Liability Design with Information Acquisition

TL;DR

This paper analyzes liability rules for firms with private information about product risks, showing how evidence-based tariffs influence due diligence and risk management, with implications for policy design.

Contribution

It introduces a framework where liability mechanisms depend solely on evidence acquired after damage, linking private information, due diligence, and tariff design.

Findings

Higher prior risk leads to more due diligence but less than socially optimal.

Liability mechanisms can be implemented via evidence-dependent tariffs.

Under certain conditions, launch thresholds are enforceable through monotonic tariffs.

Abstract

How to guarantee that firms perform due diligence before launching potentially dangerous products? We study the design of liability rules when (i) limited liability prevents firms from internalizing the full damage they may cause, (ii) penalties are paid only if damage occurs, regardless of the product's inherent riskiness, (iii) firms have private information about their products' riskiness before performing due diligence. We show that (i) any liability mechanism can be implemented by a tariff that depends only on the evidence acquired by the firm if a damage occurs, not on any initial report by the firm about its private information, (ii) firms that assign a higher prior to product riskiness always perform more due diligence but less than is socially optimal, and (iii) under a simple and intuitive condition, any type-specific launch thresholds can be implemented by a monotonic tariff.