---



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