A Model of Product Recalls with Asymmetric Information

Abstract

This paper presents a model of involuntary product recall in which a firm has private information on its ability to produce safety. The ex post regulation of safety is motivated through a parametric imperfection in the product liability system which results in a firm under internalizing expected liability expenses. We treat the problem as one of mechanism design, where the regulator designs a recall procedure. This framework illuminates the point that recall is an interesting blend of ex ante and ex post regulation. We characterize a perfect recall procedure, contrast this with real world imperfect procedures, and study the interaction of the recall and the liability systems. Further, we analyze the interaction between optimal recall policy and product market structure.