An Activity-Generating Theory of Regulation

We propose an activity-generating theory of regulation. When courts make errors, tort litigation becomes unpredictable and as such imposes risk on firms, thereby discouraging entry, innovation, and other socially desirable activity. When social returns to activity are higher than private returns, it may pay the society to generate some information ex ante about how risky firms are and to impose safety standards based on that information. In some situations, compliance with such standards should entirely preempt tort liability; in others, it should merely reduce penalties. By reducing litigation risk, this type of regulation can raise welfare.