Information acquisition and liability for unknowable risk

Abstract

Some product harm is exogenously unknowable until after some consumers have suffered the harm. There is a legal debate over whether such unknowable harm to these early consumers should be given immunity. This article finds that when the seller bears strict liability with compensatory damage on the unknowable harm, the seller’s incentive is distorted. There is an incentive to secretly over-test the product, so the seller can drop or attempt to fix a harmful product to reduce the public’s detection. At the same time, there is also an incentive to under-test the product to avoid a negative test result being leaked out by a whistle-blower. To achieve the socially optimal outcome under strict liability, the damages on the unknowable harm must be punitive and tailored to the events. Granting immunity for unknowable harm can remove inefficiency without complicated damages. (JEL K13, D83).