Strategic R&D Investment Under Liability Law

Abstract

This paper analyzes the incentives of duopolists to invest in advanced care technology under liability law. We establish that investment incentives under strict liability are in line with the taxonomy of Fudenberg and Tirole (1984), whereas the investment incentives under negligence most likely are not. Indeed, investment incentives under negligence are dependent on the timing of the policy maker’s regulations, whether or not due care is firm specific, and whether or not precautionary measures are durable.

Key Words:

• Strategic Behavior
• Care
• Induced Technical Change
• Liability Law
• Imperfect Competition

JEL classifications:

• L13
• K13

Acknowledgements

The authors are indebted to two anonymous referees for very helpful suggestions on a former version.

Notes

1. Shavell (1987) analyzes the liability of firms without allowing for care technology decisions. The fact that most markets are imperfectly competitive has also received treatment in the literature. For example, Boyd (1994) analyzes monopolist’s safety and output choices.

2. For clarity, this contribution is concerned with cases in which victims are strangers instead of customers of the firm. For an analysis of the latter scenario, see Geistfeld (2009), for example.

3. If a regulatory standard applies to the industry, it might be of interest for the relatively more efficient firm to increase the standard by investment in order to raise the rival’s costs. These interdependencies via the regulatory standard are non-existent in the case of firm-specific standards. For a recent analysis in the realm of environmental economics, see Puller (2006).

4. Nussim and Tabbach (2009) analyze the case of durable precaution in detail.

5. The analysis that obtains for μ = 1 is qualitatively similar.

6. An alternative assumption would be that the policy maker seeks to change the output levels via a change in due care so as to maximize the sum of consumer welfare and producer surplus, less expected harm. This change in the policy maker’s objective would not qualitatively affect the arguments, which follow below.

7. Shavell (2008) provides an analysis of the social optimality of changing legal rules when the characteristics of the context in which the rule applies have changed.

8. Consequently, we assume that the policy maker is not myopic in the case of ex-ante regulation, but anticipates the technological advance.

9. Note that the similarity of findings has led us not to discriminate between firm-specific and industry-wide regulation.

10. This is in the spirit of Daughety and Reinganum (2006). In that study, firms choose care at the first stage and output at the second. The social planner then is assumed to choose care while taking as given how firms determine output given care at the second stage.