The Impact of Product Recalls on the Wealth of Sellers

What happens to the wealth of shareholders of firms producing defective products? Our answer-for producers of drugs and autos that were recalled from the market-is that the shareholders bear large losses. They are substantially greater than the costs directly emanating from the recall-for example, costs of destroying or repairing defective products. In fact, they are plausibly larger than all the costs attributable specifically to the recalled product; the losses spill over to the firm's "goodwill." They also spill over to competitors. This negative externality may even be larger in the aggregate than the losses to the producer of the recalled product.