UCL School of Management is delighted to welcome Victor DeMiguel, LBS, to host a research seminar discussing ‘Cover-up of safety hazards in product recalls.’
Several automakers including Toyota and GM have been recently caught by the U.S. regulator deliberately hiding product defects in an attempt to avoid massive recalls. Interestingly, the U.S. and the U.K. regulators employ different policies in utilizing information on potential defects, and this could affect how manufacturers decide to submit such information to the regulator in each country. Specifically, the U.S. regulator publicly discloses all on-going investigations of potential defects to provide consumers with early warning, whereas the U.K. regulator does not. To understand how the two countries’ different policies affect cover-up decisions of automakers, we model the strategic interactions between a manufacturer and a regulator, and study whether and when the manufacturer has an incentive to cover up its potential defect. We find that, under both countries’ policies, the manufacturer has an incentive to cover up when the suspected defect is highly likely to exist and it could inflict only relatively moderate harm. However, only under the U.S. policy does the manufacturer have an incentive to cover up a potential defect with significant harm if there is only a moderate chance that the defect may actually exist.
Moreover, the U.S. regulator tends to conduct fewer investigations than the U.K. regulator to avoid unnecessary public warning. Overall, the U.S. policy makes the regulator reluctant to investigate and discourages manufacturers to report potential defects with significant harm, compared to the U.K. policy. We find that a hybrid policy, in which a regulator conducts a confidential investigation only when the potential harm poses a significant risk to the public, can better prevent cover-ups than each country’s policy.