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1. Introduction
According to competitive market principles, allocation efficiency is achieved when costs of products and services offered in markets are born by producing firms and are included, entirely, in selling prices; in other words, maximum efficiency gains are realized when producers internalize all costs. If producers externalize a portion of their costs, they would: be able to produce more (perhaps excessively); withhold incentives for R&D necessary for production process and physical capital innovation; sell at lower prices; encourage wasteful use of their products; discourage recycling; cause pollution, health problems, and wrongful accidents in the work place and in the outside stakeholder community. Needless to say that internalization of costs may be practiced not only by producers but, in a contributory fashion, by their stakeholders as well.
Of course, as it has been demonstrated by [3] Coase (1960) when transaction costs are zero or negligible, the business firm may rely on clearly defined property rights and/or contracts (credible commitments) to deal with the violation of property and safety rights or, in other words, the internalizing of external costs between it and its various stakeholders. (See the Appendix for a description of Coase's invariance theorem.)
When transaction costs are high, the business firm would have to rely on tort liability laws. According to [4] Cooter and Ulen (1996, p. 262), "the economic essence of tort law is its use of liability to internalize externalities created by high transaction costs". A tort is a "wrong" committed by the firm against its stakeholders (or vice-versa ) and it may range from inadvertent to deliberate, from severe to insignificant, from crime to irritation. For more on torts and liability laws see [1] Brown (1973), [2] Calabresi (1970), [5] Posner (2007) and [6] Shavell (1980, [7] 1987) (for definitions and examples see: www.psychservices.psychiatryonline.org/cgi/content/full/51/6/817-a; www.the-injury-lawyer-directory.com/negligence.html; www.contributorynegligence.org/).
In the remainder of this paper, I assume that a business firm is the defendant responsible for precautionary safety in the workplace, and an employee, working for the firm, is the plaintiff. Would the firm (employee) have the incentive to provide (undertake) sufficient precaution? To answer this question, I rely on simple marginalist economics concepts and popular legal rules and compensation formulas. More specifically, I discuss incentive mechanisms for internalization of costs in conjunction with...