Do banks price production process failures? Evidence from product recalls

Shafu Zhang, Michel Magnan, Yetaotao Qiu, Cheng Colin Zeng

Research output: Journal PublicationArticlepeer-review

1 Citation (Scopus)

Abstract

This paper examines the impact of product failures on the pricing of bank loans using hand-collected data on product recalls. We find that banks tend to charge higher loan prices for firms involved in product recalls. Uncertainty as to a recall's ultimate impact on a firm's credit risk conditions banks’ loan-pricing reaction, as reflected in a firm's default risk, information asymmetry and governance deficiency, and by the damage to its reputation, arising from the recall. Further analysis reveals that the impact of product recalls on the cost of debt is stronger in firms that rely more extensively on bank financing, firms with more severe recalls, and those adopting passive recall strategies. However, medical device firms, for which product recalls are often considered a normal part of doing business, do not experience a rise in their bank financing costs following a recall. Finally, we find that recall firms experience a deterioration in their financial performance and a rise in product lawsuits post recall. Overall, our findings shed new light on the economic consequences of product failures through the lens of creditors.

Original languageEnglish
Article number106366
JournalJournal of Banking and Finance
Volume135
DOIs
Publication statusPublished - Feb 2022

Keywords

  • Default risk
  • Information asymmetry
  • Loan spread
  • Product recall
  • Reputation

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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