Impact of Financial Leverage on the Incidence and Severity of Product Failures: Evidence from Product Recalls

Abstract

We study the impact of financial leverage on a firm’s ability to produce safer products that result in fewer recalls. Using a variety of tests, including two quasi-natural experiments that result in exogenous negative cash flow shocks, we find that firms with higher financial leverage or distress likelihood have a greater probability of a product recall. These firms also experience more frequent and severe recalls. Further tests indicate that, more than debt overhang, financial constraints is the channel through which leverage affects product failures. Overall, we show that a firm’s financial condition has real effects that impact product safety.