Delivering Bad News: Market Responses to Obstetricians' Negligence

One of the goals of the legal liability system is to ensure that sellers provide appropriate care. In addition to direct punishment by the legal system, reputation effects may work to deter negligence. The little available evidence suggests that such effects are minimal, however. Focusing on medical malpractice, we examine this effect using a micro-level dataset in an environment in which sellers are of heterogeneous quality and face two types of demand, private consumers who exhibit downward sloping demand (i.e., private health insurance) and government consumers who exhibit perfectly elastic demand at a fixed price (i.e., Medicaid insurance). We find that high quality sellers who are sued may see their caseloads shift from private to government patients. Combining individual patient-level data from Florida for the years 1994-2003 with physician-level litigation data, we find evidence that physicians experience large reputation effects that differ across patient segments in accordance with the theory.