Dangerous products, liability, and bankruptcy

Date of Completion

January 2005


Economics, General|Economics, Commerce-Business




Dangerous products liability has become a topic of increasing interest in recent years as products such as breast implants, prescription drugs and asbestos have produced thousands of lawsuits and cost defendants and insurance companies millions of dollars. Standard approaches suggest that strict liability should induce firms producing potentially dangerous products to appropriately consider the possible damages of their products and invest in adequate precautionary measures. However, distortions such as free-riding on research, potential bankruptcy, and spillover liability all distort these incentives. ^ In the first chapter of this dissertation, we will develop a general model of dangerous products liability in which firms invest in research before deciding whether or not to produce. This research is not perfect but can reveal whether or not a product is dangerous. When there are multiple firms involved in researching the same product, there is an opportunity for free-riding which induces the firms to choose less research than is socially optimal. Surprisingly, the free-riding also induces the firms to not produce in cases in which it would be socially optimal for them to do so. In the second chapter, we expand the model to address a specific issue of interest in the asbestos litigation. Because victims of asbestos-related diseases typically file against many firms, as some defendants have gone bankrupt, the plaintiffs have responded by increasing their demands on the others. This spillover liability can offset the disincentive to research that bankruptcy alone presents. However, spillover liability can also induce entry and so can actually be welfare-reducing. In the third chapter, we investigate another interesting issue in asbestos litigation. Because of the potential for spillover liability, when one firm becomes bankrupt due to asbestos liability, other firms in the industry may fear that the liability will spill over onto them and possibly even render them bankrupt. We quantify these effects through an event study of seven asbestos related bankruptcies. We find that on average firms in the same or related industries as a firm bankrupted by asbestos litigation do see a negative spillover liability effect. However, this effect varies by industry. ^