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The Value of Apology: How do Corporate Apologies Moderate the Stock Market Reaction to Non-Financial Corporate Crises?

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Abstract

In a crisis, managers are confronted with a dilemma between their ethical responsibility to respond to victims and their fiduciary responsibility to protect shareholder value. In this study, we use a unique and comprehensive dataset of 223 non-financial crises between 1983 and 2013 to investigate how corporate apologies affect stock prices. Our empirical evidence shows that the stock price response from apologizing depends on the firm’s level of responsibility for the crisis. We find that to protect shareholder value, management needs to match its formal response strategy with the degree of its responsibility for the crisis. Further, failing to match the proper response is harmful to shareholders: Both apologizing when the firm is not directly responsible for the crisis and failing to apologize when the firm is directly responsible reduce shareholder wealth. However, apologizing for a crisis when the firm is directly responsible mitigates losses to shareholder value that arise because of the crisis, as does refraining from apologizing when the firm is not directly responsible.

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Notes

  1. We use CAR and not raw returns to mitigate the influence of other trends such as decreasing market share due to competitors or contemporaneous events such as earnings announcements. We provide a more detailed discussion of CAR in the “Methods and Data” section.

  2. See Fiske and Taylor (1991) for an overview and several variations of attribution theories.

  3. A crisis can affect firm value by directly reducing cash flows (crisis disrupts operations) or indirectly by increasing the riskiness of the cash flows (increased lawsuits or revealing an increased risk for a specific firm or industry), or both. We do not attempt to distinguish how a crisis or an apology affects these components independently, but rather we are concerned more generally with the overall effect on share price.

  4. Walker et al. (2005) also consider long-term returns and find that by 12 months, the abnormal returns are − 1.73% and by 24 months, they are 5.74%, (although in both cases they are not significantly different from 0). One could argue that this long-term reversal is due to an overreaction and subsequent correction, but the fact that it takes over a year to correct does not lend credibility to such a claim. In our analysis, we include multiple event windows between 2 and 20 days and rule out over- or under-reaction and subsequent correction as the cause of our results.

  5. Intuitively, apologizing for a crisis yields costs and benefits. Costs are associated with taking responsibility and correspond to legal obligations (or an implicit promise of compensation). Benefits come from improved reputation and stakeholder relations. Indirect costs and benefits can arise from how the apology signals the future: Acknowledgement of fault suggests past incompetence, which could signal future incompetence. On the other hand, apologizing could signal understanding of a past mistake, reducing the likelihood of repeating it. SCCT suggests that matching response to responsibility helps ensure that the benefits outweigh the costs.

  6. Kim’s (2014) results have limited generalizability due to the single high profile case used in the experiment and by having participants recall information that may have been distorted due to “the curse of knowledge” (Camerer et al. 1989).

  7. Because of financial loss, investors could be considered as at least secondary victims of all crises. However, there is an important distinction, since, as the primary victims, they would be the wronged party who is owed the apology, whereas as secondary victims, an apology to shareholders would be inappropriate.

  8. For robustness, we run all of our analysis excluding the 23 non-US firms. Dropping these 23 firms does not alter our results.

  9. For robustness, we use several other models to calculate the expected return. These include the equally weighted CRSP index to proxy the market portfolio in the single-index model, the Fama–French three-factor model, and the Carhart four-factor model. We also use a GARCH(1,1) model to account for potential heteroskedasticity. We find marginal differences in event window CARs, but no significant differences between the various event study outcomes that affect our interpretation of the results.

  10. To avoid subjective measurement error in our classification of crises that did not have an associated government report, we repeated all our analyses (unreported) with only those crises that have an official government report. This subsample yields similar, albeit slightly weaker results.

  11. For robustness, we also measured fatalities as an ordinal variable and our results are unchanged.

  12. The average time for a firm with repeat crises is 4.5 years. For robustness, we reran our analyses using a HISTORY variable that equalled 1 if the firm had a crisis within the previous 1, 2, or 10 years. All three variations of measuring HISTORY had no effect on the results.

  13. For robustness, we replaced industry average by 0 for missing values, similar to Cao et al. (2012). This change had no effect on our main conclusions about preventable crises and apologies, but it did increase the statistical significance of the REPUTATION coefficients.

  14. For robustness we used the log of total assets as an alternative measure of size. Our results are not sensitive to how firm size is measured.

  15. For robustness we also used the 2-digit SIC code. We find similar results using this alternative industry measure.

  16. Although we report only two test results, we ran two more parametric tests, CDA and BMP, as well as one other non-parametric test, RANK, as part of our analysis. These additional measures did not change our inferences, and hence, for brevity, we report only the CSECT and SIGN test results.

  17. If the reputation of missing values is replaced by 0 rather than the industry average reputation, then reputation does have a positive effect on CAR, but does not affect our inferences regarding our hypotheses.

  18. We exclude industry and year fixed effects in the first stage because APOLOGY does not have sufficient variation among different time periods and industries, which reduces the sample size by more than half for most event windows.

  19. Semadeni et al.  (2014) use an F test and ordinary regression analysis to determine if instruments are weak in the first stage regression. Our endogeneity issue surrounds a binary variable (APOLOGY) and thus we used probit analysis. We have adapted our tests appropriately.

  20. We perform a Durbin test and a Wu-Hausman test for endogeneity on each of the five event windows and find that our instrument is valid for the 5-day and 20-day event windows. For the other event windows, the standard OLS regression in Eq. (1) performs just as well or better than the 2SLS regression.

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Authors and Affiliations

  1. University of Saskatchewan, Saskatoon, SK, S7N 5A7, Canada

    Marie Racine & Craig Wilson

  2. Wilfrid Laurier University, Waterloo, ON, N2L 3C5, Canada

    Michael Wynes

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  1. Marie Racine
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Correspondence to Marie Racine.

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Racine, M., Wilson, C. & Wynes, M. The Value of Apology: How do Corporate Apologies Moderate the Stock Market Reaction to Non-Financial Corporate Crises?. J Bus Ethics 163, 485–505 (2020). https://doi.org/10.1007/s10551-018-4037-5

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