Regulation with Experimentation : Ex Ante Approval, Ex Post Withdrawal, and Liability

We analyze in a two-phase model the optimal mix of ex ante experimentation and ex post learning for the dynamic adoption of activities with uncertain payoffs. In a first pre-introduction phase, costly experimentation is undertaken to decide whether to adopt the activity or abandon experimentation. In a second stage following adoption, learning takes place while the activity is maintained; the withdrawal option is exercised following the accumulation of sufficiently bad news. We derive positive and normative implications for the three main tools used to regulate private experimentation and adoption incentives: liability, withdrawal, and authorization. Liability should be preempted to avoid chilling of activities that generate large positive externalities, consistent with the preemption doctrine. Liability should be used to discourage excessive experimentation for activities that generate small positive externalities. Authorization regulation should be lenient whenever it is used, consistent with the organization of regulation in a number of areas ranging from product safety to antitrust regulation