Risk, Liability, and Monopoly

The paper explores a monopolist's safety and output choices when there are potentially large-scale claims that can lead to firm insolvency. Analysis of a monopolized market yields different conclusions than models of rule choice where perfect competition or simple cost-minimization are assumed. The following are shown to be true when consumers do not internalize expected, uncompensated hazard costs: (1) potentially insolvent firms may make more efficient safety and output choices than fully capitalized firms and (2), for any level of capitalization, compliance with a negligence rule—where liabilities are removed—may in fact result in less output and safety than under strict liability, where hazard costs are at least partially internalized. When consumers fully discount risks, a negligence rule dominates strict liability because it allows for less costly, credible commitments to profit- and welfare-maximizing safety investments. The analysis demonstrates that the optimal legal system—including financial responsibility requirements—is particularly sensitive to market structure and the characteristics of firms' risk reduction technology