Equilibrium and Welfare in a Model of Torts with Industry Reputation Effects
43 Pages Posted: 10 Apr 2012 Last revised: 12 Dec 2012
Date Written: December 11, 2012
We study the problem of torts in a framework where a firm's accident adversely impacts all firms in the industry because of the presence of industry reputation effects. Industry reputation effects lead to interdependence among firms and give rise to strategic firm behavior. We characterize the industry equilibrium and the socially optimal industry configuration in such a setting. We then elucidate how the presence of industry reputation effects and the introduction of a liability regime in the form of a strict liability rule determine whether industry equilibrium is aligned or misaligned with the socially optimal industry configuration. Our results show that both the impact of industry reputation effects and the impact of the strict liability rule are in general contingent on the specifics of the tort problem at hand. In particular, we find that the presence of industry reputation effects can substitute for a suboptimal liability regime and that, in the presence of industry reputation effects, the introduction of the strict liability rule may be detrimental by steering the industry equilibrium away from the socially optimal industry configuration.
Keywords: Industry reputation effects, torts, industry equilibrium, social welfare, strict liability
JEL Classification: K13, L14, D60
Suggested Citation: Suggested Citation