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Safety monitoring, capital structure, and "financial responsibility"

Author

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  • Ulrich Hege

    () (GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique)

  • Eberhard Feess

Abstract

We compare different modes of extending liability to third parties motivated by the problem that firms may exert too little preventive care if damages are likely to exceed their equity. In our model, moral hazard about the choice of care that can be mitigated through stochastic monitoring, we show that the optimal allocation can always be implemented by a liability regime of full "financial responsibility," that is mandatory liability coverage for total harm that can be fulfilled either by, an insurer or by a lender. All other liability regimes are shown to lead to distortions in the capital and debt structure. The difference between our results and related models finding liability below the level of harm to be optimal is explained by our treatment of safety monitoring and of optimal monitoring-dependent insurance contracts. The mechanism is robust vis-a-vis the introduction of risk aversion, provided that optimal wealth transfer are taken into account.

Suggested Citation

  • Ulrich Hege & Eberhard Feess, 2003. "Safety monitoring, capital structure, and "financial responsibility"," Post-Print hal-00459915, HAL.
  • Handle: RePEc:hal:journl:hal-00459915
    DOI: 10.1016/j.irle.2003.09.008
    Note: View the original document on HAL open archive server: https://hal-hec.archives-ouvertes.fr/hal-00459915
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    References listed on IDEAS

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    Cited by:

    1. Hutchinson, Emma & van 't Veld, Klaas, 2005. "Extended liability for environmental accidents: what you see is what you get," Journal of Environmental Economics and Management, Elsevier, vol. 49(1), pages 157-173, January.
    2. Marcel Boyer & Donatella Porrini, 2007. "Sharing Liability Between Banks and Firms: The Case of Industrial Safety Risk," CIRANO Working Papers 2007s-04, CIRANO.
    3. Eberhard Feess & Gerd Muehlheusser & Ansgar Wohlschlegel, 2009. "Environmental liability under uncertain causation," European Journal of Law and Economics, Springer, vol. 28(2), pages 133-148, October.
    4. Henry van Egteren & R. Smith & Dean McAfee, 2004. "Harmonization of Environmental Regulations When Firms are Judgment Proof," European Journal of Law and Economics, Springer, vol. 17(2), pages 139-164, March.
    5. Bidénam Kambia-Chopin, 2010. "Environmental risks, the judgment-proof problem and financial responsibility," European Journal of Law and Economics, Springer, vol. 30(2), pages 77-87, October.
    6. Juan José Ganuza & Fernando Gómez, 2003. "Optimal negligence rule under limited liability," Economics Working Papers 759, Department of Economics and Business, Universitat Pompeu Fabra, revised May 2004.

    More about this item

    Keywords

    Lender liability; Compulsory insurance; Choice between private and public debt; Limited liability effect;

    JEL classification:

    • 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; Forensic Economics
    • K32 - Law and Economics - - Other Substantive Areas of Law - - - Energy, Environmental, Health, and Safety Law

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