The Liability of Good Reputation: A Study of Product Recalls in the U.S. Automobile Industry

In this paper, we explore how a firm’s reputation affects both the reaction of the market to that firm’s product defects, as well as the firm’s learning response. In contrast to a variety of arguments set out by information economists and market sociologists claiming that reputation serves as an organizational asset, we explore the possibility that reputation can be an organizational liability. We propose that a good reputation is less advantageous than a poor reputation in absorbing the impact of product defects, and thus high reputation firms are more likely to be punished by the market. We also propose, however, that this liability is transformed into a future asset by providing high reputation firms with more incentives to learn from these mistakes, and thus reduce their subsequent defect rate. Low reputation firms are also incented to learn, which means that moderate-reputation firms are likely to have the greatest problems learning from these defects. We empirically test these propositions using data on product recalls in the U.S. automobile industry from 1975 to 1999, and find support for predicted relationships. High reputation firms are punished more than low reputation firms, and learning from product recalls has an inverted U-shaped relationship with firm reputation. We conclude with a discussion of the implications of these results for learning and organizational status/reputation