Optimal liability when the injurer's information about the victim's loss is imperfect

Abstract

A central result in the economic theory of liability is that, if an injurer's liability equals the victim's loss, then either the rule of strict liability or the rule of negligence can induce the injurer to behave properly. However, for this result to hold, the injurer must know the victim's loss before the injurer decides whether to engage in the harmful activity and, g fortiori, before any harm has occurred. This paper reevaluates the rules of strict liability and negligence when the injurer's information is imperfect. Two questions are addressed: Under each rule, should the level of liability imposed on the injurer still equal the victim's loss? Are the rules of strict liability and negligence still equally desirable? With respect to the first question, it is demonstrated that the optimal level of liability generally is not equal to the victim's loss. With respect to the second question, it is shown that if the injurer's liability equals the victim's loss, then the two rules are equivalent, but if liability is set optimally under each rule, then strict liability generally induces the injurer to behave in a more appropriate way.