Before It’s Too Late: Product Recall Delays and Policy Design

Abstract

Problem definition: We examine a firm’s investigation and recall decisions when a defect occurs and provide policy implications on how to deter long delayed recalls. Practical relevance: When a safety defect occurs, manufacturers often use product recalls to mitigate potential consequences. Although consumers expect on-time recalls for product defects, anecdotal examples suggest that firms may be passive in investigating potential defects and/or severely delay their recall decisions. Understanding how firms make their recall timing decisions has important business and social implications. Methodology: We study decisions on investigation efforts and recall timings for a profit-maximizing manufacturer by incorporating a Bass diffusion model to capture sales patterns for products with long life cycles. We then test our implications using data from the automobile industry and find supporting evidence. Results: We first find that a firm will consider a delayed recall when the defect is noticed early, when sales suffer more negative impacts from (external) media exposure on a recall, and when the product has a relatively high margin-to-recall-cost ratio. Second, a firm that will consider a delayed recall exerts a smaller investigation effort, and it will further reduce the effort when the defect is more likely to lead to a recall. When we consider the case in which a firm’s learning effect and information updating occur in an investigation and recall process, our results remain consistent. Managerial implications: Our model not only helps us understand how firms make their decisions when defects occur but also offers governments and regulatory bodies new instruments (e.g., investigation efforts, penalty design, information disclosure, firm supervision) to help firms be proactive should a defect occur, thereby reducing potential casualties associated with delays in a recall progress.