Kathleen Segerson
As shown in Figure 1, if the firm chooses to undertake protective
measures voluntarily, there is some probability q (0≤q≤1) that a
contamination episode will occur.17 In most cases, we would expect the
protective measures to reduce the likelihood of contamination but not to
eliminate it completely. Thus, q>0. However, if those measures ensure a
completely safe product, then q=0.
The payoffs from undertaking protective measures voluntarily depend on
the associated costs and benefits. Let Cv denote the additional cost the firm
incurs as a result of undertaking the measures voluntarily. The magnitude
of Cv reflects the fact that voluntary adoption keyed to performance
standards allows the firm maximum flexibility in choosing the means by
which those standards will be met. We would thus expect Cv to represent
the minimum cost of ensuring a particular level of product safety. Let S
represent the amount of the subsidy, if any, that the firm receives as a result
of voluntary adoption of food safety measures. The magnitude of the
subsidy that the government might be willing to pay to induce voluntary
adoption will depend on a number of factors, including the social cost of
raising the funds necessary to finance the subsidy and the expected benefit
from voluntary adoption.18 Let Bv denote the benefit that the firm receives
from voluntary adoption. Bv will reflect not only revenue (net of
production costs) from the sale of its product, including any increase in
revenue due to increased demand for the product because of its increased
safety, but also any public relations benefits (e.g., increased current or
future demand because of increased "good will" toward the firm). Finally,
let L denote the firm's expected loss as a result of a contamination episode.
The magnitude of L will reflect a number of factors, including the
magnitude of the actual damages to the victim, the liability rule that is
externality), the firm does not internalize any of the external costs through the
market. As will be seen below, in the context of food safety where the damages are
borne by the consumer of the product, the market can sometimes provide a
mechanism for internalizing some of those damages. Given this, we would expect
the outcome of a bargaining between firms and the government over voluntary
measures to lead to greater levels of protection than would have been the case in the
absence of any internalization.
17 Because our interest is in firm-level incentives, we focus here on
contamination that can occur during the production or processing stages. We do not
explicitly consider the role that consumers can play in determining damages
through use of safe handling procedures. Instead, we simply interpret q as the
probability of contamination given some level of care taken by consumers to avoid
ingestion of contaminated food. We note, however, that the level of care that is
likely to be taken by consumers will depend on a number of factors, including the
information they have regarding potential contamination and the liability rule in
place. See further discussion below.
18 See Segerson and Miceli (1997) for a model that explicitly incorporates the
government's decision regarding the magnitude of a subsidy for voluntary measures
for environmental protection.