Regulating Product Return Policies: The Trade-off between Efficiency and Distribution

The proliferation of product returns entails substantial financial and environmental costs. Nonetheless, regulators typically restrict firms from charging consumers high fees for returning products, which facilitates returns. To analyze the consequences of such interventions, we consider a market in which consumers have private information about their expected consumption utility. We show that monopolistic sellers have an incentive to inefficiently trigger too many returns even without regulation, as low return fees enable them to screen consumers and reap their surplus. Regulators then face a trade-off: upper bounds on return fees exacerbate inefficiency by causing sellers to trigger even more returns but also lead to a redistribution of wealth from monopolistic sellers to consumers. This trade-off also arises when consumers have an endowment effect. However, if sellers can induce overoptimistic beliefs about the utility from consumption (for example, through advertisements), upper bounds on return fees may also lead to higher social welfare.