Recall class biggest factor on bottom line

By Joseph James Whitworth

- Last updated on GMT

Stock market prices were used to determine costs of food recalls
Stock market prices were used to determine costs of food recalls

Related tags Stock market

The class of a recall is the most impactful factor on bottom line when a firm faces a meat or poultry recall, according to research.

Other factors impacting stock price reactions include the size of the recall and the company, if the firm has prior experience dealing with recalls and media coverage.

Veronica Pozo, assistant professor in the Department of Applied Economics at Utah State University, and Ted Schroeder, professor in the Department of Agricultural Economics at Kansas State University, analyzed price reactions in financial markets in the time around recall events​.

It takes four days on average after the recall event for stock prices to react in a statistically significant way, they said.

However, if there was a major health hazard, stock price could take a hit potentially within one day.

From January 1994 to December 2013 USDA-FSIS reported almost 1,300 meat and poultry recalls, representing 638 million pounds of product.

Researchers identified 163 recalls from 31 different publicly traded firms.

Recalls from publicly traded companies accounted for almost 45% of total amount of product during the past two decades, about 278 million pounds.

For publicly traded companies, 115 recalls were Class I, 39 Class II, and nine Class III.

ConAgra, Sara Lee and Thorn Apple Valley realized almost 70% of the total product volume recalled by publicly traded firms and ConAgra and Tyson Foods represented 36% of recalls.

Tyson Foods had the largest number of recalls at 35 but Sara Lee had the largest product volume with nearly 38 million pounds across 13 recall events.

Study methods

Researchers used daily stock price data for 31 public firms in the sample, calculating actual stock price returns.

Then, abnormal returns were calculated as the difference between actual stock price returns, observed during the recall event, and predicted stock price returns, expected when there had not been a recall.

Next, abnormal returns were aggregated across time and recall events to estimate the overall impact of meat and poultry recalls on stock price returns.

Results are presented for the day of the recall announcement (day 0) and up to 20 trading days after.

Five days after the recall announcement stock returns decreased on average 1.15% after a Class I recall. If a health hazard was not there the stock price returns decreased on average 0.63%.

“This means that the average firm in our sample, with 472 million shares of stock outstanding and a $20 per share value on the day of a recall announcement, realized a reduced value of approximately $109m in market equity 5 days after a recall event.”

Class II and Class III recalls did not have statistically significant stock price impacts, suggesting that stock markets tend to only react adversely to Class I recalls likely because of the health risk involved.

Size of recall and company and past experience

It appears if a company experienced a recall and within a year faced another one they would have less stock devaluation for the same recall compared to those experiencing one for the first time.

Firms with limited experience handling a food recall, can learn from recurrent firms that have successfully managed them.

Larger, more diversified firms are expected to be more able to weather a recall than small companies.

Small businesses should consider investing more in food safety technologies and protocols as they have greater risk of bankruptcy in the event of a recall, said the study.

Researchers said there are several implications, particularly regarding recall management.

“One implication is related to recall size. Firms should try to rapidly identify contaminated products, perhaps by testing products in smaller lots, so that recalls of massive amounts of product are less likely.

“Large recalls are immensely costly to the firm and result in sizeable stock price impacts which can potentially result in firm bankruptcies.

“Finally, since factors such as firm size, recall size and media information can potentially cause substantial shareholder losses, investors may want to know more about the firm’s food safety experience and strategy before investing.”

Related topics Food Safety & Quality

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