Strict liability in a principal-agent model

Abstract

Previous analytical work examining strict liability has generally ignored the existence of moral hazard problems within the firm. In this work, the firm has been implicitly modeled as a single individual (for example, Shave11 [1980, 19821, Landes and Posner [ 19811, Polinsky [1980], Polinsky and Rogerson [1983], and Mantel1 [1984]).’ However, it is often the case that an owner of a firm (principal) hires an employee (agent) to perform activities which could result in the harm of a third party. For example, in the recent industrial accident case of the 1984 Bhopal, India gas leak, Union Carbide Corporation had established the subsidiary Union Carbide India Ltd., which in turn hired Indian employees to operate a chemical plant. In general, if the preferences of the agent differ from those of the owner and if the agent’s effort is unobservable, then a moral hazard problem may exist within the firm. This study examines the socially optimal level of care and the care taken under strict liability in the presence of moral hazard through the application of principal-agent economic models.* Since this paper examines environments in which a principal hires an agent to engage in a productive activity, the influence that strict liability has on firm behavior can be analyzed in settings where firm ownership is separated from management (for example, as in the Union Carbide Bhopal, India accident). While previous research has considered the direct influence of liability rules on the care taken by an owner-manager, this paper examines the influence that strict liability