IDEAS home Printed from https://ideas.repec.org/a/bla/randje/v39y2008i4p926-948.html
   My bibliography  Save this article

Strategic judgment proofing

Author

Listed:
  • Yeon-Koo Che
  • Kathryn E. Spier

Abstract

A liquidity-constrained entrepreneur raises capital to finance a business activity that may harm bystanders. The entrepreneur raises senior (secured) debt to shield assets from the tort victims in bankruptcy. For a fixed level of borrowing, senior debt creates better incentives for precaution taking than either junior debt or outside equity. The entrepreneur's level of borrowing is, however, socially excessive. Giving tort victims priority over senior debtholders in bankruptcy prevents overleveraging but leads to suboptimal incentives. Lender liability exacerbates the incentive problem even further. A limited seniority rule dominates these alternatives. Shareholder liability, mandatory liability insurance, and punitive damages are also discussed. Copyright (c) 2008, RAND.

Suggested Citation

  • Yeon-Koo Che & Kathryn E. Spier, 2008. "Strategic judgment proofing," RAND Journal of Economics, RAND Corporation, vol. 39(4), pages 926-948.
  • Handle: RePEc:bla:randje:v:39:y:2008:i:4:p:926-948
    as

    Download full text from publisher

    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1756-2171.2008.00044.x
    File Function: link to full text
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Peter M. DeMarzo & Ilan Kremer & Andrzej Skrzypacz, 2005. "Bidding with Securities: Auctions and Security Design," American Economic Review, American Economic Association, pages 936-959.
    2. T. Randolph Beard, 1990. "Bankruptcy and Care Choice," RAND Journal of Economics, The RAND Corporation, pages 626-634.
    3. Craswell, Richard, 1989. "Performance, Reliance, and One-Sided Information," The Journal of Legal Studies, University of Chicago Press, pages 365-401.
    4. Lewis, Tracy R. & Sappington, David E. M., 1999. "Using decoupling and deep pockets to mitigate judgment-proof problems1," International Review of Law and Economics, Elsevier, vol. 19(2), pages 275-293, June.
    5. Boyd, James & Ingberman, Daniel E, 1997. "The Search for Deep Pockets: Is "Extended Liability" Expensive Liability?," Journal of Law, Economics, and Organization, Oxford University Press, vol. 13(1), pages 232-258, April.
    6. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    7. Dieter Balkenborg, 2001. "How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk: Comment," American Economic Review, American Economic Association, pages 731-738.
    8. Edward M. Iacobucci & Ralph A. Winter, 2005. "Asset Securitization and Asymmetric Information," The Journal of Legal Studies, University of Chicago Press, pages 161-206.
    9. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
    10. Mattiacci, Giuseppe Dari & Parisi, Francesco, 2003. "The cost of delegated control: vicarious liability, secondary liability and mandatory insurance," International Review of Law and Economics, Elsevier, vol. 23(4), pages 453-475, December.
    11. Yolande Hiriart & David Martimort, 2006. "The benefits of extended liability," RAND Journal of Economics, RAND Corporation, vol. 37(3), pages 562-582, September.
    12. Boyd, James & Ingberman, Daniel E, 1994. "Noncompensatory Damages and Potential Insolvency," The Journal of Legal Studies, University of Chicago Press, pages 895-910.
    13. Boyd, James & Ingberman, Daniel E., 1999. "Do punitive damages promote deterrence?1," International Review of Law and Economics, Elsevier, vol. 19(1), pages 47-68, March.
    14. Boyer, Marcel & Laffont, Jean-Jacques, 1997. "Environmental risks and bank liability," European Economic Review, Elsevier, pages 1427-1459.
    15. Perotti, Enrico C & Spier, Kathryn E, 1993. "Capital Structure as a Bargaining Tool: The Role of Leverage in Contract Renegotiation," American Economic Review, American Economic Association, pages 1131-1141.
    16. Ulph, Alistair & Valentini, Laura, 2004. "Environmental liability and the capital structure of firms," Resource and Energy Economics, Elsevier, vol. 26(4), pages 393-410, December.
    17. Steven Shavell, 2004. "Minimum Asset Requirements and Compulsory Liability Insurance As Solutions to the Judgment-Proof Problem," NBER Working Papers 10341, National Bureau of Economic Research, Inc.
    18. Lawrence F. Katz & Alan B. Krueger, 1991. "Changes in the Structure of Wages in the Public and Private Sectors," Working Papers 662, Princeton University, Department of Economics, Industrial Relations Section..
    19. Tracy R. Lewis & David E. M. Sappington, 2001. "How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk: Comment," American Economic Review, American Economic Association, pages 724-730.
    20. Shavell, S., 1986. "The judgment proof problem," International Review of Law and Economics, Elsevier, vol. 6(1), pages 45-58, June.
    21. Lucian Arye Bebchuk & Jesse Fried, 1998. "The Uneasy Case for the Priority of Secured Claims in Bankruptcy: Further Thoughts and a Reply to Critics," NBER Working Papers 6472, National Bureau of Economic Research, Inc.
    22. Pitchford, Rohan, 1995. "How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk," American Economic Review, American Economic Association, pages 1171-1186.
    23. Bruce Hay & Kathryn E. Spier, 2005. "Manufacturer Liability for Harms Caused by Consumers to Others," American Economic Review, American Economic Association, pages 1700-1711.
    24. Ringleb, Al H & Wiggins, Steven N, 1990. "Liability and Large-Scale, Long-term Hazards," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 574-595, June.
    25. Spier, Kathryn E. & Sykes, Alan O., 1998. "Capital structure, priority rules, and the settlement of civil claims," International Review of Law and Economics, Elsevier, vol. 18(2), pages 187-200, June.
    26. Hart, Oliver & Moore, John, 1995. "Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management," American Economic Review, American Economic Association, pages 567-585.
    27. Hart, Oliver & Moore, John, 1995. "Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management," American Economic Review, American Economic Association, pages 567-585.
    28. Kathryn E. Spier & Michael D. Whinston, 1995. "On the Efficiency of Privately Stipulated Damages for Breach of Contract: Entry Barriers, Reliance, and Renegotiation," RAND Journal of Economics, The RAND Corporation, pages 180-202.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Mondello, Gérard, 2012. "La responsabilité environnementale des prêteurs : difficultés juridiques et ensemble des possibles," L'Actualité Economique, Société Canadienne de Science Economique, vol. 88(2), pages 257-278, Juin.
    2. Ichinose, Daisuke, 2011. "Contractor selection problem under extended liability," International Review of Law and Economics, Elsevier, vol. 31(1), pages 48-57, March.
    3. Vasiliki Bageri & Yannis Katsoulacos & Giancarlo Spagnolo, 2013. "The Distortive Effects of Antitrust Fines Based on Revenue," Economic Journal, Royal Economic Society, vol. 123(11), pages 545-557, November.
    4. Juan José Ganuza & Fernando Gomez, 2011. "Soft Negligence Standards and the Strategic Choice of Firm Size," The Journal of Legal Studies, University of Chicago Press, pages 439-466.
    5. Arbel, Yonathan A., 2016. "Shielding of assets and lending contracts," International Review of Law and Economics, Elsevier, vol. 48(C), pages 26-35.
    6. Ben White, 2015. "Do control rights determine the optimal extension of liability to investors? The case of environmental policy for mines," Journal of Regulatory Economics, Springer, pages 26-52.

    More about this item

    JEL classification:

    • K0 - Law and Economics - - General
    • G3 - Financial Economics - - Corporate Finance and Governance

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:randje:v:39:y:2008:i:4:p:926-948. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Wiley-Blackwell Digital Licensing) or (Christopher F. Baum). General contact details of provider: http://edirc.repec.org/data/randdus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.