Analyst Following and Product Recall

Description

Product recalls are the outcome of severe product quality failures which typically result in significant costs to the recalling firms. Despite the negative outcomes of product recalls and the emergence of high-impact product recall events in recent years, there are limited studies on the determinants of product recalls. This proposal plans to fill in the gap in the literature by exploring the effect of financial analysts, an important information intermediary in the capital market, on the likelihood of a product recall. Analyst following has two potential effects on product recalls. On the one hand, financial analysts may serve as external monitors of managers and mitigate firm financing frictions by reducing firm information asymmetry. This makes firm investments in production more efficient and effective, which should reduce the likelihood of product recalls. On the other hand, financial analysts' forecasts impose excessive performance pressure on managers, which could induce them to cut investments in production in order to meet short-term targets. As a result, firm investments in production would be inadequate, which should result in higher likelihood of product recalls. To explore the effect of analyst following on product recalls, we will use product recall data from four U.S. regulatory agencies. To alleviate the endogeneity concerns, we will perform difference-in-difference (DiD) tests around two exogenous shocks to analyst following. We will also conduct cross-sectional analyses to investigate whether the effect of analyst following on product recalls varies for firms with different institutional ownership, media coverage, product market competition, and analyst experience. Our study will contribute to three strands of literature. First, it will contribute to the product recall literature by investigating whether financial analysts, an important information intermediary in the capital market, have any effect on the likelihood of product recalls. Second, it will contribute to the line of research that documents the real effect of the stock market on firm operations by exploring whether activities by market participants, such as financial analysts, affect firms' production decisions. Third, it will contribute to the analyst following literature by providing new evidence on the role of financial analysts. Our study will answer the question whether financial analysts play a positive or a negative role in firms' production decisions.