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Liability and Organizational Choice

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  • Brooks, Richard R W

Abstract

Scholars have long maintained that increases in liability encourage firms to contract out risky activities in order to take advantage of so-called judgment-proof strategies. These strategies allow entities to limit their liability through contractual arrangements with nearly insolvent firms. However, the use of judgment-proof firms triggers countervailing effects: it provides opportunities to externalize liability through judgment-proof firms, but the insolvency of these firms introduces distortion in care levels that can generate more liability costs. These costs may outweigh the benefits of externalizing liability, making contracting out suboptimal. A simple model of organizational decision making with judgment-proof firms is developed and applied to the oil industry, where contracting out decreased in response to heightened liability following the Exxon Valdez oil spill. Copyright 2002 by the University of Chicago.

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  • Brooks, Richard R W, 2002. "Liability and Organizational Choice," Journal of Law and Economics, University of Chicago Press, vol. 45(1), pages 91-125, April.
  • Handle: RePEc:ucp:jlawec:v:45:y:2002:i:1:p:91-125
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    File URL: http://dx.doi.org/10.1086/340386
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    1. T. Randolph Beard, 1990. "Bankruptcy and Care Choice," RAND Journal of Economics, The RAND Corporation, vol. 21(4), pages 626-634, Winter.
    2. 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.
    3. Tiller, Emerson H, 1998. "Controlling Policy by Controlling Process: Judicial Influence on Regulatory Decision Making," Journal of Law, Economics, and Organization, Oxford University Press, vol. 14(1), pages 114-135, April.
    4. Badrinath, S G & Bolster, Paul J, 1996. "The Role of Market Forces in EPA Enforcement Activity," Journal of Regulatory Economics, Springer, vol. 10(2), pages 165-181, September.
    5. Posey, Lisa Lipowski, 1993. "Limited liability and incentives when firms can inflict damages greater than net worth," International Review of Law and Economics, Elsevier, vol. 13(3), pages 325-330, September.
    6. Shavell, S., 1986. "The judgment proof problem," International Review of Law and Economics, Elsevier, vol. 6(1), pages 45-58, June.
    7. Craig, Ben & Thiel, Stuart E., 1990. "Large risks and the decision to incorporate," Journal of Economics and Business, Elsevier, vol. 42(3), pages 185-194, August.
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