Judicial Errors, Legal Standards and Innovative Activity

We analyze the effects of judicial errors on the innovative activity of firms. Successful research investment allows to take a new action that may be ex-post welfare enhancing or welfare decreasing (illegal). Deterrence in this setting works by affecting both the incentives to invest in research and the ex-post choice of the action (marginal deterrence). The two goals may contrast each other and their relative importance shapes the optimal policy. For increasing probabilities of social harm, the enforcer initially promotes research and disregards marginal deterrence: in this case no accuracy is chosen and the policy adopts first a per-se legality and then a (moderately enforced) per-se illegality rule. Conversely, for higher likelihood of social harm, the enforcer favors marginal deterrence eliciting the ex-post efficient actions at the cost of depressing firm’s investment: the optimal policy calls for positive .nes and improved accuracy, with a stronger effort to reduce type-I than type-II errors and the adoption of asymmetric protocols of investigation. Improved accuracy allows to discriminate between beneficial and harmful actions, an instance of effect-based legal standard.