1 Product Recall and Liability

This paper examines a firm’s private incentives to recall its product after learning of potential harm that the product may cause to consumers. It also discusses consumers ’ incentives to return the recalled product and whether courts should protect negligent consumers who do not comply with the recall. Consumers are heterogeneous with different likelihoods to be harmed. Product returns are costly to both the firm and consumers. The firm’s costs depend on consumers ’ return rate. However, consumers do not internalize the firm’s costs when deciding whether to return the product, and with heterogeneous consumers, the firm may not provide sufficient reimbursement for consumers ’ return costs. Such effects distort consumers ’ return decisions and the firm’s incentives to recall the product. Two distinct liability rules are compared. Under the “no duty to return ” rule, the firm bears the same liability to a harmed consumer no matter whether the firm has made a recall or not. The firm then may not recall the product as often as socially desired, or may provide insufficient reimbursement for consumers ’ return costs. In contrast, the “duty to return ” rule allows the firm to deny future liabilities after it makes a recall. However, consumers then are more likely to return the product, which would reduce the firm’s incentives to recall the product. Overall, the “duty to return ” rule may or may not generate more product recalls or higher social welfare than the “no duty to return ” rule. The comparison depends on the firm’s liability, consumers ’ return costs, the distribution of consumers ’ likelihoods to be harmed and the distribution of the potential harm level