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How Do Large Recalls Affect Auto Companies' Stock Prices?

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On Friday morning, Fiat Chrysler announced a recall of 4.8 million vehicles to repair a defect that can cause cruise control to remain engaged even after the driver has used the brake to disengage it.  The company describes the series of events necessary to cause the problem as “extremely rare” and says that even if the problem were to occur, a driver could still slow the vehicle with the brake pedal and/or by shifting to neutral to avoid a collision.

Only one incident involving the faulty cruise control has been reported and it did not result in a collision or injuries.
Nevertheless, Fiat Chrysler warned owners of the recalled vehicles to avoid using the cruise control feature until they have received a no-cost software update to fix the issue.

Shares of FCU sold off 2% on the news.  

Is a recall like this a harbinger of bad things to come for the automaker and its shareholders?  Probably not.  Let’s take a look at similar recalls from other automakers.

Toyota’s “Unintended Acceleration”

Starting in 2009, Toyota Motor Company (TM - Free Report) was the subject of claims that its vehicles suffered from “unintended acceleration.”  The NHTSA received 6,200 complaints which included 89 deaths and 57 injuries resulting from the issue.  There was even a dramatic news story about a driver who called 911 from his moving vehicle which he claimed he could not stop.  That incident was later proved to be fraudulent, but the news still fanned the fires.

Toyota was slow to respond, initially blaming floormats that had slipped into the accelerator pedal, then fingering a sticky mechanical linkage for the accelerator pedal and finally admitting problems with the anti-lock braking system on a small number of cars.

Worldwide, approximately 9 million cars were recalled for one or more of these issues.

In 2013, the NHTSA found that there was no electronic defect in Toyota vehicles and that driver error or pedal misapplication was found responsible for most of the incidents.  For Toyota, however, the damage was already done. Shares dropped 20% in a month and worldwide sales declined approximately 20%.

Toyotas financial performance and share price have since recovered, though it took several years. It should also be noted however that these incidents took place in the midst of a huge global economic slowdown, to which Toyota's lagging performance could also be largely attributed.

General Motors’ Faulty Ignition Switch

In 2014, General Motors (GM - Free Report) began to recall vehicles to repair a faulty ignition switch that would occasionally turn the car off while driving, rendering the steering, brakes and airbags ineffective.  In all, 124 deaths and 275 injuries were attributed to the issue, which GM had been aware of as early as 2005.

After initially obfuscating the count of deaths and injuries, GM finally came clean, recalling 29 million cars, firing 15 executives who did not act quickly enough on knowledge of the problem and setting aside $675 million to compensate victims in a fund administered by Kenneth Feinberg – the former trustee of the victims compensation fund for the attacks of 9/11.

GM shares did not suffer nearly as much as Toyota in the immediate aftermath of the incident.

What About Fiat Chrysler?

Ultimately, the cost of doing the repairs in a large scale recall and even the cost of compensating victims are generally smaller than the cost in sales due to a tarnished reputation.  Once public awareness of a potential safety issue reaches critical mass, stories of defective and unsafe vehicles can take on a life of their own as customers file claims about accidents (after the fact) with the newfound belief that the car – and not the driver – were responsible.

Some of this happened to Toyota and older readers will recall that Audi was almost bankrupted in the 1980’s by a similar issue - even though they were cleared of wrongdoing.

For now, the issue at Fiat Chrysler seems to be just a little smoke and no fire.  Because there have been no accidents, injuries or fatalities, and because the repair involves a simple and free software fix, selling the stock today in anticipation of a big decline seems unwise.  On a slow Friday before a holiday weekend, the recall made for an interesting news story, but unless we start to see reports of serious incidents because of the problem, it’s unlikely to have any appreciable effect on FCU’s long-term fortunes.

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