Corporate risk analysis: a reckless act?

• Author: Viscusi, W. Kip
• Position: Statistical Data Included

[Editorial note--the Stanford Law Review has solicited comments to this piece that will be published in forthcoming issues.]

INTRODUCTION

In 1999, a Los Angeles jury imposed a $4.8 billion punitive damages award on General Motors for a case involving severe burns to passengers in a 1979 Chevrolet Malibu.(1) This award, which is the largest punitive award ever in a personal injury case,(2) arose in part because the company had undertaken an explicit analysis of the types of fire risks and design change costs associated with burn injuries.(3) The main issue raised by this award is whether, in fact, a corporation is being irresponsible if it undertakes a risk analysis and chooses not to make an unbounded cost commitment to safety.

On a personal level, the approach of accepting risk tradeoffs is implicit in our daily lives. We take chances all the time. We ride in motor vehicles, fly on planes, eat potentially risky foods, and live in an environment that is not risk-free. Some tradeoffs of this kind are inevitable as we seek to strike an appropriate balance between the harm inflicted by risks and the benefits such activities offer for our lives. The task for the individual is to make those personal decisions that confer sufficient benefits to outweigh the associated risks.

When faced with options that have different levels of safety, we often pay a higher price for safer products, though not without limit. Millions of consumers purchase cars with antilock brakes and protective side air bags, but few of us have such an unlimited concern for safety that we purchase a tank-like Hummer vehicle. The degree of concern for safety that consumers manifest in turn sends signals to corporations in terms of the kinds of goods and levels of safety that we value. The risk tradeoffs that we are willing to make in effect set the price for safety in the market and provide guidance to corporations, which must supply the products and services we purchase. If corporations generate products that create more hazards than we want to bear given the product price, or include unnecessary safety features that we do not value, then the product risk mix will not be successful in the marketplace. Thus, the task of corporations is to assess the risks of products and activities and to determine which safety efforts are worthwhile and in line with consumer preferences. For risks arising in a market trade with the party bearing the risk, informed consumer choices will lead to efficient risk levels. Not all risks, however, are priced in the market. Environmental hazards are an example of risks that are not. In this instance, government regulation can be used to provide appropriate incentives.

The formal mechanism for making tradeoff judgments is a risk analysis that outlines the pluses and minuses of different safety options. Risk analysis consists of a variety of different levels of analyses. First, risk analysis involves assessing the magnitude of the hazard. Is it a serious threat or a minor background risk? Second, are the risk-reducing policies selected cost-effective; i.e., do they achieve the greatest risk reduction possible for the amount of funds expended? Third, do the policies pass a benefit-cost test? Do the societal benefits of risk reduction outweigh the costs? Firms' interest in profits will lead them to choose the most cost-effective option, and risk awareness by consumers will lead firms to adopt risk reduction efforts that pass a benefit-cost test. However, in the absence of informed and rational choice, firms may not adopt all safety improvements that are efficient in terms of benefits exceeding costs--a relationship that is tested through negligence tests in the court and benefit-cost analyses in the policy arena.(4)

Any systematic attempt to trade off costs and risk-reduction benefits may appear to be a cold-blooded calculation invented by economists.(5) Seeking the right tradeoff between risk and cost is not an abstract economic exercise, but lies at the heart of the real choices that must be made. Indeed, we want corporations to think about risks in a systematic manner and to undertake such calculations to ensure that there is appropriate risk balancing that is sufficiently protective. We all benefit when corporations select the level of safety that correctly reflects our own concern with safety and the costs of providing it. The merits of the analysis and the ultimate balance struck should be the main manner of concern, not whether undertaking a systematic analysis allegedly reflects a cold-blooded attitude towards human life. Of course, the fact that companies have undertaken such balancing does not imply that they should be vindicated on economic grounds. Even armed with an extensive risk analysis, companies may fail to make sufficiently protective decisions. But liability for corporate behavior should hinge on the risk and cost decisions, not on whether the finn undertook a risk analysis. We want to encourage corporations to do such systematic thinking about risk and cost. The fact that they have done such analyses and have perhaps erred in the process should not itself be regarded as a reckless act. Indeed, our society will only become safer if we think carefully about safety and make the right choices given our limited resources.

A major difficulty arises if a company that undertakes a risk analysis and yet proceeds with a potentially dangerous act or a risky product triggers a bias among jurors against it simply for having undertaken the risk analysis. Such biases might be especially pronounced in situations in which there is a general anti-corporate bias or a suspicion of the motives underlying corporate decisions.(6) Undertaking explicit risk-cost tradeoffs, which in effect balance lives lost and environmental damage against monetary costs, may offend jurors' sensibilities. The fact that a company has undertaken a risk analysis--even a sound analysis--may lead jurors to award punitive damages rather than compensatory damages alone. The highly charged atmosphere of many court proceedings often prompts juries to impose large awards to send corporations a message. Such message-sending has the purported intent of generating incentives for safety. As a former president of the Consumer Attorneys of California put it: "The purpose of punitive damages is to deter despicable acts by corporate America."(7)

But what are these "despicable acts"? In some cases, the alleged despicable act may be the actual undertaking of a risk analysis itself rather than a failure to strike an appropriate risk-cost balance in its product safety or environmental risk choices. A prominent example is the recent case of Sergio Jimenez, who was killed in his Chrysler Minivan because of an allegedly defective rear-door latch. In 1994, Sergio Jimenez, who was six years old, was riding unbuckled in the back seat of a 1985 Dodge Caravan in Charleston, South Carolina. As his mother ran a red light, her van was smack on the side by a Honda that was traveling under fifteen miles per hour. The van rolled over, the rear door opened, and Sergio Jimenez was thrown to the street and died. The plaintiffs claimed that the door lock was defective, and more importantly, that Chrysler had analyzed the defect and failed to repair it.(8)

Jimenez v. Chrysler Corp. led to a $250 million punitive damages award against Chrysler Corporation.(9) The company was faulted not only for the defective door latch, but also for trading off risk against cost. In Chrysler's view, the defect posed no significant risk, but the cost would have been $100,000 for a one-time tooling cost, plus $0.50 per vehicle for the new part.(10) In such instances, jurors are unlikely to compare the costs and the expected benefits, given the probability of an accident. Instead, they may compare the $0.50 per vehicle cost with an identifiable death, between which there is a stark difference. The plaintiff's attorneys demonized Chrysler's analysis in their post-trial memorandum: "Chrysler officials at the highest level coldbloodedly [sic] calculated that acknowledging the problem and fixing it would be more expensive, in terms of bad publicity and lost sales, than concealing the defect and litigating the wrongful death suits that inevitably would result."(11)

Suppose that the company did the analysis correctly, in a manner in line with contemporary sound and responsible economic principles. Would the existence of the risk analysis itself make jurors more likely to conclude that the corporation acted recklessly by placing excessively risky products on the market? To explore this issue, I present new empirical evidence based on an original survey that I undertook with almost 500 juror-eligible citizens. Ideally, jurors should take into account responsible risk-cost balancing. A corporate risk analysis that showed that the benefits of the safety improvement did not exceed the costs should not only eliminate the possibility of punitive damages, but also eliminate negligence-based claims. Unfortunately, any such analysis seems to have adverse effects. Undertaking even a sound risk analysis in line with that used by government regulators leads mock jurors to impose greater sanctions for risk decisions, despite the fact that these choices may have struck an appropriate risk-cost balance.

This behavior of mock jurors is not consistent with the intent of tort law. There are no existing legal provisions indicating that firms should be punished for having undertaken a risk analysis. The type of behavior reflected by the mock jurors is also borne out in actual eases, such as Jimenez v. Chrysler Corp. and other cases discussed below. A detailed review of instances in which firms have undertaken risk analyses indicates that such careful risk and cost assessments tend to affect firms adversely. The well-known example involving the stigmatization of Ford following the release of the internal Ford Pinto...