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Review of Industrial Organization

Erschienen in:

27.04.2022

Product Liability and Strategic Delegation: Endogenous Manager Incentives Promote Strict Liability

verfasst von: Tim Friehe, Cat Lam Pham, Thomas J. Miceli

Erschienen in: Review of Industrial Organization | Ausgabe 2/2022

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Abstract

We derive the socially optimal allocation of liability for product-related accidents when firms delegate their output and safety choices to managers under a contract that depends on profits and revenues. With exogenous product risk, the optimal contract emphasizes revenue over profits as a way of inducing managers to increase output independently of the liability allocation. When product safety is endogenous, however, this strategy distorts managers’ product safety choice because the managers underweight the cost of safety relative to expected harm whenever consumers bear some share of liability. It is then socially optimal to hold firms fully liable for victim losses.

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More recent contributions describe how the market environment and product liability jointly determine firms’ product safety incentives (e.g., Chen & Hua, 2017; Daughety & Reinganum, 2006; Ganuza et al., 2016).

The firm’s share of liability is strict in the sense that it does not depend on the level of product safety, as would be the case under a negligence standard. The only question, then, is the allocation of liability between firms and the consumers (victims).

In classical delegation games such as Fershtman and Judd (1987) and Sklivas (1987), quality is exogenous.

For example, Fumas (1992) and Miller and Pazgal (2001) consider contracts based on both duopolists’ profits. Jansen et al. (2007) substitute the “revenues” with “market share” and compare the equilibrium to that of the original game. Fershtman et al. (1991) show that collusive profits can be achieved with profit target compensation functions. Other schemes that condition compensation on accidents could also be imagined, though the law and actual contracts between firms and their officers usually shield the latter from liability (e.g., Engert & Goldlücke, 2017; Spamann, 2016).

It is essential to note from Eq. (14) that the marginal effect of product safety on output is equal to zero at \(x_i^*\) and \(x_j^*\) (because the equilibrium product safety level always satisfies Eq. (9)). This is important when it comes to the socially optimal loss shifting because inducing inefficient safety levels cannot be beneficial due to their lack of influence on output levels.

This indirect approach that uses the benchmark with fixed product safety is convenient because determining how the value of the left-hand side of (15) changes with a variation in the weight on profits is difficult. More importantly, the indirect approach directly leads to our result with respect to the socially optimal extent of loss shifting.

Some mathematical derivations are relegated to our “Appendix”.

See “Appendix 2” for details.

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Titel: Product Liability and Strategic Delegation: Endogenous Manager Incentives Promote Strict Liability
verfasst von: Tim Friehe
Cat Lam Pham
Thomas J. Miceli
Publikationsdatum: 27.04.2022
Verlag: Springer US
Erschienen in: Review of Industrial Organization / Ausgabe 2/2022
Print ISSN: 0889-938X
Elektronische ISSN: 1573-7160
DOI: https://doi.org/10.1007/s11151-022-09870-1

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