Question

1. In an L.A. Law episode, an automobile manufacturer knowingly built cars that had a significant safety flaw. Rather than redesigning the cars (at substantial additional cost), the manufacturer calculated the expected costs of future lawsuits and determined that it would be cheaper to sell an unsafe car and defend itself against lawsuits than to redesign the car. What issues does the financial analysis overlook? What is the consequence of not redesigning the car?

Answer 1

When a automobile manufacturer knowingly built a unsafe car, the manufacturer has only accounted for the potential financial loss from the lawsuits to defend against the unsafe car but not the potential reputation loss and its financial impact. Reputation loss has long term impact on the company's sales,growth & the profit making ability. Loss of reputation impacts the public & investor sentiment which can also impact the share price and the market capitalization of the company. Loss of reputation can also impact the automobile manufacturers access to funds though banks or other investors. Reputation loss can also impair/deplete the value of the firm

There is also an increased trend of shareholder activism in recent times which can move against the automobile manufacturers plans for the company. It can even overthrow the authorities in-charge of this decision. These activities can further impact the long term possibility for recovery of the company.

Along with lawsuits from customers safety & regulatory bodies are now increasingly concerned about safety factors and this could possibility lead to fines or penalties imposed on the automobile manufacturer increasing the financial strain on the company.

Thus the decision to sell unsafe car rather than redesign of car can have increased financial impact than what was earlier accounted for.