Van'tVeld, Klaas Rausser, Gordon Clyde Simon, Leo K.
Year of Publication:
Nota di Lavoro, Fondazione Eni Enrico Mattei 83.1997
When liability for environmental spills, product failures, or other types of accidents is imposed on firms with insufficient wealth, those firms may file for bankruptcy ---thereby becoming ''judgement proof''--- as soon as a major accident occurs. As a result, they are unlikely to choose socially optimal levels of care or scale of operation. This paper offers the first analysis of this problem, known as the ''judgement proof problem,'' that takes full account of the firm's optimal financial decisions in the face of liability, as well as the competitive pressures it faces in capital and output markets. By analysing the firm's dividend decision, the paper is able to clear up a persistent confusion in the existing literature concerning the optimal care level chosen by judgement-proof firms. By analysing the firm's bankruptcy decision itself, the paper shows that, in contrast to common pollution externalities, the externality caused by the judgement proof problem is never fully offset by market power. Finally, by analysing how hazardous industries as a whole restructure in response to liability, the paper is able to identify a very simple condition on scale economies in accident prevention under which imposing liability is guaranteed to improve welfare. If, in contrast, the condition fails, imposing liability may amount to a high-stakes gamble on welfare outcomes.
Judgement proof problem Liability Industrial accidents Bankruptcy Tort law Environmental law Safety law Market structure Monopoly Firm size