Tort Liability and the Market for Prescription Drugs

Nearly all the empirical literature on tort liability in the healthcare sector focuses on physicians. Yet both drug companies and physicians lose roughly the same portion of revenue (2 percent) to liability expenses.Moreover, the health care system’s expenditures on drugs are rising nearly twice as fast as expenditures on physician and hospital care. In this paper we model and estimate the welfare effects of failure‐to‐warn suits, the most common type of tort litigation involving drug companies. We find that tort liability ‐‐ proxied by punitive damage caps ‐‐ increases drug prices but that it also reduces side effects. Moreover, we find that tort liability increases the equilibrium quantity of drug sales. This suggests that liability not only increases cost and reduces supply, but also increases expected safety and thus demand. Together the increase in equilibrium quantity and reduction in side effects suggests that tort liability improves social welfare.