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This paper develops a model to analyze safety regulation when decisions made by both the firm and the firm’s employees (workers) have effect on the risk of accidents. In the model, the safety investments by the firm are contractible (perfect enforcement) while the safety efforts of workers can be contractible or non-contractible. We show that in the absence of regulation, a first-best outcome is unattainable unless third-party accident costs are zero and worker effort is contractible. The optimal standard produces suboptimal solutions and depends on factors such as safety effort costs, accident technology, the distribution of accident costs across firms, workers, and third parties, and whether or not worker effort is contractible. Under specific assumptions the optimal standard is more lenient than the safety investment level chosen by the firm in the absence of regulation.
