Accident Prevention and Damage Reduction in an Extended Liability Scheme

Abstract

This study explores how an extended liability scheme affects a judgment-proof firm’s precaution levels to prevent accidents and reduce damage when the regulator cannot observe the firm’s private transactions. For this purpose, we incorporate the firm’s precautions to reduce damage into the model proposed by Hiriart and Martimort [1], who only investigated accident prevention. Then, we examine the optimal regulation of a firm that takes measures to reduce not only the probability of a serious environmental accident but also the extent of the damage of such an accident and analyze how the levels of these two types of efforts are affected by introducing an extended liability scheme. We expand the results of Hiriart and Martimort [1] by showing that extending liability to the firm’s stakeholders may improve social welfare by enhancing accident prevention efforts and by weakening damage reduction efforts even when the regulator cannot observe the private transactions between the firm and its stakeholders.

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Tomori, A. (2015) Accident Prevention and Damage Reduction in an Extended Liability Scheme. Theoretical Economics Letters, 5, 246-255. doi: 10.4236/tel.2015.52029.

Conflicts of Interest

The authors declare no conflicts of interest.

References

[1] Hiriart, Y. and Martimort, D. (2006) The Benefits of Extended Liability. The RAND Journal of Economics, 37, 562-582. http://dx.doi.org/10.1111/j.1756-2171.2006.tb00031.x
[2] Pitchford, R. (1995) How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk. American Economic Review, 85, 1171-1186.
[3] Pitchford, R. (2001) How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk: Reply. American Economic Review, 91, 739-745. http://dx.doi.org/10.1257/aer.91.3.739
[4] Lewis, T.R. and Sappington, D.E. (2001) How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk: Comment. American Economic Review, 91, 724-730. http://dx.doi.org/10.1257/aer.91.3.724
[5] Balkenborg, D. (2001) How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk: Comment. American Economic Review, 91, 731-738. http://dx.doi.org/10.1257/aer.91.3.731
[6] Hutchinson, E. and Van’t Veld, K. (2005) Extended Liability for Environmental Accidents: What You See Is What You Get. Journal of Environmental Economics and Management, 49, 157-173. http://dx.doi.org/10.1016/j.jeem.2004.03.003
[7] Tomori, A., Araki, K. and Konishi, H. (2011) Disaster Prevention versus Disaster Reduction. mimeo.

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