Product Liability and Strategic Delegation: Endogenous Manager Incentives Promote Strict Liability

We derive the socially optimal allocation of liability for product-related accidents when firms delegate their output and safety choices to managers under a contract that depends on profits and revenues. With exogenous product risk, the optimal contract emphasizes revenue over profits as a way of inducing managers to increase output independently of the liability allocation. When product safety is endogenous, however, this strategy distorts managers’ product safety choice because the managers underweight the cost of safety relative to expected harm whenever consumers bear some share of liability. It is then socially optimal to hold firms fully liable for victim losses.