) recall, which usually involves a lengthy and costly
The process of government-ordered recalls is relatively clear and transparent.
The main purpose of the recall is to remove the defective products from the consumer
market or channel members as quickly as possible to the extent that the public can
access to the understandable and accurate information about the defective products.
The course of investigation action also provides the public the relevant and detailed
information about the hazard products in a timely manner (CPSC, 2012). Once a
mandatory recall is decided by the governance agency, there is little room of choices
in the recall process. Because of the disclosed information from the government
investigation and the standard recall process, the information contents involved in
involuntary product recalls announcements is straightforward. An involuntary recall
often signals that a firm reluctantly stand behind its products, and offers the clue that
the product is so defective that the government has to intervene in to correct the
situation (Davidson and Worrell, 1992).
In contrast to a mandatory recall, a voluntary recall may involve more complex
information contents. On the one hand, voluntary recalls may be motivated by the
attempt to send favorable signals. Siomkos and Kurzbard (1994) argue that if firms
respond to a recall event by executing a voluntary recall or super-effort strategy,
future purchases will be less negatively influenced by the current crisis because
sustains positive consumer impressions. Davidson and Worrell (1992) and Laufer and
Coomb (2006) suggest that a voluntary recall may reassure consumers that a company
willingly takes part in its products as well as appears thinking of shareholder benefits
and demonstrates concern for consumers. Voluntary product recalls are more often
recognized as responsible because a voluntary manner is indicated as trustworthiness
and uprightness to temper stakeholders’ doubt on brand equity and customer loyalty
(Dawar and Pillutla, 2000).
On the other hand, while managers may attempt to send a signal of diligence
about product quality issues, corporate trustworthiness and integrity by voluntary
recalls, investors may actually negatively interpret a voluntary recall as pending worse
financial consequences (Chen et al., 2009). A firm acting proactively to deal with
defects may signal to investors expensive and uncertain recall costs that indicate
future cases of product liability (Hora et al., 2011). Moreover, hazardous recalls are
likely to be initiated by firms who know better about the potential impacts on the
ensuing losses than outsiders (Rupp and Taylor, 2002). Although a voluntary recall
aims at minimizing the damages, investors may worry about the unforeseen losses
behind it to an extent that they deconstruct the information in a way of worst-case
scenario especially when they are uncertain of the information content released
significant difference in the abnormal stock returns between voluntary and mandatory
product recalls. Chen et al. (2009) show that firms with proactive product recalls
experience significantly more negative firm value change than passive recalls. The
discussion above indicates that the information contents of voluntary recalls involve
greater uncertainty than involuntary recalls. Since various factors are involved in
voluntary recalls, it can be difficult for investors to distinguish the true underlying
motivation in assessing the financial impacts of product recalls based on the recall
announcements per se.
Prior research has documents consistent evidence that CSR has an important
certification effect on the quality of information when information uncertainty is
strong. El Ghoul, Guehami, Kwok and Mishra (2011) show that the CSR performance
significantly reduces cost of equity capital because better CSR is able to successfully
signal greater level of information disclosure and lower perceived idiosyncratic risks
that meet investors’ preference. Chih et al. (2008) find that firms with greater
commitment to CSR activities can convince investors that they provide financial
information of quality, and engage less in earnings smoothing behavior. Similarly,
Shleifer (2004) argues that CSR reduces the possibility of opportunistic earnings
management because it augments information transparency and disclosure quality,
investors. Ramchander, Schwebach and Staking (2012) indicate that CSR not only
uncovers new information about the firm’s performance, but also serves as a
communication role in delivering messages to outside investors because CSR is able
to mitigate the information uncertainty of investors regarding investment orientation
and assessment.
To the extent that CSR has an effective effect in certifying information quality
associated with product recalls announcements, the influence should be dependent on
the extent of information uncertainty. Since the information uncertainty of voluntary
recalls is expected to be greater than involuntary recalls, we argue that, upon the
announcements of product recalls, the effect of CSR is expected to be stronger for
voluntary recalls than involuntary recalls. Thus, we propose the following hypothesis.
Hypothesis 2: The effect of a firm’s CSR performance on abnormal stock returns is greater for announcements of voluntary product recalls than for involuntary ones.
2.3 The Components of CSR: TCSR and ICSR
The discussion above suggests that the effect of CSR activities on the financial
impacts of product recall announcements rests on how CSR can help investors
important medium in reducing information uncertainty. Nevertheless, not all CSR
activities are alike, and they may target different group of stakeholders. While CSR in
general is expected to have a positive effect on the announcement return of product
recalls, we believe the impact could be more dependent on the CSR activities that
focus more towards stakeholders who are associated with product-related issues.
Mattingly and Berman (2006) categorize CSR activities into technical CSR
(TCSR) and institutional CSR (ICSR). A firm’s institutional orientation indicates the
source of normative expectations of a firm, whereas the technical orientation is the
source of resource exchanges among direct stakeholders. That is, TCSR involves
more in buisness operation, whereas ICSR relates more in community and diversity in
treatement of various races, disabled and different genders. As the explicity in a
firm’s social activities surrounds managerial preferences for prioritizing stakeholders,
firms would likely differentiate the stakeholder groups they interact with. Building on
the theoretical characteristics on TCSR and ICSR, we follow Godgrey et al.’s (2009)
social action constructs to link stakeholder relationship management. TCSR-oriented
firms that concern more about business operation link should be targeting primary
stakeholders who are essential to business operation, containing dimensions such as
governance, employee and product relations. In contrast, secondary stakeholders who
target to ICSR-oriented firms, including community and diversity dimensions
(Godfrey et al., 2009).
Primary stakeholder relationship ties closely with corporate survival where
information gap between firms and outside investors are likely to be the most acute
(Ramchander et al., 2012). As TCSR activities target primary stakeholders including
investors, employees and customers that produce advantageous exchange capital,
TCSR-oriented firms may send a credible signal to investors that the recall is made
not only to further check product quality and protect the safety of the public, but also
exhibits the most prompt socially responsible course of action. As Mattingly and
Berman (2006) defined, technical factors in CSR activities are involved in resource
exchanges with firms, issues around product quality and safety should be under
surveillance of primary stakeholders closely because the inputs and actions of CSR
activities are in line with firm value that directly affects primary stakeholder interests.
CSR as the mitigating factor in mens rea attribution process is manifest as a
TCSR-oriented firm announces a product recall. When the wealth of stakeholders is
jeopardized in product safety issues or health violations, the importance of TCSR is
thus apparent (Godfrey et al., 2009), particularly for product-related stakeholder
group (i.e. primary stakeholders). Primary stakeholders request more useful
corporate resources used for social issues signal a positive message to investors that
the participation in social activities are directly related to shareholder value. Therefore,
managing better primary stakeholder relationship may lead to increased shareholder
wealth.
In contrast to TCSR, ICSR targets secondary stakeholders that possess different
profile. The apparent differenec between ICSR and TCSR lies in the attribute of direct
or indirect partnership in business operation. Secondary stakeholders generally have
less power and urgency to press their claims on firm value. Thus, they may not have
as strong influence on the valuation effect of product recalls as primary stakeholders.
In addition, secondary stakeholders plea voluntary acts of social beneficence, and
emphasize the community relationship and the other-regarding orientation (Godfrey et
al., 2009). As a result, relative to TCSR activities, the ICSR activity is less directly
related with the financial impacts of product recalls. Because of the differences in
CSR activities targeted stakeholders between TCSR and ICSR, we propose the
following hypotheses.
Hypothesis 3a: A firm’s technical CSR performance is positively associated with abnormal stock returns upon the announcements of a product recall.
Hypothesis 3b: A firm’s institutional CSR performance is insignificantly associated with abnormal stock returns upon the announcements of a product recall.
2.4 CSR Components and Product Recall Strategies
For similar reasons provided in preceding sections, we further posit that TCSR
activities should have a greater impact on a voluntary recall strategy than an
involuntary recall strategy because TCSR activities, emphasizing the product-related
issues and governance mechanism, are more likely to reduce the information
uncertainty associated with voluntary recalls. In addition, TCSR activities relate to
more informational relevance for primary stakeholders. The more information that
investors obtain, the lower information uncertainty exists and hence lead to better
valuation effect. As investors are uncertain of the signals from a voluntary recall
strategy, they reply heavier on public information as monitoring tool. Accordingly,
TCSR provides the certification effect as a voluntary recall strategy announces, and
the monitoring mechanism of primary stakeholders also rests assure outside investors.
In contrast, ICSR-oriented firms that target secondary stakeholders involve less acute
information gaps and thus experience insignificant stock market reactions.
Relative to a voluntary recall strategy, a firm that announces an involuntary
information uncertainty between firm insiders and outside investors, therefore, the
effects of both TCSR and ICSR on the value assessment of investors are less likely to
be significant. Extensive hypotheses are proposed as below:
Hypothesis 4a: For voluntary product recall strategies, the impact of TCSR on abnormal stock market reactions to recall announcements is more pronounced than that of ICSR.
Hypothesis 4b: For involuntary recall strategies, neither TCSR nor ICSR affect the abnormal stock market reactions to product recall announcements.
3. Data and Methodology
3.1 Data
The sample of product recall announcements was collected from LexisNexis
Academic during 1991 to 2008. We applied the structured content analysis approach
(Jauch, Osborn and Martin, 1980) to identify if the recall announcements belong to
voluntary or involuntary strategy. Following Siomkos and Kurzbard (1994), we
searched for voluntary product recalls using the keywords “voluntary”, “improve” and
keywords “order”, “mandatory” and ”refuse”. If there are multiple recall
announcements for the same product, only the first one is included in the sample. In
addition, we deleted the recall announcements when other important news is released
around the product recall announcement date to avoid their confounding effects on
stock market reactions1
To measure the abnormal returns, we require the sample firms to be listed on
the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) and
NASDAQ. The daily stock return data is obtained from the Center for Research
Security Prices (CRSP) database. We draw on the Compustat database for a firm’s
financial information. The final sample includes announcements of 355 voluntary
recalls, and 55 involuntary recalls. .
3.2 Event Study Analysis
Event study methodology has been widely applied in marketing and
management research (Mathur and Mathur, 2000; McWilliams and Siegel, 1997;
Sorescu, Shankar and Kushwaha, 2007). Based on the Market Efficiency Hypothesis
(Fama, 1998), the financial impact of product recalls should be quickly reflected in
stock price changes when the information is disclosed to the public. Thus, The
valuation impacts of an event is measured by the abnormal changes in share prices
surrounding the time of the event announcements.
We measure abnormal stock returns by subtracting expected returns from real
returns. The expected stock returns are measured by estimating the following equation
with the ordinary least squares technique: rit = +ai b Ri mt + , where eit r ＝ the stock it
return for firm i on day t; a and i b are the regression parameters for firm i; i R mt
is the return of the market portfolio on day t; and e is the residual term. The it
abnormal returns AR associated with recall announcements are measured by the it
following equation: ARit = −rit (aˆi+b Rˆi mt), where AR is the abnormal return for it
firm i on day t, and ˆa and ˆi b are parameters estimated for the i a and i bi in the preceding equation by using a 140-day estimation period prior to the
announcement day (Chen, Ho, Ik and Lee, 2002). We use the cumulative abnormal
returns on the announcement date and one day before the announcement date, CAR
(-1,0) as the dependent variable in the empirical analyses.
3.3 Variables
The first independent variable is a binary variable, VOLUNTARY, that takes a
value of 1 for voluntary product recalls, and zero for involuntary recalls. The second
CSR ratings from KLD STATS. CSR is an indicator variable that equals 1 if a firm’s
number of CSR strengths minus the number of weaknesses is nonnegative, and 0
otherwise (Siegel & Vitaliano, 2007). Furthermore, based on the CSR classification in
KLD STATS provided in Mattingly and Berman (2006), we measure technical and
institutional CSR. Specifically, TCSR is a dummy variable that is 1 if the number of
strengths minus the number of weakness in the items of TCSR is nonnegative, and 0
otherwise. The variable ICSR is similarly defined.
We control several important factors on the market reactions to product recall
announcements in the regression analyses. REPUTATION measures a firm’s
reputation based on the rating scores in the annual America’s Most Admired
Companies survey appeared in Fortune magazine in the product recall year (Chen et
al., 2009). To capture the effect of serious incidents on the value assessment of
investors, we use a dummy variable INJURY that equals 1 if injury is reported in the
recall news, and 0 otherwise.
Chen et al. (2009) shows that the stock market reactions to recall
announcements may be related to the recalling firm’s size and financial leverage. We
thus control those two factors in the analyses. The variable SIZE is measured by the
logarithm of book value of total assets for the fiscal year of the product recall
book value of total debt divided by the book value of total assets for the fiscal year
preceding the announcement (Lang, Ofek and Stulz, 1996). In addition, product
recalls may have a greater impact on firms that have more growth opportunity
because the valuable growth options may disappear due to the recall events. Thus, we
include the growth opportunity variable, TOBIN’S Q, measured by the ratio of the
market to book value of a firm’s assets, where the market value of assets equals the
book value of assets minus the book value of common equity plus the market value of
common equity (Chen et al., 2002). To capture possible trends of the impact of recalls
on returns, a time variable, Year trend effect is included (Chen et al., 2009) in the
analyses, measured by the number of years between 1991, the earliest sample year,
and the year of the recall. Finally, we control for the industry-specific effects by
including the industry dummy variables based on the two-digit Standard Industry
Classification (SIC) codes.
4. Results
4.1 Descriptive Statistics
Table 1 illustrates the distribution of the entire sample. The majority of the
recalls in the sample were made by firms operating in 20 industries based on the
2-digit SIC codes. The majority of recalls announcements happened in the
manufacturing industries (SIC codes from 20 to 39), and the Transportation
equipment industry (SIC code 37) accounts for around 30% of the entire sample. ---
Insert Table 1 Here ---
Panel A of Table 2 presents descriptive statistics for the variables in the
analyses. For CSR performance and firm reputation, we find there is no significant
difference between the voluntary and involuntary subsamples. The results indicate
that injuries occur significantly more frequently for involuntarily recalled products
than voluntarily ones. The evidence for TOBIN’S Q suggests that firms involving
voluntary recalls have significantly greater growth opportunity than those with
involuntary recalls. The non-parametric statistics for the difference in median are very
similar. Finally, no significant difference is found in the leverage ratio between
voluntary and involuntary recalls. Panel B presents the Pearson correlations among
the variables.
--- Insert Table 2 Here ---
4.2 Analyses of Impact of CSR Performance on Recall Strategies
Table 3 presents the comparison in CAR based on the recall strategy and CSR
performance. Panel A shows that while voluntary and involuntary recalls are both
associated with negative announcement returns, voluntary recalls receive marginally
greater abnormal returns than involuntary recalls.2
Panel C considers both recall strategy and CSR performance simultaneously.
The findings show that for voluntary recalls, the mean CAR for high-CSR firms is
positive (0.04%), although statistically insignificant. On the contrary, the CAR for
low-CSR firms is significantly negative (-0.54%). The difference in mean CAR
between high- and low-CSR firms is statistically significant at the 5% level. For
involuntary recalls, firms in both high- and low-CSR groups receive negative mean
CAR, and the difference is not statistically significantly different from zero. The Pane B compares CAR based on
CSR performance. The results show that high-CSR firms have an insignificant mean
CAR of -0.12% (t = 0.55), and, in a sharp contrast, low-CSR firms experience a
significantly negative mean CAR of -0.58% (t = -3.12). The difference in CAR is
statistically significant at the 10% level. The results suggest a firm’s CSR
performance may be considered as a positive signal to investors in their assessment of
the valuation impacts of product recalls.
overall evidence in Panel C suggests that CSR plays an important role in investors’
value assessment for voluntary recalls, but not involuntary recalls. ---
Insert Table 3 Here ---
In Table 4 we further decompose CSR ratings into TCSR and ICSR
components based on the activity classification in Mattingly and Berman (2006).
Panel A shows that there is no significant difference in the mean CAR between the
high- and low-ICSR subsamples. However, the results show a very different pattern
when focusing on TCSR. The mean CAR for the high-TCSR firms is significantly
positive, but that for the low-TCSR firms is significantly negative, and the difference
is strongly significant at the 1% level (t = 3.27). The results imply that the information
content of product recalls is more related with the involvement in TCSR activity of
the recalling firms.
Panel B presents the impacts of TCSR and ICSR on the abnormal returns of
recall strategy. Consistent with the evidence in Panel A, ICSR rating does not yield
important difference in the mean CAR for both voluntary and involuntary recall
announcements. However, for TCSR rating we find that high-TCSR firms have
evidence strongly indicates that the result for overall CSR is mainly driven by TCSR
performance, rather than ICSR. In sum, the evidence presented in Tables 3 and 4
suggests that how investors perceive and evaluate product recalls does not only rely
on the recall strategy per se, it is also dependent on the CSR ratings of the announcing
firms, particularly the TCSR performance.
--- Insert Table 4 Here ---
4.3 Cross-sectional Regression Analyses
Table 5 presents the cross-sectional regression analyses of the recall
announcement abnormal returns. To control for the possibility of heteroskedasticity in
the sample, the t-values reported are computed with heteroskedasticity-consistent
standard errors (White, 1980). Model 1 tests the effect of product recall strategy and
CSR for the overall sample. The results show that the coefficient of VOLUNTARY is
insignificantly positive, implying voluntary recalls per se do not necessarily result in
better result in firm value change than involuntary recalls. The effect of the CSR
dummy is positive and statistically significant at the 5% level, suggesting that CSR
performance has a strong impact on the value assessment during product recalls
significantly positive impact on abnormal returns, but the effect of ICSR is found to
be very weak. The findings indicate that the positive influence of CSR in Model 1 is
driven by TCSR performance. The evidence in Models 1 and 2 lends strong support to
Hypotheses 1 and 3.
To test the interaction effect of CSR and recall strategy, we stratify the overall
sample based on recall strategies. In the subsample of voluntary strategy, Model 3
shows that CSR is strongly positively associated with abnormal returns of product
recalls. In contrast, in the subsample of involuntary strategy, Model 5 shows that the
effect of CSR is statistically insignificant. Moreover, when considering the
component of CSR activities, we find insignificant effects of ICSR for both voluntary
and involuntary recalls in Models 4 and 6. The coefficients of TCSR, however, are
significantly positive for the voluntary subsample, but statistically insignificant for the
involuntary subsample. The overall results in Table 5 are consistent with those in
Panels A and B in Table 4.
For the control variables, we find LEV is positively and significantly related to
abnormal returns for the whole sample. But the effects of most of the other control
variables are statistically insignificant. To test if there is a multicollinearity problem,
we use the variation inflation factor (VIF) in all regression models. The values of VIF
--- Insert Table 5 Here ---
A number of robustness checks are employed to test the sensitivity of our
findings. Firstly, while the choice of event window CAR (-1,0) is not uncommon
based on previous studies, it may not completely catch the announcement effect of
product recalls. To test if the choice of event window could bias the empirical results,
we further test different events windows of CAR (-1,1) and CAR (-2,2) as the
alternative independent variables and re-test the regression analyses. We find that for
the event window CAR (-1,1), the results of VOLUNTARY (t = 0.83), CSR (t = 2.82),
ICSR (t = 0.36) and TCSR (t = 3.26) are all consistent with those presented in Table 5.
The evidence for CAR (-2,2) is very similar. Secondly, the measure of CSR dummy is
categorical, and thus, may not catch the linear trend of CSR on abnormal returns. We
thus also try a continuous variable of CSR performance measured by the number of
strength minus the number of weakness of CSR performance in the KLD databank,
and re-do Models 1, 3 and 5 in Table 5. The result of the continuous measure of CSR
remain the same, significantly positive at the 5% level for Model 1 (t = 2.63) and the
1% level for Model 3 (t = 3.34), and insignificant in Model 5 (t = 0.99). Similarly, we
widely used in measuring abnormal returns in the event study approach, prior studies
had employed alternative approach to measure abnormal returns. We follow Yermack
(1996) and measure a firm’s abnormal return at day t by subtracting market return
from the actual return on the same day. We find that the results from this alternative
measure of abnormal returns are essentially the same with those reported in Table 5.
Thus our findings are not sensitive to different approaches of measuring abnormal
returns. Finally, Godfrey et al. (2009) also investigate the influences of TCSR and
ICSR with a slightly different measure from our study. In Godfrey et al.’s study
(2009), TCSR (ICSR) is measured as a dummy variable that is equal to one if the firm
scored greater than zero on any of the positive items related to TCSR (ICSR) in the
KLD database, while in this study TCSR is one when the number of strengths is equal
to or greater than the number of weakness in the related items3
3 The related items of TCSR are those under the governance, employee relations, or product relations
. To check if our
findings on TCSR and ICSR are sensitive to different measures, we follow the
measures of TCSR and ICSR in Godfrey et al. (2009) and redo the analyses in Table 5.
The results are very similar. With the alternative measures, the results for voluntary
recalls show that the coefficient of TCSR is positive and significant (t = 1.82), and
that of ICSR is insignificant (t = -0.22); for involuntary recalls, both TCSR and ICSR
of TCSR and ICSR.
5. Discussions and Implications
The nexus of this paper emphasizes the important effect of information
certification on investors' reactions to product recall strategies. While managers may
intend to convey positive messages through voluntary product recalls, the messages,
however, may not be well received. Voluntary recalls involve different motivations
and thus result in greater information uncertainty that increases the difficulty for
investors in interpreting the signals. Our findings suggest that CSR performance
positively affects investors' valuation on the financial impacts of voluntary product
recalls. The effect of CSR, however, becomes insignificant for involuntary recalls
since the underlying information is more straightforward in involuntary recall
announcements.
To the best of our knowledge, this paper is the first one in the literature to link
CSR performance with the financial impacts of product recall strategies. Chen et al.’s
study (2009) investigates the differences in financial value changes around the
announcements of product recalls comparing proactive and passive recall strategies.
paper examines voluntary and involuntary product recalls, while Chen et al. (2009)
measure proactive and passive recall strategies by whether the recalls involve any
incidents or not. The different focus may explain why our sample size of voluntary
recalls is much larger than proactive recalls in their study. Second, our study
considers the contingent effect of CSR on product recall strategies, while Chen et al.
(2009) does not. Finally, the sample in our study includes more product recall
announcements, and covers a longer time period.
This study is related with Cheah et al.’s (2007) that investigate the effect of
CSR on the abnormal returns of product recall announcements. They find that CSR
does not have a significant effect on the abnormal returns of product recall
announcements in both the U.K. and U.S. samples. While with similar focus on CSR
effect, their analyses does not consider that recall strategies may receive
heterogeneous impacts from CSR performance. In contrast, our study emphasizes the
characteristics of information uncertainty associated with voluntary and involuntary
recalls that can yield different impacts of CSR on investors' perception about the
financial impacts of product recalls.
Godfrey et al. (2009) investigate the risk management hypothesis by studying
the effect of CSR on shareholder wealth for a sample of negative events involving
important role in mitigating the unfavorable impacts of negative events, they also
suggest that social initiatives targeting a firm's primary stakeholders may yield the
insurance-like benefits when the negative events affect primary stakeholders. Our
evidence is consistent with the predictions. Product recalls involve the manufacturing
process of business operation, and the consequence has strong impacts on the welfare
of primary stakeholders, including customers, suppliers, employees and shareholders.
Since TCSR activities target primary stakeholders, it is actually not surprising that our
findings show that TCSR indeed are more effective in reducing the impacts of product
recalls, particularly for voluntary recalls. This paper, together with Godfrey et al.
(2009), provides strong evidence that not all CSR activities are alike. The effect of
CSR on firm value change is critically dependent on whether the nature of the events
is consistent with the types of CSR activities. TSCR performance is expected to be
more effective when the events have strong impacts concerning primary stakeholders,
while ICSR is more important when the shocks have greater influences on secondary
stakeholders.
Managerial Implications, Limitations and Future research
Our results suggest an important implication for managers in recall strategies
products. A growing body of literature has indicated that the strategic use of CSR
positively links with firm performance (McWilliams et al., 2006), yet, how CSR can
benefit a firm in negative corporate events may closely hinge on target stakeholders’
behavior. Our findings suggest that the certification role of TCSR germane to direct
stakeholder relationship may nurture practical knowledge to invest functional CSR as
future assets under budgetary concerns. Furthermore, this paper accentuates the
qualitative usage of CSR that signifies the novelty and nature of the research in CSR
area. Managers can help reduce the negative impact of a product recall by effectively
developing and communicating the intangible values created from the CSR
engagement. In doing so, managers would more align investor expectations with
insurance property. In conclusion, managers had better march to the beat of different
stakeholder preferences in a given market.
The study sheds light on the informational attribute of socially responsible
activities for investors to evaluate a product recall strategy. As the debate if the CSR
investment in companies links to firm value remains a puzzle (see a systematic review
in Taneja, Taneja and Gupta, 2011), this study attends to find the value proposition in
CSR engagement upon a product recall announcement that helps resolve investor
uncertainty to an extent that influences stock market reactions. By means of CSR
may heighten to an optimal level on the premise that the financial loss is acceptable.
In other words, as messages from the recall strategies are ambiguous to outside
stakeholders, it is the informational attribute of CSR activities publicly obtained from
third parties that decrease investor doubts on the consequences. While the empirical
results show a negative effect of both voluntary and involuntary recall strategies, the
certification role of CSR has been shed more lighted on differentiating the potential
impact on different recall strategies. Finally, the study encourages managers to
concern more on investment horizon in CSR in terms of business operational viability
that is conducive to long-term value creation. The investment in CSR initiatives has
cumulated more governance role of monitoring and disciplining corporate behavior to
the significance (Bhattacharya, Korschun and Sen, 2009). As a TCSR-oriented
activity relates more with governance, employees and product aspects (Mattingly and
Berman, 2006), firms can choose a favorable investment policy to maintain target
stakeholder.
There are some limitations in our research. Firstly, the event study methodology
is usually constrained as it goes to detect the long-run effects. Our study provides
evidence surrounding the announcement of a product recall strategy which may not
necessarily predicts long-term effects. Research on whether CSR activities could
in KLD database are S&P1500 publicly listed firms, our results may not be
generalized to privately-held firms. The information uncertainty ought to be much
higher for private firms, and hence the certification role of CSR activities should have
a greater impact. It would be interesting to explore the impact of CSR activities on
privately held firms in future research. Finally, the evidence in this study suggests the
certification function of CSR is important in voluntary recalls. CSR, however, is
certainly not the only mechanism that a firm can use to certify information. Other
mechanisms, such as reputations and corporate governance can also perform the
certification function. It is thus interesting to see if our findings also exist in other
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