DP13224 | Regulation with Experimentation: Ex Ante Approval, Ex Post Withdrawal, and Liability

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Dynamic adoption policies of activities with uncertain returns are characterized by three key decisions: in the ex ante experimentation phase, the decisions when to abandon experimentation and when to introduce to market; in the ex post learning phase, the decision when to withdraw following the accumulation of bad news. In a tractable continuous-time model, we study the optimal mix of the three instruments regulators employ to align the private incentives of firms: ex ante approval regulation, ex post withdrawal regulation, and liability. Our results can rationalize the array of regulatory environments observed across applications ranging from product safety to patent protection. We also consider costly lying and show that the social planner can be better off when the firm privately observes research results.