Abstract
Firms will exert too little care due to a limited liability effect if damages are likely to exceed their equity. This is particularly important for environmental and product liability and motivates the current discussion about mandatory insurance and extending liability to creditors. We model the choice of the care level as a moral hazard problem that can be solved through costly monitoring. Conventional strict liability and lender liability both lead to distortions in the capital structure and to inefficiently low care. By contrast, mandatory liability coverage (financial responsibility) that can be satisfied by either an insurance contract or a lender guarantee leads to the first best allocation if managers can self-insure, and to the second best if managers cannot self-insure but choose to be monitored.
Article PDF
Similar content being viewed by others
Avoid common mistakes on your manuscript.
Author information
Authors and Affiliations
Additional information
We wish to thank Marcel Boyer, Dominique Demougin, Hendrik Lando, Göran Skogh and Georg Nöldeke for useful discussions and two anonymous referees for helpful remarks. Seminar participants at the EALE - Geneva Association Joint Conference in Rotterdamprovided stimulating comments. Financial support from Thyssen Stiftung is gratefully acknowledged.
Rights and permissions
About this article
Cite this article
Feess, E., Hege, U. Environmental Harm and Financial Responsibility. Geneva Pap Risk Insur Issues Pract 25, 220–234 (2000). https://doi.org/10.1111/1468-0440.00061
Published:
Issue Date:
DOI: https://doi.org/10.1111/1468-0440.00061