A relatively small number of recalls by a few large manufacturers appears to result in decreased sales and capital market losses for the segment as a whole.
In 2007, the Consumer Product Safety Commission (CPSC) issued 276 recalls of toys and other children's products -- an 80 percent increase over the number of children's items recalled in 2006. Many of the 2007 recalls involved paint with excessively high levels of lead content and almost all of the recalled toys were manufactured in China. This period of recalls attracted substantial media attention and, according to consumer surveys, resulted in significant consumer uncertainty about the safety of toys in general. The furor led to the passage of new safety regulations in the Consumer Product Safety Improvement Act of 2008.
In Product Recalls, Imperfect Information, and Spillover Effects: Lessons from the Consumer Response to the 2007 Toy Recalls (NBER Working Paper No. 15183), co-authors Seth Freedman, Melissa Schettini Kearney, and Mara Lederman investigate how these recalls affected consumer demand for toys during the Christmas season that followed. In addition to studying the direct effects of recalls, the researchers also examine whether, and to what extent, recall announcements had spillover effects to non-recalled items. The recalls here involved a shared industry practice, in this case, production in China, so they had the potential to result in significant negative spillovers.
The authors use sales data from the market research firm NPD Group to track sales of "Infant/Preschool" toys from 2005 through 2007. They find that manufacturers' 2007 Christmas season sales of toys in categories that experienced recalls were down by about 30 percent, compared to other toys that these manufacturers sold (that is, a manufacturer who recalled a toy in the "Vehicles" category experienced a decrease in sales of toys in that category, relative to its other categories). But, the manufacturers' sales of toys that were sufficiently dissimilar to those named in the recalls did not seem to be negatively affected. In other words, in response to a recall, consumers did not appear to be "punishing" the manufacturer more generally. This would be consistent with consumers not drawing inferences about product quality at the manufacturer level, or, it could be that consumers do not recognize that dissimilar toys are produced by a common manufacturer. It could also be that manufacturers made costly investments in rebuilding their brand name, in which case the recalls would be imposing costs on these manufacturers, just not in the form of sales losses across categories.
The study also finds that companies who did not have any recalls saw substantial sales losses; their 2007 Christmas season toy sales were down about 25 percent compared to 2005. Given that sales of other consumer products over this period (for example, books and video games) generally were not falling, this suggests that these recalls influenced consumers' expectations of toy safety in general.
The spillover effect of the recalls also hurt the market value of publicly-traded toy companies. An index created by the authors to track the stock market value of companies facing recalls fell 25.6 percent by year-end 2007 from the earliest round of recalls in May of that year. The index of toy firms not facing recalls fell 7.6 percent in the same period. The finding that a relatively small number of recalls by a few large manufacturers appears to result in decreased sales and capital market losses for the segment as a whole suggests that, from an industry perspective, investments in safety may be too low. When a shared industry practice is involved, such as production in China in the case of the toy recalls, the potential for spillover effects appears to be especially large.
-- Frank Byrt