Realistic Standards: Optimal Negligence with Limited Liability

Abstract

We study the standard economic model of unilateral accidents under the assumption that the injurers have limited assets. We identify a second‐best optimal rule that selects as due care the minimum of first‐best care and a level of care that takes into account the wealth of the injurer. We show that such a rule in fact maximizes the precautionary effort by a potential injurer. The idea is counterintuitive: being softer on an injurer, in terms of the required level of care, actually improves the incentives when he or she is potentially insolvent. We extend the basic result to an entire population of potentially insolvent injurers and find that the optimal general standards of care do depend on wealth and the distribution of income. We also show that, under certain conditions, wealthier populations should be subject to higher general standards of care in the case of accidents.