Soft Negligence Standards and the Strategic Choice of Firm Size

In risky activities the extrinsic incentives for care are driven mainly by liability rules and by the asset levels of potential injurers. When the level of assets of the potential injurer is endogenous, we show that softer standards outperform the traditional standards based on first-best behavior, as well as strict liability: firms have incentives to choose to be larger, the lower the standards are. We also show that liability standards should increase in the costs of reducing assets and liability exposure. This means, counterintuitively, that when other instruments that restrict firms' size are relaxed, the optimal response is to relax, and not to tighten, liability standards. Also, in a regulatory competition setting we find that a country lowering its regulatory standards will not attract worse firms in terms of size. On the contrary, the best firms in terms of assets and care will be those benefiting from regulatory competition.