A Model of the Socially Optimal Use of Liability and Regulation
NBER Working Paper No. 1220
Liability and safety regulation are examined as means of controlling risks in a theoretical model of the occurrence of accidents. According to the model, regulation does not result in appropriate reduction of risk -- due to the regulator's lack of knowledge about risk -- nor does liability result in that outcome -- because the incentives it creates are diluted by the chance that parties would not be sued for harm done or would not be able to pay fully for it. Thus, either liability could turn out to be superior to regulation or the reverse could be true. But as is stressed, joint use of the two means of controlling risk is generally socially advantageous, and the characteristics of their optimal joint use are determined.
Published: Shavell, Steven. "A Model of the Optimal Use of Liability and Safety Regulation." Rand Journal of Economics, Vol. 15, No. 2, (Summer 1984), pp. 271- 280.