Regulation vs.

Litigation

Regulation vs. Litigation

Regulation

Designed to __________ behavior

Liability Rules
generally aimed at resolving private disputes
But the rules have evolved to perform a
regulatory function: _____________________
behavior
Efficiency of the Common Law hypothesis

Society has a mix of liability rules and

regulations

Why?

Shavell, Liability for Harm

vs. Regulation of Safety
(1984)

Efficiency:

Defined as maximizing ___Social welfare_____

Social welfare: B-C

Parties benefits from activities (B)
Costs of harms and controller action (C)

Internal/external harms
Prevention activities
___administration expense_________

Goal:

Use mix of litigation & regulation that

maximizes B - C

Liability vs. Regulation

What affects relative ability of
controller (regulator or private
parties through the courts) to
maximize social welfare?
1.

2.
3.
4.

Difference in knowledge about risky

activities
Ability to pay for harm
Chance that parties will not be sued
Magnitude of administrative costs

Liability vs. Regulation

1. Difference in knowledge about risky
activities

If private parties have _better info__, legal

system is better
If regulators have _better info_, reg. is better
Obvious _ risks: Private parties know best
_Hidden____: Regulators may know best

Examples:

Leaving a rusty old car on your property

Producing a toy with lead paint

Liability vs. Regulation

2. Private parties ability to pay for
harm

___Judgement Proof Problem______: Party is

unlikely to be able to pay for the full cost of
harm created less incentive to avoid
creation of the harm

___Moral Hazard_____: Insurer cant monitor

the behavior of party with liability insurance
diminished incentive to act safely

___Agency Problems______: Employees have

less of an incentive to act safely than
company.

Liability vs. Regulation

2. Private parties ability to pay for
harm
Regulation has an advantage where
judgment proof problems, agency
problems, or moral hazard is likely
to occur
Examples: Exxon Valdez, Post
Valdez(Agency Problem)

Liability vs. Regulation

3. Chance that culpable parties will
not be sued

__Dispersed Harms_: Harm to many, but

harm to each is small little incentive
for any one party to sue

__Time Lapse___: Long time between

exposure and harm difficult to prove
harm, culpable parties may be gone

Liability vs. Regulation

3. Chance that culpable parties
will not be sued
As chance of being sued falls,
incentive to act safely (deterrent
effect) falls
Regulation may be preferable when
chance of suit occurring is small
Examples: irritation, serious injury,
asbestos

Liability vs. Regulation

4. Magnitude of administrative
costs

___Regulatory____ Costs:
Certainly borne by government
Enforcement (through inspections and
administration of fines/legal proceedings)
can be costly

Liability vs. Regulation

4. Magnitude of admin. costs

__Legal___ Costs:
Only borne if party is not deterred
effectively and harm occurs
Most cases (95%) settled out of court
Enforcement is private

Net: If litigation is an effective

deterrent, __legal____ costs will be
cheaper than ___regulatory___ costs
Example: Tree trimming rules

Liability vs. Regulation

Summary of Effects
Factors generally favoring _legal
rules_____
Difference in knowledge about risky activities
Magnitude of administrative costs

Factors generally ___favoring

regulation_____
Ability to pay for harm
Chance that parties will not be sued

Liability vs. Regulation

Implications
Often times, both legal rules and
regulations are appropriate
If both are used, regulations dont have
to be as onerous as when only
regulations are used

Marty Munch owns a large company in Ohio that manufactures

brake pads. The company, Sure-Stop, Inc., has $10 billion in
assets(judgement proof) in Ohio and does not carry
liability insurance.(no moral hazard) Brake pads, if they
are not manufactured properly, can come apart during the
operation of an automobile. This, in turn, may lead a driver
to lose control of their vehicle and get in an accident. If such
an accident occurs, the damages to the victims are likely to
be substantial and immediate. A routine investigation of
such an accident will readily reveal that the brake pads are
at fault.(Litigation deals with this problem)
Marty has hired the best of the best. Her engineers know more
about the brake pad safety than anyone else in the world.
Her quality assurance specialists, though only paid minimum
wage, are put through an exhaustive training program.
(Agency Problem)
1. If all brake pad manufacturers are like Sure-Stop, would
regulation or liability be more likely to result in the efficient
deterrence of negligently manufactured brake pads? Why
(explain using at least three arguments)?
2. Would negligent manufacturing by Sure-Stop be more
effectively deterred if Sure-Stop were required to purchase
liability insurance? Why?

A large number of small companies are

promoting herbal remedies that (they claim)
prevent diabetes. In fact, scientific testing
has demonstrated that these concoctions not
only have no effect on diabetes, but also show
that the remedies cause cancer in 1% of
consumers 20 years after using the remedy.
The manufacturers of these remedies
typically each sell to 1,000 consumers a year,
have no scientific or medical expertise, and
have assets of less than $100,000. Would
regulation or liability be more likely to result
in the efficient deterrence of negligently
marketed herbal supplements?