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.
Highlights
There has been an increasing interest in the means of the internalization of the externality of a serious accident
To the best of the author’s knowledge, no study of how an extended liability scheme influences the judgment-proof firm’s precaution level to prevent accidents and reduce damage when the regulator cannot observe the private transactions between the firm and its stakeholders has far been carried out
This study examines the relationship between an extended liability scheme and the optimal regulation of a judgment-proof firm carrying out a risky activity that may be exposed to the possibility of a large accident
Summary
There has been an increasing interest in the means of the internalization of the externality of a serious accident. One branch of such studies focuses on exploring how extending the firm’s accident liability to its stakeholders under a so-called extended liability scheme modifies the incentives of the firm and of its stakeholders. Insights into the mechanism of how a judgment-proof firm’s precaution levels against a serious environmental accident are affected by extending the scope of the parties potentially responsible for such an accident have been accumulated. How to cite this paper: Tomori, A. (2015) Accident Prevention and Damage Reduction in an Extended Liability Scheme.
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