The Rationale for Regulation: Shareholder Losses under Various Assumptions about Managerial Cognition

Abstract

The Rationale for Regulation: Shareholder Losses under Various Assumptions about Managerial Cognition ALFRED MARCUS University of Minnesota PHILIP BROMILEY University of Minnesota 1. INTRODUCTION Three types of regulation bolster the incentives for safe design and manu- facture provided by the product liability system: (1) direct controls influenc- ing how a product is used, (2) premarket restrictions that affect the characteristics of a product, and (3) recalls made after the product reaches the market. 1 When the costs of an accident or illness are difficult for the courts to measure or entail irreversible and noncompensable losses, and when the dangerous activity can be limited at reasonable expense, direct controls over product use and characteristics are economically justified. 2 This is the The authors would like to acknowledge the assistance of Mark Weber and Scott Hallstrom, who helped with the analysis of the data. Pat Hess, Isaac Fox, Gordon Alexander, and Robert Vigeland provided assistance in the early stage of this research. Robert Goodman, Barry Mit- nick, Fred Thompson, and an anonymous reviewer commented on an earlier draft. Funds from a University of Minnesota Graduate School Grant-in-Aid were used to complete this project. All findings and comments remain the responsibility of the authors. 1. The common law burdens the firm with a number of costs, including tort actions, if it manufactures unsafe products. The publicity surrounding these actions may result in lost sales, but regulation may be needed as well if tort remedies and market forces fail to provide timely and useful infom1ation about product characteristics (Posner). Consumer choice based on feed- back from product liability litigation is sometimes hindered by long delays in legal proceedings. In addition, cases settled out of court limit the feedback of relevant information. As a conse- quence, the government may need to intervene in some areas to provide adequate and inde- pendent assessments of product worthiness (Arrow). 2. See Wittman. For example, the courts are not able to measure the costs of an accident accurately, especially when it involves pain, suffering, and potential loss oflife, and the relation between speeding or drunken driving and accidents is generally accepted. ]oornal of Law, Economics, and Organization vol. 4, no. 2 Fall 1988 © 1988 by Yale University. All rights reserved. ISSN 8756-6222