Product liability and firm owners’ delegation to overconfident managers

Abstract

Abstract This article analyzes the socially optimal liability allocation when strictly liable Cournot firms delegate their safety and output choices to managers whose potential biases are chosen by firm owners and consumers misperceive product risks. Firm owners always hire managers who are overconfident about their product safety’s effectiveness in reducing product-related accident risk. However, the extent of overconfidence depends on consumers’ risk perceptions and the allocation of liability. As a result, the socially optimal liability allocation hinges on whether consumers underestimate or overestimate product risk. When consumers overestimate product risks, firms should be held liable for all losses incurred by consumers. However, when consumers underestimate risk, firms should only be held liable for a part of consumer losses. We also show that, in some circumstances, negligence produces socially more desirable outcomes than strict liability (JEL: K13, L13, L14).