The Optimal Decoupled Liabilities: A General Analysis

The “decoupled” liability system awards the plaintiff an amount that differs from what the defendant pays. The previous approach to the optimal decoupling design is based on the assumption of complete information, which results in an optimal liability for the defendant “as much as he can afford.” This extreme conclusion may hinder the acceptability of the decoupling system. This paper proposes an alternative design based on the assumption that agents in the post-accident subgame have asymmetric information. Our model indicates that the optimal penalty faced by the defendant is generally greater than the optimal award to the plaintiff. When the potential harm is sufficiently large, the optimal penalty can be approximated by a multiple of the harm, but the plaintiff receives only a finite amount of the damages regardless of the loss suffered. Such a decoupling scheme deters frivolous lawsuits without reducing the defendants’ incentives to exercise care. Additionally, this paper derives comparative static results concerning how the trial costs of the plaintiff and defendant affect the optimal design of decoupling.