Do banks price production process failures? Evidence from product recalls

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

Journal of Banking & Finance, 2022, vol. 135, issue C

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.

Keywords: Loan spread; Product recall; Default risk; Information asymmetry; Reputation (search for similar items in EconPapers)
JEL-codes: G21 G30 L15 M11 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:135:y:2022:i:c:s0378426621003174

DOI: 10.1016/j.jbankfin.2021.106366

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