Safety monitoring, capital structure, and "financial responsibility"
AbstractFirms will exert too little preventive care if damages are likely to exceed their equity. This is particularly important for environmental and product liability and motivates the current discussion about extending liability to creditors. We propose a model where the firm can be financed by equity, bank debt or publicly traded debt. There is a moral hazard problem about the choice of care that can be mitigated through stochastic monitoring of its safety standards. We show that the optimal allocation can always be implemented by a liability regime of "financial responsibility", that is mandatory liability coverage that can be fulfilled either by an insurer or by a lender. We find that the first best can only be achieved if the defendants are fully liable. This result is in contrast to related models which find liability below the level of harm optimal, and we show that the difference is due to the inclusion of safety monitoring. Financial responsibility is strictly superior to lender liability alone or strict liability without extended liability, but their relative ranking may vary.
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Bibliographic InfoArticle provided by Elsevier in its journal International Review of Law and Economics.
Volume (Year): 23 (2003)
Issue (Month): 3 (September)
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Web page: http://www.elsevier.com/locate/irle
Other versions of this item:
- Feess, E. & Hege, U., 2000. "Safety Monitoring, Capital Structure, and "Financial Responsibility"," Discussion Paper 2000-33, Tilburg University, Center for Economic Research.
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- K13 - Law and Economics - - Basic Areas of Law - - - Tort Law and Product Liability
- K32 - Law and Economics - - Other Substantive Areas of Law - - - Environmental, Health, and Safety Law
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