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On extended liability in a model of adverse selection

  • Dieter Balkenborg

    (Department of Economics, University of Exeter)

We consider a model where a judgment-proof firm needs finance to realize a project. This project might cause an environmental hazard with a probability that is the private knowledge of the firm. Thus there is asymmetric information with respect to the environmental riskiness of the project. We consider the implications of a simple joint and strict liability rule on the lender and the firm where, in case of a damage, the lender is responsible for that part of the liability which the judgment-proof firm cannot pay. We use a weighted version of the neutral bargaining solution (Myerson 1983 / 1984) to determine the financial contract between the lender and the firm. In the given model we show that either full or a punitive liability is optimal.

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Paper provided by Exeter University, Department of Economics in its series Discussion Papers with number 0404.

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Date of creation: Nov 2004
Date of revision:
Handle: RePEc:exe:wpaper:0404
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