optimal design of liability rules: how courts set damages (or should) paul m. goldbart and ian ayres...
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Optimal design of liability rules: How
courts set damages (or should)
Paul M. Goldbart and Ian Ayres
w3.physics.uiuc.edu/~goldbart
Department of PhysicsUniversity of Illinois
Yale Law SchoolNew Haven, CT
To appear in Mich. Law Rev., vol. 100, p. 1 (Centenary Volume, 2001)
Outline
Property rules and liability rules Concerns of judges Central aims Nuisance disputes Options view of liability rules Analyzing liability rules Practical advice for courts
decoupling allocational & distributional concerns
choosing among liability rules
Property rules & liability rules
Property rules: protect by deterrence
Liability rules: protect by
compensation
Example: Abbott breaks Costello’s
armIntentionally
focus on taker’s welfare (a criminal offence) traditionally protect via a property rule
Through negligencefocus on takee’s welfare (compensatory
damages) traditionally protect via a liability rule
Property rules & liability rules
Property rules are not efficient
Example: Laurel steals Hardy’s hat Property rule: Hardy can sue to recover hat
(replevin) Liability rule: can also sue for value of hat
(trover) Advantage if hat is worth $10 to Laurel, $5 to
Hardy
Example: Barney holds over in Fred’s apartment Fred can sue to for trespass or to force Fred to rent for another year
Goal of liability rules: Add efficiency by compensating initial entitlement
holderfor transfer of entitlement (goes beyond mere deterrence)
Concerns of judges re liability rules
Traditional view: identity of the initial entitlement holder
compensation as deterrence
Modern view: identity of the more efficient chooser
decouple allocative and distributional concerns
liability rules: a means by which an imperfectlyinformed court can delegate choice to private litigants thus harnessing their superior information
Central aims
Expand and simplify classes of liability
rules that courts have at their disposal
Provide guidance in selecting… class maximizing ex post allocational
efficiency
member of class with best distributional
attributes
(equity, ex ante investment incentives)
Focus on nuisance dispute settings
A/c noise reduced value of adjacent residence Estancias Dallas Corp. v. Shultz (Tex. App. 1973)
Hotel addition obstructed view of adjacent hotel Fontainbleu Hotel v. Twenty-Five Twenty-Five
Inc. (Fl. 1959)
Dog-track lights interfered w/ drive-in movie theater Amphitheaters, Inc. v. Portland Meadows (Or.
1948)
Pollution from Con Ed plant disrupted new carpreparation business Copart Indus. v. Con. Ed. Co. (N.Y. 1977)
Examples of nuisance disputes
Property rules & liability rules
What courts might do in nuisance disputes E.g. Boomer v. Atlantic Cement (N.Y. 1970)
Resident/Plaintiff (Boomer): discomforted by pollution
Polluter/Defendant (Atl. Cem.): factory operator
Prior to Calabresi & Melamed (’72): Rule 1: nuisance / injunction on Pol (stop!)
Property rule
Rule 2: nuisance / Pol pays damages to continue Liability rule
Rule 3: not a nuisance / Pol continues Property rule
Property rules & liability rules
After Calabresi & Melamed (’72): Rule 1: nuisance / injunction on Polluter (stop!)
Property rule
Rule 2: nuisance / Pol pays Res dam’s & continues
Liability rule
Rule 3: not a nuisance / Polluter continues Property rule
Rule 4: nuisance? / Res pays Pol dam’s to stop Pol
Liability rule
Call option choice of whether or not to pay a non-
negotiatedamount to purchase the entitlement
choice of forcing seller to sell (be paid)
Options: Call flavour
After Morris (’93): Rule 1: nuisance / injunction on Polluter
(stop!) Property rule: entitlement to Resident
Rule 2: nuisance / Pol can pay dam’s & continue Liability rule: (initial) entitlement to Res; call
option to Pol
Rule 3: not a nuisance / Polluter continues Property rule: entitlement to Polluter
Rule 4: nuisance? / Res can pay dam’s to stop Pol Liability rule: (initial) entitlement to Pol; call
option to Res
Liability rules as call options
Rules 2 vs. 4: Who chooses (to pay)?
Options: Calls and Puts
Call option choice of whether or not to pay a non-
negotiated amount to purchase entitlement
choice of forcing seller to sell (be paid)
Put option choice of whether or not to be paid a non-
negotiated amount to sell entitlement
choice of forcing buyer to buy (pay)
Rule 2: nuisance / Pol can pay damages to continue
Liability rule: initial entitlement to Res; call option to Pol
Rule 4: nuisance / Res can pay damages to stop Pol
Liability rule: initial entitlement to Pol; call option to Res
Rule 5: nuisance / Pol can require damages & stop
Liability rule: initial entitlement to Pol; put option to Pol
Rule 6: nuisance / Res can require dam’s & allow Pol
Liability rule: initial entitlement to Res; put option to Res
Liability rules as call or put options
Put: force to buy Call: force to sell
Rules 2 & 6 v. 4 & 5: Who pays?
Rule 2: Entitlement to Resident; call to
Polluter
Boomer v. Atlantic Cement (N.Y. 1970)
Rule 4: Entitlement to Polluter; call to
Resident
Spur Indus., Inc. v. Del E. Webb Dev. Co. (Ariz.
1972)
Rule 6: Entitlement to Resident; put to
Resident
Thelma builds an encroaching wall on Louise’s
land;
Louise can sue Thelma to remove the wall or
to force
Thelma to buy the encroached land
permanently
Realizations
Imperfectly informed court Explore classes of rules Ex post efficiency as
criterion forwhich rule to adopt? several continuous families of
rules
beyond single-chooser rules dual-chooser rules and veto
power
higher-order rules
Emerging guidelines for courts
Basic ingredients for analyzing
liability rules
E.g. Rule 2: initial ent to Res; call option to Pol Value of asset to Resident: (known only to
Res) Value of asset to Polluter: (known only to
Pol) Imperfectly informed court: (jpd
known to all)
Analyzing liability rules
RV
PV),( PR VVP
RV
PV
Qpivot
),( DVD P
)0,( RV
profit, (Resprofit) Pol
damages
which at of value PVexercised is option
)( PR VQV
)( QVV PP
meanTotal:profit
Rule 2: initial ent to Res;
call option to Pol
value to Res, Pol ,jpd pivot , damages
Analyzing liability rules
RV PV),( PR VVP
RV
PV
Q
),( DVD P )0,( RV
Q D
)(
)(
DV
DVVD
P
PR
Strategy: 1) choose pivot to
max total mean profit
2) choose damages to elicit this pivot
DQ
i.e. damages =nonchooser’s mean
E.g. Rule 6: initial ent to Res; put option to Res Value to Resident: Value to Polluter: jpd (known to all):
Analyzing liability rules
RV PV),( PR VVP
RV
PV
Q
),( DVD P
)0,( RV
profit) Pol profit, (Res)( RP VQV
:profit meanTotal
)(
)(
DV
DVVD
R
RP
DQ
i.e. damages = nonchooser’s mean
)( QVV RR
E.g. Joint veto: initial entitlement to Res; transfer only if Res &
Pol agree value to Res: ; value to Pol: ; jpd:
Dual-chooser rules
RV PV ),( PR VVP
PV
RV
Q
),( DVD P
)0,( RV
)~
()( RPRPR VQQVVVV
:profit meanTotal
)()( DVDVDV RPP
DQQ ~
i.e. implicit eq. for damages
Q~
)()( DVVDVD PRR
E.g. second order: initial ent to Res call option to Pol call back option to
Res
Higher-order liability rules
RV
PV),( PR VVP
PV
RV
1Q
),( 11 DVD P
)0,( RV
profit) Pol profit, (Res
),( 22 DDVR
2Q
value to Resident: value to Polluter: jpd (known to all):
As usual, choose… pivots to max mean profit damages to elicit pivots
(damages are no longer pivot values: strategic takings)
Explore classes of liability rules single-chooser, dual-chooser, higher-order decouple allocational and distributional
concerns(via continuous families of extensions)
Property rules give entitlement to (estimated) higher
valuer suggested as a general practice, but…
Liability rules do better by harnessing private
information SCR: select more volatile valuer as
chooser DCR: select lower (mean) valuer as vetoee SCR v. DCR: select SCR if diff. in var’s
exceedsdiff. in means
Emerging guidelines
Correlated distributions(e.g. visual nuisances)
Higher-order rules(increased transaction costs)
Numerosity effects
Opportunities for elaboration