Costly External Finance, Regulatory Regime, and the Strategic Timing of Vehicle Recalls

Abstract

We examine how the timing of vehicle recalls depends on the regulatory regime and likely impact of adverse information on the cost of raising external financing. In particular, we argue that the passage of the Transportation Recall Enhancement, Accountability, and Documentation (TREAD) Act imposed reporting requirements on vehicle manufacturers that delayed the speed with which the National Highway Traffic Safety Administration (NHTSA) could launch defect investigations, and possibly also undermined its incentives to identify safety issues. We find that in the decade following the TREAD Act, firms delayed the timing of their recalls when they needed to raise larger amounts of external financing, compared to the previous decade. This type of strategic timing of vehicle recalls also suggests that, contrary to company statements and some internal investigations about recent large-scale recall campaigns, top management is typically aware of product defects.