Negligence Regime Research Articles

Unreasonable: A Strict Liability Solution to the FTC’s Data Security Problem

For over two decades, the FTC creatively employed its capacious statute to police against shoddy data practices. Although the FTC’s actions were arguably needed at the time to fill a gap in enforcement, there are reasons to believe that its current approach has outlived its usefulness and is in serious need of updating. In particular, our analysis shows that the FTC’s current approach to data security is unlikely to instill anything close to optimal incentives for data holders. These shortcomings cannot be fixed through changes to the FTC enforcement approach, as they are largely generated by a mismatch between the tools that Congress gave it over a century ago and what it needs to foster firms’ incentives to mimic socially optimal levels of care for the data they hold. Not only does the current framework likely suffer from informational deficiencies attendant to its focus on “reasonable” security that render liability standards uncertain, it also lacks the ability to obtain the type of relief that will force firms to internalize the costs of their data security decisions. We examine the problem of data security enforcement through the lens of the economics of optimal precautions and identify several reasons why a strict liability regime administered by the FTC, under which firms pay for the expected harm from breaches they cause, is likely to be superior to the current framework that revolves around the concept of reasonableness. The benefits of strict liability flow from the likelihood that firms do not fully internalize the costs and benefits of their data security decisions and the relatively large informational burdens associated with measuring actual and optimal care under a negligence regime. We also show why in this informational environment, strict liability is better than negligence for developing a vibrant cyber insurance market, allowing for data security regulation to be de facto outsourced to insurers who will contract with firms for optimal levels of care. Because these private contracts will harness private information on costs and benefits from precautions, they are likely to incentivize more efficient behavior.

Should environment be a concern for competition policy when firms face environmental liability?

In the recent period, more and more voices have called for unconventional competition policies as a way to achieve higher environmental investments from firms. This paper shows that this objective may come into conflict with those of environmental liability laws. We introduce a basic oligopoly model where firms produce a joint and indivisible environmental harm as a by-product of their output. We first analyze the effects on the equilibrium of alternative designs in environmental liability law, secondly, we discuss the rationale for “non-conventional” competition policies, i.e. more concerned with public interest such as the preservation of environment (as well as human health and so on). We study firms decisions of care and output under various liability regimes (strict liability vs negligence) associated with alternative damages apportionment rules (per capita vs market share rule), and in some cases with damages multipliers. We find that basing an environmental liability law on the combination of strict liability, the per capita rule, and an “optimal” damages multiplier, is consistent with a conservative competition policy, focused on consumers surplus, since, weakening firms’ market power also increases aggregate expenditures in environment preservation and social welfare. In contrast, a shift to the market share rule, or to a negligence regime, may be consistent with a restriction of competition, since firms’ entry may instead lead to a decrease in aggregate environmental expenditures and losses of social welfare. Nevertheless the fine tuning of the policy requires specific information from a Competition Authority, which we discuss as well.

Precision and Manipulation of Non‐financial Information: The Curious Case of Environmental Liability

This paper develops a model showing how the environmental liability regime and the precision of the disclosed environmental performance indicator affect managers’ incentives (1) to reduce actual pollution and (2) to manipulate the reported pollution. I assume a company with a separation of ownership and control which can be held liable for environmental damages and distinguish between a negligence regime and strict liability. The results suggest that if there is no manipulation but only a lack of precision of the disclosed environmental performance indicator, a negligence rule induces lower actual pollution levels than strict liability even though a negligence rule is considered to be more lenient. If managers are able to manipulate the disclosed environmental performance indicator, they will do so and actual pollution levels will generally increase. While manipulation makes it easier for shareholders to escape liability under a negligence regime, shareholders suffer from manipulation under strict liability due to higher actual pollution and higher expected damage compensation payments. Therefore, the manipulation level is higher under a negligence regime. My analysis contributes to the environmental performance and disclosure literature by showing that the liability regime is an important determinant affecting environmental reporting and actual pollution decisions.

An Unreasonable Solution: Rethinking the FTC's Current Approach to Data Security

For over two decades, the FTC creatively employed its capacious statute to police against shoddy data practices. Although the FTC’s actions arguably were needed at the time to fill a gap in enforcement, there are reasons to believe that its current approach has outlived its usefulness and is in serious need of updating. In particular, our analysis shows that the FTC’s current approach to data security is unlikely to instill anything close to optimal incentives for data holders. These shortcomings cannot be fixed through changes to the FTC enforcement approach, as they are largely generated by a mismatch between the tools that Congress gave it over a century ago and what it needs to foster firms’ incentives to mimic socially optimal levels of care for the data they hold. Not only does the current framework likely suffer from informational deficiencies attendant to its focus on “reasonable” security that render liability standards uncertain, it also lacks the ability obtain the type of relief that will force firms to internalize the costs of their data security decisions. We examine the problem of data security enforcement through the lens of the economics of optimal precautions and identify several reasons why a strict liability regime administered by the FTC, under which firms pay for the expected harm from breaches they cause, is likely to be superior to the current framework that revolves around the concept of reasonableness. The benefits from strict liability flow from the likelihood that firms do not fully internalize the costs and benefits of their data security decisions and the relatively large informational burdens associated with measuring actual and optimal care under a negligence regime. We also show why in this informational environment strict liability is better than negligence for developing a vibrant market for cyber insurance, which will allow data security regulation to be de facto outsourced to insurers who will contract with firms for optimal levels of care. Because these private contracts will harness private information on costs and benefits from precautions, they are likely to incentivize more efficient behavior.

Incentives to take care under contributory and comparative fault: The role of strategic complementarity

Previous literature on contributory versus comparative negligence has shown that they reach equivalent equilibria. These results, however, depend upon an insufficiently granular model of strategic incentives under the Hand Formula that ignores courts’ information constraints. Taking information constraints into account, we identify a set of cases where care by one agent significantly increases the benefits of care by the other. When such cases obtain under bilateral harm, comparative negligence generates greater incentives for care, but this additional care occurs only when it is not socially optimal (i.e., “defensive care”). By contrast, under unilateral harm or asymmetric costs of care, contributory negligence creates socially excessive care. Therefore, it is possible to socially rank negligence regimes depending upon the symmetry of potential harm and costs of care. We discuss optimal choice of rules in light of these results.

Informational Negligence Law

This article offers an analysis of negligence law in an environment with asymmetric information and costly signaling. We consider three possible variations of the negligence doctrine, based on its two elements—the standard of care and damages. We find that accounting for signaling costs affects the social desirability of the negligence rule. In a nontrivial number of cases, the social costs are lowest under the variation of the negligence regime in which the standard of care is the same for all types of victims but damages vary according to the victim’s type. This analysis provides an efficiency-based justification for the use of negligence doctrine in bodily injuries and wrongful death cases, a practice that has been considered one of the greatest “misalignment puzzles” in negligence law

Technological Triggers to Tort Revolutions: Steam Locomotives, Autonomous Vehicles, and Accident Compensation

AbstractWaves of technological change explain the most important transformations of American tort law. In this Article, I begin by examining historical instances of this linkage. Following the Industrial Revolution, for example, machines, no longer humans and animals, powered production. With greater force, locomotives and other machines inflicted far more severe injuries. These dramatic technological changes prompted the replacement of the preexisting strict liability tort standard with the negligence regime. Similarly, later technological changes caused the enactment of workers’ compensation statutes, the implementation of automobile no-fault systems in some states and routinized automobile settlement practices in others that resemble a no-fault system, and the adoption of “strict” products liability. From this history, I derive a model explaining how technological innovation alters (1) the frequency of personal injuries, (2) the severity of such injuries, (3) the difficulty of proving claims, and (4) the new technology’s social utility. These four factors together determine the choice among three liability standards: strict liability, negligence, and no-fault liability with limited damages. I then apply this model to the looming technological revolution in which autonomous vehicles, robots, and other Artificial Intelligence machines will replace human decision-making as well as human force. I conclude that the liability system governing autonomous vehicles is likely to be one similar to the workers’ compensation system in which the victim is relieved of the requirement of proving which party acted tortiously and caused the accident.

Intelligent agents and criminal law—Negligence, diffusion of liability and electronic personhood

The recent development of robotics poses new challenges for the lawgiver as well as for jurisprudence, especially when it comes to criminal law. The ascription of criminal liability to a specific individual is difficult when confronted with an autonomous, adaptive and learning robot. One possible solution could be to adapt the negligence regime to the changes in robotics. Another possibility is to ascribe a specific legal status to autonomous machines, similar to the status of legal persons (corporations). It also has to be considered that the responsibility transfer onto machines will have repercussions onto normative concepts our society is based upon. Thus, the space for these changes has to be created consciously.

Auditor Reputation Under Different Negligence Regimes

Do auditor reputation effects evolve the same way under precise negligence as under vague negligence? Or are there differences? We assume that investors update their beliefs on unobservable auditor quality when an auditor discloses an inaccurate report. We call this a reputation effect. A necessary condition for reputation effects to occur is that, ex ante, investors expect ‘good’ auditors to take more care than ‘bad’ auditors such that ‘good’ auditors are less likely to issue an inaccurate report. Consistent with empirical evidence, we assume that wealthier (‘good’) auditors tend to take more care than less wealthy (‘bad’) auditors. We find that under vague negligence, reputation effects will occur, inducing both types of auditor to increase the level of care taken. A ‘good’ auditor is likely to exert excessive care. Then, even in the absence of auditor risk aversion, a (properly defined) liability cap is necessary to induce efficient incentives. A contractual liability cap is preferable to a legally fixed liability cap. Under precise negligence, a ‘good’ auditor will exert the standard of due care. However, a ‘bad’ auditor will also do so if sufficiently wealthy. Consequently, ex ante, investors do not expect different levels of care to be taken or reputation effects to occur. A liability cap is not desirable. This paper highlights the importance of non-legal sanctions in auditor liability. Finally, it links the ‘reputation’ and ‘deep pocket’ hypotheses, both of which have attempted separately in the past to explain the positive correlation between auditor size and auditor quality.

What Mistake Of Law Just Might Be

This Article examines and evaluates a distinctive, increasingly popular account of the Mistake of Law doctrine. The doctrine, deeply ingrained in American criminal law, is at the same time notoriously unclear in its scope, content, and application. A growing number of legal theorists have criticized the traditional interpretation of the doctrine; legal moralists in particular have argued that this account is conceptually confused. Because the doctrine’s use of a strict liability punishment regime does not incentivize individuals to learn the law as well as a negligence regime might, legal moralists argue that the doctrine cannot be explained by a desire to incentivize legal knowledge. In evaluating this argument, the Article defends the traditional account, often identified with the liberal positivism of Justice Holmes. The Article advances three main arguments. First, legal moralism’s claim that a negligence standard is more effective than a strict liability standard in incentivizing individuals to learn the law is false: the safe harbor provision of a negligence rule acts as an insurance effect, disincentivizing individuals to learn the law. Second, legal moralism assumes that the moral content of the criminal law is determinate, and that agents have perfectly rational, objective motivational sets. These are illicit assumptions that result in a flawed argument. Finally, the Article contends that legal moralism misinterprets the structural core of the traditional account: properly understood, the Mistake of Law doctrine employs a negligence–strict liability hybrid, and is thus more sophisticated than legal moralists realize. The Article concludes that, contrary to what a surprising number of criminal law theorists have come to accept, legal moralism fails to make a plausible case against the traditional account of the Mistake of Law doctrine.

What Mistake of Law Just Might Be: Legal Moralism, Liberal Positivism, and the Mistake of Law Doctrine

This Article examines and evaluates a distinctive, increasingly popular account of the Mistake of Law doctrine. A growing number of legal theorists have criticized the traditional, positivist interpretation of the doctrine; legal moralists in particular have argued that the traditional interpretation is conceptually confused. Because the doctrine’s use of a strict liability punishment regime does not incentivize individuals to learn the law as well as a negligence regime might, legal moralists argue that the doctrine cannot be explained by a desire to incentivize legal knowledge. In evaluating this argument, the Article defends the traditional account, often identified with the liberal positivism of Justice Holmes. It concludes that the modal claims of legal moralists cannot be vindicated based on the arguments employed to defend them.

Tort reform and the theory of coordinating tort and insurance

An important ingredient of tort reform is the substitution of the traditional – in Common Law – Collateral Source Rule for a system of deducting insurance payments from the tort award. In the paper we offer a comprehensive analysis of the effects of the mechanisms to coordinate tort and insurance payments on the three essential decisions involved, namely precaution, risk coverage and litigation. We undertake the analysis for the Collateral Source Rule (cumulation), benefits offset (deduction), and subrogation of insurer. In the presence of a liability system, the problem of coordination makes sense only in a world in which liability rules do not operate perfectly. Under an imperfect strict liability regime, we show that solely subrogation can induce optimal incentives for risk coverage. In addition, collateral offset dilutes injurer's incentives to take care as compared to the other two regimes. Under an imperfect negligence regime, incentives to buy coverage under the collateral source rule are lower. Under collateral benefits offset, the victim may prefer to ignore tort payments entirely, buying full insurance and leaving the injurer with no incentives for precaution. The paper also discusses the litigation decision and the apparently strong advantage in terms of administrative costs of the collateral offset rule over subrogation, and points out several factors that might undermine this presumed advantage.

Incentives to Take Care Under Contributory and Comparative Fault

Previous literature on contributory versus comparative negligence has shown that they reach equivalent equilibria. These results, however, depend upon a stylized application of the Hand Formula and an insufficiently coarse model of strategic incentives. Taking this into account, we identify a set of cases where care by one agent significantly increases the benefits of care by the other. When such cases obtain under bilateral harm, comparative negligence generates greater incentives for care, but this additional care occurs only when care is not socially optimal. By contrast, under unilateral harm or asymmetric costs of care, contributory negligence creates socially excessive care. Therefore, it is possible to socially rank negligence regimes depending upon the symmetry of potential harm and costs of care. We discuss a potential reform, the Retrospective Negligence Test, that when applied in the case of bilateral harm would make comparative negligence optimal.

Loss Aversion, Audit Risk Judgments, and Auditor Liability

I investigate how different legal regimes affect auditor's effort and investors' investment decisions when the auditor is subject to probability weighting and loss aversion, which are two important characteristics of Prospect Theory. Probability weighting encourages an auditor to overrate the audit risk and the likelihood of damages leading to inflated audit fees which could help to explain the BigN audit-fee premium. With loss aversion, an auditor is sensitive to the risk of damage compensation and, thus, tends to exert excessive caution which also generates excessive audit fees. Consequently, investors may choose not to hire an auditor and, as a result, may forego an otherwise profitable investment. These effects are more intense with a strict liability regime than with a negligence rule because with the latter, the auditor is not held liable when due care has been exerted. This removes the risk of incurring losses. The paper highlights the robustness of the negligence regime when preferences are unobservable.

Relative Fault and Efficient Negligence: Comparative Negligence Explained

This paper shows that the rule of comparative negligence with relative fault – a sharing of the loss proportional to the parties’ relative departures from due care – induces the parties to an accident to be efficiently negligent. Comparative negligence is more efficient than simple or contributory negligence regimes because it serves as a buffer against excessive due-care standards. If due-care standards are too high, comparative negligence facilitates efficient negligence, inducing parties to violate excessive due-care standards only when this is socially desirable. If due-care standards are too low, all negligence rules perform in the same way. Of all possible comparative negligence rules, relative fault provides for the sharing rule that maximizes this effect. The same principle also applies to the contribution rule among multiple tortfeasors.

Legal systems and auditor independence

This paper examines whether an appropriate legal system, which is a combination of a legal regime and a damage apportionment rule, effectively enhances auditor independence. Economic and psychological hypotheses derived from a one-period game model in which the auditor may commit either a technical audit failure (resulting from the auditor’s inability to detect true output given a lack of audit effort) or an independence audit failure (resulting from the auditor’s intentional misreporting on false output) are tested. Three major findings are documented. First, auditor independence affects firm investment, which in turn affects audit effort. Under this strategic dependence, no single legal system can provoke audit effort, improve auditor independence, and encourage firm investment simultaneously. To enhance auditor independence and motivate investment, a legal system consisting of both a strict regime and a proportionate rule is preferred. Second, the strict regime induces more auditor independence than the negligence regime, while the proportionate rule induces higher audit effort than the joint-and-several rule. Finally, auditors’ moral reasoning and penalty for misreporting are both positively associated with their independence. In addition, the effect of moral reasoning on auditor independence diminishes as the level of penalty increases. These two results hold only when the legal systems that auditors face are considered.

Socially optimal liability rules for firms with natural monopoly in contestable markets

This article considers the problem of socially efficient liability rules for firms in contestable markets where natural monopoly prevails due to decreasing average cost. If the fixed cost that pushes the entry-limiting price above marginal cost is large relative to the level of external harm of firms, the negligence regime is socially superior to the strict liability regime. In the opposite case, the strict liability rule may be socially superior.

Comparative Negligence as a Buffer Against Erroneous Standards

This paper shows that the rule of comparative negligence with relative fault --- a sharing of the loss proportional to the parties' relative departures from due care --- induces the parties to an accident to be efficiently negligent. Comparative negligence is more efficient than simple or contributory negligence regimes because it serves as a buffer against excessive due-care standards. If due-care standards are too high, comparative negligence facilitates efficient negligence, inducing parties to violate excessive due-care standards only when this is socially desirable. If due-care standards are too low, all negligence rules perform in the same way. Of all possible comparative negligence rules, relative fault provides for the sharing rule that maximizes this effect. The same principle also applies to the contribution rule among multiple tortfeasors.

LIABILITY REGIMES, REPUTATION LOSS, AND DEFENSIVE MEDICINE

This article explores the effects of litigation under negligence and strict liability regimes on physicians' reputations, and consequently, on physicians' incentives to practice defensive medicine and to settle claims. That no-fault liability will reduce physicians' reputation loss and therefore is likely to reduce the problem of defensive medicine is a common theme in the literature. The article refines this insight by calling into attention the pooling of negligent and non-negligent physicians found liable under strict liability: physicians found liable under strict liability might be either negligent or not and often this indeterminacy would not be solved at the end of the litigation. This suggests that almost all physicians found liable are likely to suffer equally some reputation loss, which will be almost always smaller than the one produced following a finding of liability under a negligence regime. Such a result is seemingly problematic based on both efficiency and distributive grounds since cautious physicians suffer part of the reputation loss which is due to the negligence of negligent physicians. However, given courts' fallibility, cautious physicians might prefer strict liability since it serves as an insurance against the otherwise significant uninsurable reputation loss which follows a finding of liability under negligence.

Socially Optimal Liability Rules for Firms with Natural Monopoly

It has been shown by Polinsky and Shavell that the strict liability rule is socially superior to the negligence liability rule when firms are injurers, strangers are victims, and accidents have a unilateral nature if prefect competition among firms prevails. This article considers the problem of socially efficient liability rules in a market where natural monopoly prevails due to decreasing average cost. We especially consider a quasi-competitive case where average cost pricing is achieved in a naturally monopolized market either through well-organized government regulation or the weak invisible hands of contestability. In contrast to the perfectly competitive economy, the present article shows that in most cases, the negligence regime is socially more desirable than the strict liability regime from the view point of economic efficiency.