Strategic Judgment Proofing

Abstract

A liquidity-constrained entrepreneur needs to raise capital to finance a business activity that may cause injuries to third parties -the tort victims. Taking the level of borrowing as fixed, the entrepreneur finances the activity with senior (secured) debt in order to shield assets from the tort victims in bankruptcy. Interestingly, senior debt serves the interests of society more broadly: it creates better incentives for the entrepreneur to take precautions than either junior debt or outside equity. Unfortunately, the entrepreneur will raise a socially excessive amount of senior debt. Giving tort victims priority over senior debtholders in bankruptcy prevents over-leveraging but leads to suboptimal incentives. Lender liability exacerbates the incentive problem even further. A Limited Seniority Rule, where the firm may issue senior debt up to an exogenous limit after which any further borrowing is treated as junior to the tort claim, dominates these alternatives. Shareholder liability, mandatory liability insurance and punitive damages are also discussed.

Drilling Like There’s No Tomorrow: Bankruptcy, Insurance, and Environmental Risk

“…Shavell (2002) assumes that firms produce only a single unit, and Pitchford (1995) describes firms as considering a single project. Ganuza and Gomez (2011) and Che and Spier (2008) assume identical output across firms while allowing for strategic choice of asset level and capital structure, respectively. Van 't Veld (2006) considers optimal firm sizes with and without liability rules, but not heterogeneity in firms or projects, or an insurance requirement.…”

The Distortive Effects of Antitrust Fines Based on Revenue

“…6 This distortion reminds us of how firms react, inefficiently increasing leverage, when courts take into account their financial situation when establishing fines, the so-called 'judgment proof' problem; see e.g. Shavell (1986), Che and Spier (2008) and with reference to Antitrust, Spagnolo (2007, 2008).…”

Misselling through Agents

“…In most of the literature on strategic information transmission and delegation (e.g., Vincent Crawford and Joel Sobel, 1982, Wouter Dessein, 2002, and Ricardo Alonso and Niko Matouschek, 2008, this preference divergence is given exogenously. 13 Our assumption that the principal (the …rm) bears responsibility for the actions of its agents has been investigated more broadly in the literature on vicarious liability (see for example Rohan Pitchford, 1995, andYeon-Koo Che andKathryn E. Spier, 2006). More generally, our paper analyzes policy intervention when the targeted action-the quality of advice in our setting-is not carried out directly by the targeted …rm, but rather it is delegated to agents.…”