How Companies and Governments React to Disasters

A two-stage model is developed between a company and a government. The government, representing the general public, earns taxes on production and chooses the tax rate in stage 1. The company allocates its resources into productive effort and safety effort. The disaster probability is modeled as a contest between the disaster magnitude and the two players’ safety efforts. Three new propositions are developed. First, both the government’s and the company’s safety efforts decrease in the unit safety effort costs, and the company’s safety effort increases in the unit production cost and in the company’s resources. Second, both players’ safety efforts are inverse U shaped in the disaster magnitude. Third, the company’s safety effort increases, and the government’s safety effort decreases, in taxation. Taxation can thus ameliorate companies’ incentive to free ride on governments’ provision of safety efforts.