Internalization of costs, liability and negligence, performance and reliance

Purpose – The purpose of this paper is to discuss incentive mechanisms and procedures for cost internalization by both potential defendants and plaintiffs. Design/methodology/approach – The approach taken is to rely on the concepts of liability, negligence, precaution and methodologies for estimation of compensatory damages in conjunction with the Coase theorem. Findings – The paper finds that the decision to internalize and minimize cost depends upon marginal precautionary costs and marginal expected harms. Research limitations/implications – Research needs to be conducted from a law and economic perspective on developing procedures for estimating precautionary costs and expected harms. Practical implications – This paper calls upon business firms and their stakeholders (primarily employees and customers) to use and pro‐actively manage their precautionary responsibilities and further refine the existing formulas. More specifically, it aims to help law and economics students as well as practitioners in law and regulation to better understand the implications of marginal precautionary costs and marginal expected harms in the process of cost internalization. Originality/value – In exploring the precautionary responsibilities of firms and their stakeholders, this paper contributes to a better understanding of liability and negligence issues and, as a result, to the important intersection of law and microeconomics.