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Recall Impact Study Brings Unexpected Results
April 02, 2015
Question to our readership:
If two companies had to recall the same amount of the same product, for which company would you expect stockholders to have the greatest negative reaction?
The answer? According to at least one sound research project, researchers from Utah State University found that, contrary to what you may expect, a company that incurred a previous food recall within the past year and efficiently followed procedures for managing it while establishing clear communication channels with stakeholders was seen as less of a threat to the stock market than was a company with its first recall in recent history. It is, however, important to note that this is not to imply that the second recall was positive or a stock boost for the company, just that the negative impact was seen as less severe. The impact? Right out of the gate on this issue, we’re seeing a very clear need for food companies to execute any recalls very swiftly and efficiently. In order to do that, two key ingredients are needed—a recall/crisis management plan and regular practice of that plan. Such recall experience was just one finding of the study, Costs of Meat and Poultry Recalls to Food Firms, for which the researchers analyzed price reactions in financial markets following recall events, then quantified the impact of meat and poultry recalls on the market value of firms by obtaining a measure of abnormal returns—the stock price movement associated with each specific recall. Another unexpected finding of the study was that the stock effects were not immediate. Rather it tended to take four days after a recall event for stock prices to react in a statistically significant way. We see this as a very positive finding for the food industry, as it means that companies have this time to respond, react, and communicate with their stockholders and consumers, to reassure them that steps are being taken to not only take care of the existing situation but to correct the root cause and put corrective actions in place to ensure the same situation will not happen again. This finding may also provide some explanation for why a second recall had less impact—as the company’s prior experience taught it important lessons in quick reaction and communication. In short, this gives companies a small window of opportunity to get it “right”—to get the situation under control both by way of messaging and operational controls. But it is not much of a window and it’s precious time. That is why having the pre-established recall/crisis plan and practicing against that plan becomes so valuable. The researchers also studied the factors of a recall that had greatest impact on stock prices, finding five key factors. Along with experience (described above), these included recall class, recall size, company size, and media coverage. Following are details of each, along with some industry implications from TAG and/or the researchers. 1. Recall Class. Stock price reactions are greatest after Class I recalls—as would be expected since these pose the most human health threat. With an average decrease of 1.15% by Day 5, the study’s average firm (472 million shares of stock outstanding at $20/share on recall-announcement day) lost about $109 million in market equity five days after a recall event. Class II and Class III recalls did not have statistically significant stock price impacts. Implications: Stock markets reacting most adversely to Class I recalls proves to us that a risk-based approach to food safety is the right one to take for financial as well as food safety reasons. While lower risk foods should not, of course, be neglected, high-risk foods with high-health risk potential should be prioritized. 2. Recall Size. The larger the recall, the greater the impact on stock returns; and the importance of this increases over time following the recall. That is, the longer recalls are announced in high numbers, the greater the impact. Implications: Companies should make every effort to keep the “book ends” around a recall really, really tight. In order to do this, consider looking at reducing lot sizes in the most high-risk products and making sure you have top-notch product-tracking systems and recordkeeping. The latter is especially important to be able to show regulators your proposed recall scope and to do it fast. All of this will make recalling massive amounts of product less likely. This will be especially helpful if you happen to have a Class I recall—otherwise you would have a “double-whammy” recall—a Class I and a large recall, causing a significant stock impact. 3. Company Size. On average, larger firms experience lesser impacts after a recall, perhaps because larger, more diversified firms are expected to be more able to weather a food safety recall than small companies. Implications: Small companies should consider investing more of their total value in food safety technologies, human resources (whether internal or external), and protocols, as small companies have greater risk of significant financial impact including bankruptcy in the event of a recall. This would be especially true for high-risk products that are more likely to be involved in a Class I recall. 4. Media Coverage. As would be expected, the more media coverage, the greater the impact. For example, one additional recall-related article published within five days after the recall, decreases stock returns an average of 10%. Implications: Last week’s article discussed the importance of having a recall plan in place before it is needed, including communications. This finding simply substantiates that assertion, demonstrating—in dollars—why companies need to be ready to immediately implement plans to try to reduce adverse impacts of media while dealing with a food recall. So if you don’t have a recall plan, or if you don’t feel the communication part of your recall plan is solid, we recommend that you address that as soon as possible.
- A company that had had a previous recall during the same year
- A company for which this was its first major recall.