Taggert Brooks Economics Consulting
Taggert Brooks - Economic Consulting

Liability and Entrepreneurs

Marginalrevolution has a post on firm size and liability.

I would like to tile my front porch steps and have been shopping. Lowe’s and Home Depot have plenty of tile but although they advertise installation they won’t install it outdoors. The salespeople, however, will surreptitiously recommend small family contractors. Call Jose, they tell me handing me a number. Why won’t the big firms install outdoor tile?

As best as I can figure the answer is liability. A few slips, falls and an enterprising lawyer or two and Lowe’s could be out millions of dollars. The revenues aren’t worth the risk so small firms step into the breach. The key, of course, is that the small firms won’t be sued because they are judgment proof.

Roberta Romano was here yesterday and offered another example. The big auditing firms won’t do SOX audits for small firms because the revenues are low relative to the risks. The smaller firms must turn to judgment proof auditors of less reliable reputation.

In one sense, this is a good workaround for a liability system that seeks out deep pockets. Consumers are better off than they would be if neither Lowe’s nor the judgment proof firms offered services and they are also better off than if Lowe’s was required to offer services, because the price at which Lowe’s would do so voluntarily would be prohibitive (consumers would be forced to buy insurance they didn’t want at the price).

But more deeply the resulting system is inefficient. Consumers don’t get the insurance that the liability law is supposed to provide and they must turn to lower quality, higher cost service providers even when they would prefer larger firms with solid reputations.

So small entrepreneurs appear to be in some part an answer to our often litigious society.

Posted: March 20th, 2008
Categories: Entrepreneurship
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