Product Liability versus Reputation

Abstract

The Tort system and especially Product Liability is a socially costly tool to provide manufacturers with incentives for safety. Recently, it has been argued that market reputation could, to a significant extent, constitute a cheaper alternative to Product Liability. Our paper departs from the sometimes overlooked fact that market reputation is not for free, but requires to implement "market sanctioning" mechanisms that are costly for consumers and manufacturers. We show that Product Liability positively affects the functioning of manufacturer's market reputation by reducing its costs. Thus, to an important extent, reputation and Product Liability are not substitutes but complements. We also specifically show the effects of different relevant legal policies in Product Liability, and namely that negligence reduces reputational costs more intensely than strict liability, and that legal and Court errors in determining liability interfere with the reputational cost reduction function of Product Liability.

Keywords: Reputation, Relational Contracts, Product Liability and Consumer Protection

JEL Classification: K13, K23, L51, H24