Venkat Subramaniam

On the Determinants, Financial and Operating Consequences, and the Product Market Effects of Product Recalls

We study a large sample of product recalls that include a wide variety of products such as consumer products, food, drug, medical devices, and automobiles and show that such product quality failures have significant adverse value consequences for the recalling firms. Our analysis sheds light on factors that affect the incidence of product recalls, the financial and operating consequences for the recalling firms, and the actions taken by them in response to the recall. We also study the value implications for the rivals and suppliers – which enable us to draw important inferences about product market linkages. We find that the financial condition, competitive position, coordination costs, incentives of workers and management, and monitoring environment impact recall likelihood. Recall events result in significant costs for key suppliers which are further exacerbated if they have made larger relationship-specific investments. Further, instead of benefiting from the recalling firms’ problems, industry rivals suffer adverse contagion effects, perhaps due to anticipated regulation and diminished perceptions about the product category. We find that a larger investment in brand capital alleviates the negative wealth effects for the recalling firms. Finally, using a difference-in-differences approach, we find that recalling firms suffer sales declines and increase advertising expenditures – consequences and policy changes that we further show are not just due to a continuation of a differential trend from before the recall event and, therefore, directly attributable to the recall.

Impact of Financial Leverage on the Incidence and Severity of Product Failures: Evidence from Product Recalls

We study the impact of the financial condition of firms on firms’ ability to produce safer products that result in fewer recalls. Using a variety of tests, including two quasi-natural experiments that result in exogenous negative industry cash-flow shocks, we find that firms with higher leverage or distress likelihood have a greater probability of a product recall. These firms also face more frequent and severe recalls. Further, firms with more debt due at the onset of the financial crisis experience a greater likelihood and frequency of recalls. We conclude that a firm’s financial condition has real effects that impact product safety.

When is Equity More than Just Financing? Evidence from Strategic Alliances

A strategic alliance is a hybrid organizational form that is between an arms length contract and a full-fledged merger between firms. In some alliances firms take a minority equity stake in the partner firm. We refer to these as equity alliances. Using data on 759 alliances, we examine the motivation for the use of equity in alliances. We study whether equity is intended to strengthen the contractual performance of the alliance or whether it is primarily a means of financing for the capital constrained partner in the alliance. Consistent with the incomplete contracts theory, we find that equity is more likely to be used in alliances where the exact nature and the sharing of the output is ambiguous. We also find that equity is more likely to be used when the difference in bargaining powers between the partners is higher, such as when the partners differ significantly in size, market power, and growth opportunities. Finally, we find that equity alliances are especially likely when the smaller partner (which is almost always the partner selling equity) is high growth but is capital constrained. Thus, equity from alliance partners is a viable alternative source of capital for such firms. Consistent with the view that equity usage mitigates contracting costs and capital constraints, the market reaction to equity alliances is significantly higher compared to other alliances. Overall, the evidence suggests that the market views equity investments in alliances as more valuable than toeholds taken by potential acquirers without a product market relationship.

The composite dividend tax rate

Dividends often impose taxes on investors. However, as certain prior financial models indicate, they also can produce a tax gain from leverage. Hence the composite marginal dividend tax rate can be specified as the nominal rate minus the offsetting tax gain from leverage. Although this principle has been embedded in theoretical models for more than 40 years, no prior study has examined empirically whether the dividend-induced tax gain from leverage influences dividend policy. We address this empirical void and find dividends decrease in the nominal dividend tax rate and increase in the offsetting tax gain from leverage. In addition, we find the composite tax rate outperforms traditional measures in explaining dividend policy for our full sample of firms. Consistent with prior theory, we also find the composite rate varies in influence according to the financing source for a dividend.