Ambiguity and Accident Law

Environmental accidents often involve ambiguous risks, i.e., the relevant probabilities are unknown. This paper studies how liability rules are affected by ambiguity. The injurer and the victim choose a level of care, which is observable, and an unobservable action. Both actions may affect the size and/or likelihood of loss. We analyze the welfare implications of tort rules. First, we show that with ambiguity, negligence is likely to perform better than strict liability. Second, we propose a tort rule of negligence and punitive damages, which gives the efficient levels of both care and unobserved actions.     

On the efficiency of the negligence rule

The three versions of the negligence rule discussed in the literature differ regarding whether a negligent injurer is liable for the entire loss or only for the incremental loss; or regarding whether negligence is defined as failure to take at least due care or failure to take a cost‐justified precaution. It is shown in the paper that the incremental version with untaken precaution notion of negligence is not efficient; not even for the unilateral case. The paper also establishes, for the bilateral case, the efficiency of the incremental version with the shortfall‐from‐due‐care way of defining negligence.     

A Complete Characterization of Efficient Liability Rules: Comment

In a recent article, Jain and Singh (2002) prove that a condition they call negligence liability is necessary and sufficient for any liability rule to be efficient. In this note I criticize their result on two accounts: First, their result crucially depends on implicit restrictions they impose on the liability assignment function. If we drop the assumption that the liability apportionment between two non-negligent parties is constant for all combinations of non-negligent care levels, the equivalence between the condition of negligence liability and the efficiency of liability rules breaks down. Second, their attempt to drop the assumption of uniqueness for the social optimum improves the generality of the model at a substantial cost, since it must be accompanied by a new assumption that is possibly even more unrealistic. The importance of the uniqueness assumption is shown in a simple discrete care model, in which comparative negligence may lead to an inefficient outcome when the existence of two social optima leads us to interpret due care as a varying standard based on the other partys actual choice.     

EFFICIENCY OF LIABILITY RULES WITH INTERDEPENDENT COSTS OF CARE

Abstract.  Most of the results of the law and economics literature relating to the question of efficiency of liability rules have been obtained in the context of two-party interactions in which the cost of care of each party is independent of the care level of the other. In this paper we analyse the question of efficiency of liability rules in the context of interactions in which the cost of care of at least one of the parties is not independent of the care level of the other and characterize efficient liability rules whenever possible and in all other instances we obtain impossibility results.     

Rules of evidence and liability in contract litigation: The efficiency of the General Dynamics rule

We examine rules of evidence and liability in contract litigation. When a contractor fails to perform, it has a legal defense that the buyer withheld private information relevant to the performance of the contract. Suppose the buyer claims that admitting evidence for the defense would compromise a valuable secret, for example, a state secret, what should the legal rule be? We show that the evidentiary rules introduced by the Supreme Court in General Dynamics v. U.S. lead to a more efficient outcome than either a strict liability rule or an evidentiary rule requiring the disclosure of the buyer's private information.     

A NOTE ON SELECTION EFFECTS OF THE HAND RULE

The famous Hand rule weighs the burden of precaution against the reduction in expected harm. The burden may be type‐specific, implying different standards of care for different injurer types. We show that this fact may be exploited by principals in their search for minimized individual costs. Principals may hire agents with high cost of care‐taking although other agents are available. This is shown in a unilateral‐care setting either with perfect or with asymmetric information. We therefore highlight a neglected downside of the negligence rule.     

Fault Tolerant Implementation

In this paper we investigate the implementation problem arising when some of the players are "faulty" in the sense that they fail to act optimally. The planner and the non-faulty players only know that there can be at most  k  faulty players in the population. However, they know neither the identity of the faulty players, their exact number nor how faulty players behave. We define a solution concept which requires a player to optimally respond to the non-faulty players regardless of the identity and actions of the faulty players. We introduce a notion of fault tolerant implementation, which unlike standard notions of full implementation, also requires robustness to deviations from the equilibrium. The main result of this paper establishes that under symmetric information any choice rule that satisfies two properties—  k  -monotonicity and no veto power—can be implemented by a strategic game form if there are at least three players and the number of faulty players is less than     . As an application of our result we present examples of simple mechanisms that implement the constrained Walrasian function and a choice rule for the efficient allocation of an indivisible good.     

Transaction costs and planner intervention

In this paper, I examine a two-period general equilibrium model in which transaction costs are incurred whenever financial contracts are traded. These transaction costs are real and convex. The presence of these transaction costs results in a Pareto inefficient equilibrium allocation. Attempting to fix this problem, the planner will intervene by scaling the transaction costs either up or down. The intervention must satisfy fiscal balance meaning that the summed value of transaction costs will remain constant. I prove that over a generic subset of household utility functions and endowments and subject to an upper bound on the number of household types, there exists an open set of planner interventions that lead to a Pareto superior allocation.     

RISK, INFORMATIONAL ASYMMETRY AND PRODUCT LIABILITY: An Enquiry Into Conflicting Objectives

Abstract.  Risky products inflict two costs on society; the accident and the insurance costs. The expansion in the scope of product liability since the late 1970s has increased the cost of third-party liability insurance. However, the economic analysis has, traditionally, focused on only the accident costs. Some recent works suggests a strict trade-off between minimization of the accident costs and the insurance costs. In this paper, we extend the analysis by considering both types of costs. An efficiency characterization of product liability rules is provided by assuming informational asymmetry about the risk. We show that it is possible to achieve efficiency with respect to the insurance costs as well as the care levels.     

Optimal Reimbursement and Malpractice Sharing Rules in Health Care Markets

When health care sponsors such as HMOs or PPOs can use "utilization reviews" in order to indicate to the provider what type of treatment to administer to the patient based upon a diagnosis that is established by the provider, it is possible to implement the "first best" levels of investment in cost control efforts and in aggressiveness of treatment. The implementation of the "first best" requires the utilization of the prospective reimbursement rule accompanied by the removal of all malpractice liabilities from the provider. In contrast, when the type of treatment cannot be enforced by the payer, implementation of the "first best" is not feasible if the payer places a higher weight on the welfare of consumers than that of providers in its objective function. In this case, the reimbursement scheme deviates from the prospective rule, and the provider assumes liability to part of the cost incurred by society as a result of unsuccessful medical outcomes. When the payer can enforce treatment only partially by establishing bounds on the range of acceptable treatments, a minimal acceptable standard will be established and the outcome will be an intermediate case between the above two extremes.     

Product liability and the virtues of asymmetric information

This paper analyzes a two-period setup in which firms differ with respect to costs of care and may use care-taking to signal type to consumers, who are able to observe precaution taken only ex post. Applying the refinement of the intuitive criterion to the concept of the perfect Bayesian equilibrium, we establish a unique separating equilibrium for every share of harm borne by firms. For low levels of victim compensation, we show that (i) firms choose weakly higher care in a setting in which customers do not know the firms’ type than in a setting in which they do, and (ii) the deviation in precaution taken due to asymmetric information on firm type is welfare-improving.     

Preponderance of evidence

This paper investigates the incentive properties of the standard of proof for a finding of negligence when evidence about injurers’ behavior is imperfect. We show that a “more-likely-than-not” decision rule provides maximal incentives for potential tort-feasors to exert care. An injurer is then held liable whenever inadequate care appears more likely than due care, and not liable otherwise. Our analysis provides a deterrence rationale for the exclusionary rules of evidence found in common law and the preponderance of evidence standard of proof.     

Bancruptcy in a model of unsecured claims

Summary. We study a two periods model of incomplete markets with nominal assets unsecured by collateral, where agents can go bankrupt but there are no bankruptcy penalties entering directly in the utility function. We address two cases: first, a proportional reimbursement rule under bounded short sales and limited liability and, secondly, a nonproportional reimbursement rule, favoring smaller claims, without bounds on short-sales, but assuming that liability approaches total garnishment as debt goes to infinity. Received: September 10, 1998; revised version: August 6, 2001     

Monetary policy rules for financially vulnerable economies

One distinguishable characteristic of emerging market economies is that they are not financially robust. These economies are incapable of smoothing out large external shocks, as sudden capital outflows imply abrupt swings in the real exchange rate. Using a small open-economy model, this paper examines alternative monetary policy rules for economies with different degrees of liability dollarization. The paper answers the question of how efficient it is to use inflation targeting (IT) under high liability dollarization. Our findings suggest that it might be optimal to follow a nonlinear policy rule that defends the real exchange rate in a financially vulnerable economy.     

Balanced equilibrium in a consumption loans model

In a consumption loans model with many generations, Gale's theorem on the existence of balanced equilibrium is generalized, allowing more general preferences. The new theorem shows that there are plausible conditions under which there exists a Pareto optimal (non-optimal) balanced equilibrium whenever there exists (does not exist) a monetary golden rule equilibrium.     

Oil price forecasting under asymmetric loss

Based on the approach developed by Elliott et al. (2005), we found that the loss function of a sample of oil price forecasters is asymmetric in the forecast error. Our findings indicate that the loss oil price forecasters incurred when their forecasts exceeded the price of oil tended to be larger than the loss they incurred when their forecast fell short of the price of oil. Accounting for the asymmetry of the loss function does not necessarily make forecasts look rational.     

Dividends, safety and liquidation when liabilities are long-term and stochastic

This paper investigates the optimal management of a firm faced with a long-term liability that occurs at a random date. Three issues are analysed: The optimal dividend policy; optimal expenditure on safety to delay the occurrence of the liability; and the optimal liquidation date of the firm. An owner faced with dynamic unlimited liability never liquidates and therefore accumulates capital to the golden rule level. For long-term liabilities, dividend payments and safety expenditure are non-decreasing over time. The owner protected by limited liability may liquidate the firm in finite time in order to avoid paying the liability. If this is the case, then it accumulates less capital than the dynamic unlimited liability owner; and may decrease dividend payments and safety expenditure over time. The paper shows that a finite liquidation date is more likely to be optimal when the arrival rate of the liability occurrence increases over time.     

Legal form and risk exposure in Spanish firms

Abstract. It is well-known that the legal form adopted by a firm determines the type of legal responsibility borne by its owners in case of bankruptcy. In this paper we argue that a firm under a limited liability status should be characterized by a higher than average bankruptcy probability, which ultimately captures their risk exposure when output is affected by exogenous shocks. To test this prediction we extend Lee's (1976) switching regressions model to a panel dataset of 1313 Spanish firms from 1990–1994, separating them into corporate and entrepreneurial forms (with/without limited liability, respectively). We consider both random effects and fixed effects panel data models, taking into account the potential endogeneity between risk exposure and the legal form choice. Our results confirm the hypothesis that firms under limited liability have significant higher risk exposure than firms under unlimited liability. The authors gratefully acknowledge valuable suggestions from Maite Martínez-Granado, A. Jorge Padilla, Javier Suárez and two anonymous referees. Data and financial support provided by the Fundación Empresa Pública (Madrid) and comments from participants at seminars held at CEMFI, Simposio de Análisis Económico and Universidad de Vigo are also sincerely appreciated. Mr. Campos particularly acknowledges research funding by the University of Las Palmas.     

Tax‐deferred savings plans and interest deductibility

Abstract.  Programs that defer taxes on savings (e.g., RRSPs or 401(k)s) are supposed to move income tax systems closer to the more efficient consumption tax. Whether or not RRSPs move income tax systems away from or closer to a consumption tax depends on whether or not interest on debts incurred to make RRSP contributions is deductible for income tax purposes. If people optimize as assumed in simple life‐cycle models, then it may be that governments can convert a non‐linear income tax system to a proportional consumption tax system. I argue this is plausible for some Canadian households. JEL classification: H21, H24     

The performance and robustness of simple monetary policy rules in models of the Canadian economy

Abstract.  In this paper, we evaluate seven simple monetary policy rules in a wide range of models of the Canadian economy. Our results indicate that none of the seven simple policy rules we examined is robust to model uncertainty, in that no single rule performs well in all models. In fact, our results show that the performance of some of the simple rules, particularly rules with interest rate smoothing and rules with a high coefficient on the inflation gap, can substantially deviate from that of the optimal rule and can even be unstable in some models. Furthermore, we find that "open‐economy" rules do not perform well in many models. We find that adding an exchange rate term to a simple policy rule often increases the value of the policy‐maker's loss function. Although it is not robust, we find that a simple nominal Taylor‐type rule that has a coefficient of 2 on the inflation gap and 0.5 on the output gap outperforms the other simple rules in a certain class of models. However, even in those models, the loss‐function value of this simple rule can be substantially higher than that of the optimal or base‐case rule. JEL classification: E52, E58