Due-care standards in a market setting with legal error

We consider a monopoly market setup with legal error, where social welfare is negatively related to a firm's expected liability costs. In this context, we investigate the optimal location of the due-care standard vis-a-vis any given desired care level. It is found that when both the due-care standard and the penalty multiplier are choice variables, setting the due-care equal to the desired care is unlikely to be optimal and conditions under which it should be made relatively lenient or stringent are obtained. Exogenous restrictions on the penalty multiplier may restrict the extent to which the due-care can be manipulated to improve welfare. (C) 2007 Elsevier Inc. All rights reserved.