Product Reliability and Firm Value: The Experience of American and Japanese Automakers, 1973-1992

This research analyzes the recall experience of threeAmerican (Chrysler, Ford, and GM) and three Japanese (Honda, Nissan, and Toyota) automakers during the period 1973-1992 to provide more conclusive evidence that the stock market imposes a reputation penalty on automakers that produce unreliable vehicles. We view recall campaigns as a manifestation of underlying product reliability, which is an important aspect of product quality. First, we document that the incidence of recalls for American automakers has been significantly higher than their Japanese counterparts. Furthermore, the Japanese advantage has persisted during the second decade of our sample (1983-1992). Second, we document a link between recalls and firm value by analyzing the stock market reaction to the announcement of recall campaigns. On average when an automaker announces a recall campaign, (1) the announcement has a statistically and economically significant impact on the shareholder value of the announcing firm, (2) the announcement does not significantly impact the shareholder value of competitor firms, (3) the market response to each recall is marginally larger for Japanese automakers, but (4) the total cumulative losses are larger for the US automakers. These findings suggest that the stock market functions as a disciplinary mechanism and that, ceteris paribus, automakers can improve the welfare of their shareholders by improving product reliability.