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Tort Law and Economics: A few Questions
Who am I? aromano@live.it

Why do we have legal rules?

What are the goals that we want to
achieve?

Why are legal rules shaped in the way they
are?

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The Goals of Tort Law and Economics
Corrective Justice: it involves the notion of balance, or
equipoise, between two individuals. Torts can be considered
as transactions that alter this balance; corrective justice aims
at righting the scales.

Not much has changed since Aristotle!


Law and Economics: minimizing total accidents costs
(including the utility derived by economic agents)

Are these goals compatible?
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Corrective Justice Versus(?) Efficiency
We live in a world where only two firms exist: 1 and 2.

Social Welfare= Welfare 1 + Welfare 2

Firm 1 has to decide if it should engage in an
anticompetitive conduct. 1s expected benefits (B) from this
conduct are equal to 100. However, Firm 2 will be harmed
(H) by the conduct.
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Corrective Justice Versus(?) Efficiency
Case 1: Harm equal to 150
Corrective Justice: is centered on the idea of compensation.
Therefore Compensation (D) has to be equal to the Harm.

H=D=150 ->The firm will not engage in the conduct
(B=100)!

Efficiency: the goal is to maximize social welfare. We want
firm 1 to engage in the conduct if and only if the benefits it
derives are higher than the harm imposed on the society.
Therefore compensation has to be equal to the harm!

H=D=150 -> The firm will not engage in the conduct
(B=100)!
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Corrective Justice Versus(?) Efficiency
Case 2: Harm equal to 50
Corrective Justice: is centered on the idea of compensation.
Therefore Compensation (D) has to be equal to the Harm.

H=D=50 ->The firm will engage in the conduct (B=100)!

Efficiency: the goal is to maximize social welfare. We want
firm 1 to engage in the conduct if and only if the benefits it
derives are higher than the harm. Therefore compensation has
to be equal to the harm!

H=D=50 -> The firm will engage in the conduct (B=100)!
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Corrective Justice Versus(?) Efficiency
The two different theories lead us to the same
conclusions Where is the problem?

Probability of detection (PD) is strictly smaller
than 1!

Examples: speeding, theft, corruption etc.



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Corrective Justice Versus(?) Efficiency
Case 1: Harm equal to 150; PD= 0.5

Corrective Justice:
Compensation D must be equal to the harm H.
D=H=150

How will firm 1 behave?

Expected benefits= 100
Expected liability of the firm= 150*PD = 75

The firm 1 will engage in the conduct and reduce
social welfare! So what? Who cares about social
welfare!
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Corrective Justice Versus(?) Efficiency
Case 1: Harm equal to 150; PD= 0.5

Efficiency: the goal is to maximize social
welfare. We want firm 1 to engage in the conduct
if and only if the benefits it derives are higher than
the harm. Therefore the expected liability has to be
equal to the harm!

How should D be determined? H*(1/PD)
D=150*(1/0.5) = 300

Expected liability of the firm= 300*PD = 150

The firm will engage in the conduct only when the
benefits are higher than the harm!


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Corrective Justice Versus Efficiency
As a general rule corrective justice requires that D=H. It
neglects efficiency, as fairness and justice should have the
priority.

As PD<1, within law and economics D=H* (1/PD)

Just a theoretical story? Punitive damages!

However
how do we determine PD?
Can compensation be equal to the harm?



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Economic Analysis
The economic problem: negative externalities
consequences of production or consumption that are borne by
others than the consumers or producers
price too low, quantity too high
Coase theorem
Ronald Coase: The problem of social cost (1960)
If no transaction costs: parties will reach welfare increasing
transactions, irrespective of initial distribution of entitlements
Example
If high transaction costs law needed to correct the problem
tort law?
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Actors: Injurer (I) and Victim (V)
Goal injurer: maximize utility (= minimize private costs)
Social goal: minimize total accident costs provide
incentives to take optimal care
Optimal care: the care level that minimizes total accidents
costs
Choices: (1) care level and (2) activity level
Negligence Rule: the injurer has to compensate the victim if he
has not taken due care (ex. Doctors)
due care: the level of care imposed by the court (or the
legislator)
Strict Liability: if there is an accident the injurer has to
compensate the victim regardless of its behavior (ex. Football
teams?)
Some Terminology
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- Costs of care injurer: x (assume each unit costs 1)
- Expected accident losses: L(x)
L(x)0 (non-negative); L'(x)<0 (L when care );
L"(x)>0 (decline at a diminishing rate)
- Social goal: minimize total accident costs x + L(x)
Find optimum: dTAC/dx = 0 1 + L'(x) = 0 1 = -L'(x)
MC = MR
Result: optimal level of care: x
*

Unilateral Case (Neoclassical)
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Care level
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care costs
expected accident
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x*
Unilateral Case (Neoclassical)
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expected accident
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Unilateral Case (Neoclassical)
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Unilateral Case (Neoclassical)
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Unilateral Case (Neoclassical)
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care costs
expected accident losses
x*
No liability
Deterrence Effect of Liability Rules
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Care level
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Total accident costs
care costs
expected accident losses
x*
Strict liability
Deterrence Effect of Liability Rules
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care costs
expected accident losses
x*
Negligence
Deterrence Effect of Liability Rules
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1. Unilateral accidents, only care neoclassical theory
Level of care Costs of care Accident
probability
Exp. acc.
losses
Total acc.
costs
none 0 15% 15 15
moderate 3 10% 10 13
high 6 8% 8 14

Deterrence Effect of Liability Rules
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1.No liability: only care costs I takes no care
2.Strict liability: private costs = social costs I takes
optimal care
3.Negligence: (assume due care = x*)
If x < x*: liable private costs = social costs
If x x*: not liable only care costs
I takes optimal care
Deterrence Effect of Liability Rules
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Hand Formula
Hand Formula (traditional):
Negligent if x<p*L

Marginal Hand Formula (correct!):
Negligent if (x<p.L)

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Care level
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care costs
expected accident losses
marginal Hand formula
Hand formula
Hand formula v. Incremental Hand Formula
(= p.L)
(= x)
(x<p.L)
(x<p.L)
Deterrence Effect of Liability Rules
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Strict Liability vs Negligence
What about?
Pharmaceutical companies
Drunk driving



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Care level
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care costs
expected accident losses
Correct due care level
1. Ex-ante Information: What if(is court informed?)
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expected accident losses
Too low due care level
1. Ex-ante Information: What if(is court informed?)
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expected accident losses
Too high due care level
1. Ex- ante Information: What if(is court informed?)
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care costs
expected accident losses
Extremely high due care level (de facto strict liability!
again optimal!)
1. Ex-ante Information: What if(is court informed?)
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Can the court verify ex-post the care level of the victim?

Are there relevant dimensions of care that are unobservable? (e.g.
the court cannot observe how often the driver was checking its rear
mirror!)



2. Ex post information
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(a) Differences among parties
Abstract standard: reasonable man clumsy
individual is in fact strictly liable
Why objective standard instead of subjective care level?
1. too difficult to prove differences between people
2. the standard is optimal for the entire class
3. some people should not engage in the activity
4. it encourages to improve ability to take care-> dynamic
(b) Prior precautions
Actions can influence ability to take care at later time:
Dont drink before driving
Maintain machines
Proper training/education
Optimal: minimize TAC, including prior precautions!
3. Heterogeneous Victims
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- costs of care injurer: x
- costs of care victim: y
- expected accident losses: l(x,y)
- social goal: minimize TAC = x + y + l(x,y)
In bilateral case, also the victim needs incentives:
- contributory negligence (all-or-nothing)
- comparative negligence (division of losses)
- assumption of risk? (activity level victim?)
Bilateral Case (Game Theory)
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2. Bilateral accidents, only care game theory
Level of care Costs of care
Injurer Victim Injurer Victim
Accident
probability
exp.acc.
losses
total acc.
costs
none none 0 0 15% 15 15
none care 0 2 12% 12 14
care none 3 0 10% 10 13
care care 3 2 6% 6 11

Deterrence Effect of Liability Rules
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2. Bilateral accidents, only care game theory
Level of care Costs of care
Injurer Victim Injurer Victim
Accident
probability
exp.acc.
losses
total acc.
costs
none none 0 0 15% 15 15
none care 0 2 12% 12 14
care none 3 0 10% 10 13
care care 3 2 6% 6 11

1. No liability: V always bears the costs
Injurer
Victim
No Care
Care
No Care Care
Deterrence Effect of Liability Rules
0, -15 0, -14
-3, -10 -3, -8
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2. Strict liability: I is always liable
Injurer
Victim
No Care
Care
No Care Care
Deterrence Effect of Liability Rules
-15, 0 -12, -2
-13, 0 -9, -2
Level of care Costs of care
Injurer Victim Injurer Victim
Accident
probability
exp.acc.
losses
total acc.
costs
none none 0 0 15% 15 15
none care 0 2 12% 12 14
care none 3 0 10% 10 13
care care 3 2 6% 6 11

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3. Negligence: I is liable if he took less than due care
Injurer
Victim
No Care
Care
No Care Care
Deterrence Effect of Liability Rules
-15, 0 -12, -2
-3, -10 -3, -8
Level of care Costs of care
Injurer Victim Injurer Victim
Accident
probability
exp.acc.
losses
total acc.
costs
none none 0 0 15% 15 15
none care 0 2 12% 12 14
care none 3 0 10% 10 13
care care 3 2 6% 6 11

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What are the goals? what are the problems with the goals (perfect
substitutes/PD)?
Who is I? Who is V?
Is it bilateral or unilateral?
Negligence:
1. Does the court have information on the optimal care level?
2. Can the court verify ex-post the optimal care level?
3. Are injurers heterogeneous? why it matters?
Strict Liability:
1. Does the injurer have information on the optimal care level?
2. Is the injurer rational? Biases! Overconfidence (we are all great drivers,
arent we?), neglecting risks with a very small probability, etc.
3. Is the injurer risk-lover?

Pharmaceutical Companies: checklist
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Are there losses that cannot be compensated? How that affects the
incentives of the parties?
Under strict liability the injurer acts like an insurer: are risks
correlated? Is risk predictable?
Who can bear the losses (risk aversion)? Who can get an
insurance (correlation!)?
Activity level. If you are strictly liable for accidents you might
drive less. If you get no compensation you might walk less.
Which activity should be incentivized?
Information quality injurer vs court vs victim
Judgement proof: does the rule make a difference?

What do we do?!

Pharmaceutical Companies: checklist
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What are the goals? what are the problems with the goals?
Who is I? Who is V?
Is it bilateral or unilateral?
Negligence:
1. Does the court have information on the optimal care level?
2. Can the court verify ex-post the optimal care level?
3. Are injurers heterogeneous?
Strict Liability:
1. Does the injurer have information on the optimal care level?
2. Is the injurer rational? Biases! Overconfidence (we are all great drivers,
arent we?), neglecting risks with a very small probability, etc.
3. Is the injurer risk-lover?

Credit Rating Agencies: checklist
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Are there losses that cannot be compensated? How that affects the
incentives of the parties?
Under strict liability the injurer acts like an insurer: are risks
correlated? Is risk predictable?
Who can bear the losses (risk aversion)? Who can get an
insurance (correlation!)?
Activity level. If you are strictly liable for accidents you might
drive less. If you get no compensation you might walk less.
Which activity should be incentivized?
Information quality injurer vs court vs victim
Judgement proof: does the rule make a difference?

What do we do?!

Rating Agencies: checklist
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notions of causation:
1. But-for cause. Retrospective.
Definition :
the defendant's conduct is not the cause of an injury to the
plaintiff, unless that injury would not have occurred except for
("but for") the defendant's conduct.

Traditional: condition sine qua non

It comes with the all or nothing approach! (0.5 threshold -
preponderance of evidence)
Causation : Traditional approach
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Causation
Graphically:
y

0.2 0.4 0.6 0.8 1.0
P
0.2
0.4
0.6
0.8
1.0
D
AllOrNothing
All or nothing approach:
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Example: Patient A has a probability of 0.6 of surviving. The doctor is
negligent and hence the probability of surviving is reduced to 0.4. The
patient dies.

Was the doctor the cause of the death?
The answer is bound to be no.

The patient had a probability of 0.6 of dying after the negligent conduct of
the doctor. However, 0.4 were due to the disease and hence there is no
preponderance of evidence that the death was caused by the doctor
(0.4>0.2)-> No compensation!

Paradoxically, if a patient starts with less than 50% chances of survival he
should never be entitled to any compensation, regardless of the behavior of
the doctor (ignore gross neglicence) !!

Problems with the traditional approach
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Causation: Loss of Chance doctrine
Graphically:
y

Loss of chance: in cases where causation cannot be
established with preponderance of evidence - due to the
nature of the available proofs and of the injury the victim
should still be compensated, albeit only partly.

0.2 0.4 0.6 0.8 1.0
P
0.2
0.4
0.6
0.8
1.0
D
Corte Cassazione
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Causation: Probabilistic causation
Graphically:
y

A material harm is a necessary condition for compensation,
and the latter is always proportional to the probabilities that
the negligent conduct has caused the former.

0.2 0.4 0.6 0.8 1.0
P
0.2
0.4
0.6
0.8
1.0
D
Proporzionale
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Causation: P.C. and CRAs
Graphically:
y

Pharmaceutical companies: It is not always easy to
identify causal effects. Generally pills only increase
the probability of a certain negative outcome -> no
certainty, rarely preponderance of evidence!

Rating agencies : It is hardly possible to identify the
causal link between CRAs conduct and the loss
suffered by investors. Would have they bought shares
anyway? How to prove that they bought shares just
because they had received a high rating?
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Exam: Final
What about Pharmaceutical companies ?
Goals that we want to achieve when regulating pharmaceutical
companies (problems in this context!)
Characteristics of the problem (including causation!)
Negligence Rule : pros and cons in this context
Strict Liability: pros and cons in this context
Which rule and why?
You can get information anywhere (google scholar!) but remember
to cite!
Hint that you are doing a good job: You have listed (reasonable) pros
and cons for both rules!




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Strict Liability vs Negligence
What about?
Pharmaceutical companies (bilateral?!)
Rating Agencies
Product Liability
And...
Football teams (Stadiums)
Auditors
Doctors
Lawyers






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Strict Liability vs Negligence
And...
Employees safety
Financial advisors
Environmental liability of Multinationals (e.g. British Petroleum)
Tobacco Manufacturers
Metro Lines
Strait of Messina bridge (unique)








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Strict Liability vs Negligence
And...
Toxic Wastes
Public Utilities
Consulting Companies
Vicarious Liability
Vaccines
Kindergardens











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Some literature
Goals of Tort Law and Economics:
Kaplow, Louis, and Steven Shavell. "Fairness versus welfare." Harvard
Law Review 114 (2000): 961.
Coleman, Jules L. The Grounds of Welfare." Yale Law Journal 112.6
(2003): 1511.
Romano, Alessandro. "Aristotle and Optimal Deterrence." Journal of
Politics & Law 6.3 (2013):146.













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Some literature
Strict Liability versus Negligence:
Shavell, Steven. Economic analysis of accident law. Harvard University
Press, 2009.
Get at: http://lsr.nellco.org/cgi/viewcontent.cgi?article=1184&context=harvard_olin&sei-
redir=1&referer=http%3A%2F%2Fscholar.google.it%2Fscholar%3Fq%3Dshavell%2Beconomic%2Banalysis%2Bof%2Bacci
dent%2Blaw%26btnG%3D%26hl%3Dit%26as_sdt%3D0%252C5#search=%22shavell%20economic%20analysis%20acciden
t%20law%22.

Insurance:
Priest, George L. "The current insurance crisis and modern tort law." Yale
Law Journal (1987): 1521