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Environmental Risks : Should Banks Be Liable?

  • GOBERT, Karine
  • POITEVIN, Michel

This paper studies the impact of banks' liability for environmental damages caused by their borrowers. Laws or court decisions that declare banks liable for environmental damages have two objectives : (1) finding someone to pay for the damages and (2) exerting a pressure on a firm's stakeholders to incite them to invest in environmental risk prevention. We study the effect that such legal decisions can have on financing relationships and especially on the incentives to reduce environmental risk in an environment where banks cannot commit to refinance the firm in all circumstances. Following an environmental accident, liable banks more readily agree to refinance the firm. We then show that bank liability effectively makes refinancing more attractive to banks, therefore improving the firm's risk-sharing possibilities. Consequently, the firm's incentives to invest in environmental risk reduction are weakened compared to the (bank) no-liability case. We also show that, when banks are liable, the firm invests at the full-commitment optimal level of risk reduction investment. If there are some externalities such that some damages cannot be accounted for, the socially efficient level of investment is greater than the privately optimal one. in that case, making banks non-liable can be socially desirable.

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File URL: http://hdl.handle.net/1866/481
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Paper provided by Universite de Montreal, Departement de sciences economiques in its series Cahiers de recherche with number 1198.

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Length: 27 pages
Date of creation: 1998
Date of revision:
Handle: RePEc:mtl:montde:1198
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  1. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
  2. Marcel Boyer & Jean-Jacques Laffont, 1994. "Environmental Risks and Bank Liability," CIRANO Working Papers 94s-22, CIRANO.
  3. Weitzman, M.L., 1993. "On the 'Environmental' Discount Rate," Harvard Institute of Economic Research Working Papers 1625, Harvard - Institute of Economic Research.
  4. Segerson Kathleen, 1993. "Liability Transfers: An Economic Assessment of Buyer and Lender Liability," Journal of Environmental Economics and Management, Elsevier, vol. 25(1), pages S46-S63, July.
  5. Marcel Boyer & Jean-Jacques Laffont, 1995. "Environmental Protection, Producer Insolvency and Lender Liability," CIRANO Working Papers 95s-50, CIRANO.
  6. Pitchford, Rohan, 1995. "How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk," American Economic Review, American Economic Association, vol. 85(5), pages 1171-86, December.
  7. T. Randolph Beard, 1990. "Bankruptcy and Care Choice," RAND Journal of Economics, The RAND Corporation, vol. 21(4), pages 626-634, Winter.
  8. Segerson, Kathleen & Tietenberg, Tom, 1992. "The structure of penalties in environmental enforcement: An economic analysis," Journal of Environmental Economics and Management, Elsevier, vol. 23(2), pages 179-200, September.
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