United States Small Business Administration

RS Number 123

March 1992

Purpose

This study identifies the type of liability laws that affect small businesses the most, i.e. contribute most to increased costs of goods and services for small businesses compared with their large business competitors. This study is the first part of a two-stage research project. This first stage was designed to review product liability laws in each state, review relevant literature on product liability laws, and develop an economic model by which the effects of these laws could be assessed The second stage would be the testing of the economic model.

Highlights

This report examines the differential effect of the costs (liability and insurance costs, as well as total costs) of product liability laws on small and large businesses. The study postulates that there appear to be several areas in which small firms seem better off-in the sense of bearing lower costs-than large firms, and other ways in which they are worse off.

Non-uniform product liability laws may have a less harmful effect on small businesses compared with their larger counterparts because (1) their lowered output leads to fewer accidents; (2) their smaller asset level limits expected awards in potential lawsuits; and (3) their smaller investment in reputation limits reputational losses.

On the other hand, small firms may be affected more negatively because (1) they do not enjoy scale economies in precaution and litigation costs; (2) they are less able to bargain with potential plaintiffs; and (3) their limited assets increase their need to rely on market insurance-and all the costs that entails.

Taken together, this study hypothesizes that differing state laws on product liability are likely to increase total costs to a small firm and decrease its ability to recapture those costs through price increases. State differentials would also tend to increase litigation costs (through uncertainty of the law), increase the probability of lawsuits, and increase the expected award in the event of a lawsuit. Legal uncertainty reduces the ability of firms to signal accurately to consumers-through prices-the costs of liability in different jurisdictions.

Insurance costs also adversely affect small businesses for several reasons: (1) small firms cannot self-insure as easily as large firms; (2) small firms find it more difficult to absorb large insurance deductibles; and (3) large firms can offer insurance companies bigger accounts.

The study developed an economic model to measure how the variability of product liability laws across state-as well as firm size-affects a firm's liability costs.

Scope and Methodology

The report examines the evolution of the legal theory behind product liability laws within the United States. In addition, the report examines differences in state product liability laws.

A comprehensive review of the economic literature on product liability laws, as well as discussions of other economic models, also is included within the report. This literature review includes previous studies that examined the effect of state and firm size differentials on product liability laws. An empirical model was developed from existing economic theory to determine how these differentials would affect liability costs, insurance costs, and total costs to a firm.

The report also examines methods for testing the model, such as statistical (i.e., surveys of firms) and nonstatistical (i.e., case study) techniques. Anticipated problems in measuring important variables with statistical methods are also discussed in the report. A section on study design examines the existing data bases that might be appropriate for testing the empirical model.

Summary

This study focuses on two issues concerning the growing burden of product liability: (1) the effects of not having uniform product liability laws across states; and (2) whether the effects of product liability laws are more adverse for small firms than for large firms. It examines the evolution of the current state of product liability laws in the United States.

An empirical model that measures the effect of the costs to firms as a result of product liability laws (liability costs, insurance costs, and total costs) was developed. The model predicts that variability in the law unambiguously increases firms' costs, but that firm size has ambiquous effects on firms' costs.

A section on research methods and study design examined various methods for empirically testing the model, as well as the problems that might be encountered when measuring the variables. Existing data bases were examined for possible use as a preliminary data source for testing the empirical model.

For more information, contact Raymond Rawlinson in the SBA's Office of Advocacy at (202)205-6530.

Ordering Information

The complete report is available from:

National Technical Information Service

U.S Department of Commerce

5285 Port Royal Road

Springfield, VA 22161

(800) 553-6847

Order number: PB92-181197

Cost: A08 (Paper); A02 (Microfiche)

*Last Modified 6-11-01