Optimal Agency Contracts: The Effect of Vicarious Liability and Judicial Error
Albert H. Choi
University of Virginia School of Law
Juan Carlos Bisso
University of Virginia - Department of Economics
September 3, 2007
Under the doctrine of vicarious liability, a deep-pocket principal is often held responsible for a third-party harm caused by a judgment-proof agent's negligence. We analyze the incentive contract used by the principal to control the agent's behavior when a court can make an error in determining the agent's negligence. We show that (1) reducing the error of declaring the agent not negligent even when he was (pro-defendant or type II error) is better than reducing the error of declaring the agent negligent even when he was not (pro-plaintiff or type I error) and (2) allowing the principal to penalize the agent even when the court declares the agent not negligent improves welfare. The latter supports the argument that causing an accident (or a reliable allegation of misconduct) should be sufficient to justify a just cause termination of an employee.
Number of Pages in PDF File: 22
JEL Classification: K12, K13, K31, K32working papers series
Date posted: April 5, 2006
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