Replacement Decisions for Potentially Hazardous Substances

As public awareness of environmental hazards increases, a growing concern for corporations is the potential negative environmental impact of their products and the chemicals these products contain. In this paper, we analyze the optimal decisions of a firm when a substance within its product is identified as potentially hazardous. Although the substance is not currently regulated, regulation may occur in the future. Therefore, the firm must devise a strategy for the development and implementation of a replacement substance. In an environment where replacement costs can be millions of dollars, regulation is uncertain, and both consumer and non-governmental organization pressures exist, a carefully developed plan that balances costs and risks is critical for a firm. Our results demonstrate that as long as a threat of regulation exists, a firm should always dedicate resources towards developing a replacement substance. However, it is not always optimal for a firm to implement a developed replacement. Regarding competitive dynamics, we find that competition between firms can offset a low chance of a shift in consumer perception about a substance and compel firms to replace; however, competition can lead to inefficient outcomes in which firms incur avoidable costs to implement ahead of potential regulation