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The B.E. Journal of Economic Analysis & Policy

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Volume 14, Issue 4


Volume 18 (2018)

Volume 6 (2006)

Volume 4 (2004)

Volume 2 (2002)

Volume 1 (2001)

Producer Liability and Competition Policy When Firms Are Bound by a Common Industry Reputation

Andrzej Baniak / Peter Grajzl
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  • Department of Economics, The Williams School, Washington and Lee University, Lexington, VA 24450, USA
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/ A. Joseph Guse
Published Online: 2014-05-03 | DOI: https://doi.org/10.1515/bejeap-2013-0168


We contrast the laissez-faire regime with the regime of strict producer liability and draw the implications for competition policy in a setting where oligopolistic firms cannot differentiate themselves from rivals but rather are bound by a common industry reputation for product safety. We show that, first, unlike in the traditional products liability model, firms’ incentives to invest in precaution depend on market structure. Second, depending on the magnitude of expected damages awarded by the courts, laissez-faire can welfare dominate strict producer liability. Third, the relationship between social welfare and industry size, and hence the role for competition policy, depends on the institutional regime governing the industry. Under some circumstances, restricting industry size is unambiguously welfare-enhancing.

Keywords: products liability; industry reputation; oligopoly; industry size; competition policy

JEL Classification: K13; L13; D43


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About the article

Published Online: 2014-05-03

Published in Print: 2014-10-01

Fleckinger (2007, 1), for example, describes the environments in which firms share a common reputation as “an intermediate situation between the perfect information and the asymmetric information setting”.

For recent surveys of the voluminous literature on products liability, see Daughety and Reinganum (2014), Geistfeld (2009), and Shavell (2004, 2007).

Baniak and Grajzl (2013) study the interaction of strict producer liability and industry reputation effects in a model of torts where harm occurs in a non-market setting.

See Hattori and Yoshikawa (2013) for a model with endogenous firm investments in a common property resource that could be interpreted as representing firms’ common reputation.

For discussion about the relationship between tort law and antitrust law, see also “Note: Deception as an Antitrust Violation” (2012).

The traditional products liability model summarized by Daughety and Reinganum (2014) in fact implies that profit-maximizing firms choose the socially optimal level of precaution regardless of the liability rule in place. Firms choose socially suboptimal precaution when, for example, consumers systematically misperceive the risk of harm (Spence 1977; Polinsky and Rogerson 1983; Marino 1988a). However, the level of precaution selected by firms in models where consumers misperceive risk, but at the same time all other assumptions of the traditional products liability model continue to hold, is still independent of market structure.

For analyses allowing for “scale effects” in expected harm, see Marino (1988a, 1988b) and Spulber (1988). For models featuring fixed costs of safety, see Daughety and Reinganum (2006) and Baumann and Friehe (2012).

Chiang and Masson (1988) do not provide a fully fledged welfare analysis. However, they do show that in the presence of a common industry reputation, when firms have no market power, labor is the only input, and returns to scale are constant, firm consolidation leads to higher wages.

The literature, of course, suggests reasons other than the existence of a common industry reputation for why greater intra-industry competition, as captured by the number of firms in an industry, need not increase social efficiency. One prominent reason is the existence of fixed set-up costs that firms must incur upon entry; see, e.g. Mankiw and Whinston (1986) and references therein. Another is the application of the strict market share liability rule; see Marino (1991). Stucke (2013) provides an illuminating discussion of when competition leads to suboptimal results.

Chen and Hua (2012) do not study common industry reputation effects. Instead, they focus on the impact of full producer liability, partial producer liability, and punitive damages on monopolist’s incentives to increase product safety through ex ante investment when the firm can also take ex post (i.e. after sales) remedial measures concerning product quality.

Assuming risk aversion rather than risk neutrality would render the model intractable, but would, we anticipate, not change the key qualitative insights.

In the related products liability literature that does not study implications of firms sharing a common industry reputation, linear demand is directly assumed (as opposed to derived from an underlying utility function) for example in Polinsky and Rogerson (1983) and Daughety and Reinganum (1995). In contrast, in the industrial organization literature on common industry reputation, Fleckinger (2007), for example, starts from a setup with heterogeneous consumers and develops a multiplicative inverse demand.

Another scenario that gives rise to free-riding in firms’ choice of precaution is the application of the market share liability rule, under which firms are held strictly liable for their market share of the total damages caused by the industry; see Marino (1991).

When consumers’ knowledge of risk of failure is perfect, the precise allocation of liability for losses from defective products does not matter for firms’ investments in precaution under the assumptions of the traditional products liability model (see, e.g. Shavell 1980; Landes and Posner 1985). Laissez-faire performs just as well as strict producer liability. Given administrative and litigation costs associated with products liability, laissez-faire is in fact the preferred regime.

Citation Information: The B.E. Journal of Economic Analysis & Policy, Volume 14, Issue 4, Pages 1645–1676, ISSN (Online) 1935-1682, ISSN (Print) 2194-6108, DOI: https://doi.org/10.1515/bejeap-2013-0168.

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