A
Liability Theory of Organizational Structure:
Theory and Evidence from the Oil Shipping Industry
Richard R. W. Brooks
Abstract
Many economists and legal scholars have predicted
that judgment-proof strategies will have significant detrimental
impact on the economy and the environment, ultimately leading to
the demise of our current system of legal liability. These strategies
allow firms that face potentially high sanctions to limit their
liability through contractual arrangements with judgment-proof firms.
Judgment-proof firms operate with very little capital, near bankruptcy
levels, rendering them, for all pratical purposes, unable to satisfy
legal judgments issued against them. The use of judgment-proof firms,
however, triggers two countervailing effects: On the one hand, contracting
with judgment-proof firms allows greater opportunities to externalize
liability; on the other hand, the potential insolvency of these
firms can generate more liability costs, because judgment-proof
firms have distorted incentives to exercise proper care. Since the
costs of the second effect may outweigh the benefit of the first,
these judgment-proof strategies as a means of evading legal liability
are not clearly desirable. This research develops a formal model
of organizational decisionmaking with respect to the use of limitedly
liable agents and presents empirical support from the oil industry.
Richard R.W. Brooks, School
of Law, Northwestern University
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