Abatement, Care, and Compliance by Firms in Financial Distress

46 Pages Posted: 23 Feb 2011

See all articles by Mary F. Evans

Mary F. Evans

Claremont McKenna College - Robert Day School of Economics and Finance

Scott M. Gilpatric

University of Tennessee

Date Written: February 19, 2011

Abstract

We examine precautionary behavior, specifically compliance with environmental regulations, pollution abatement, and care spending, by firms facing two sources of insolvency risk. If poor profit or a realized environmental liability triggers insolvency, then the firm forgoes a profitable future. The behavioral implications of the survival motive vary across firms. Firms for whom the principal insolvency risk is liability-related liability choose supra-optimal precaution, even though these firms would have otherwise chosen suboptimal precaution. For other firms, whose primary insolvency risk is profit-related, the survival motive reinforces incentives for suboptimal precaution arising from the familiar judgment-proof effect. We characterize how insolvency risks affect not only these ex ante precautionary decisions, but also the incentive for a firm to conceal adverse events linked to these choices, such as an accident or a regulatory violation. An understanding of these incentives, and their potential implications for environmental quality, is particularly important during recessionary periods when firms struggle to survive the downturn.

Keywords: insolvency, compliance, abatement, judgment proof, liability, care, concealment

JEL Classification: Q53, D21, K32

Suggested Citation

Evans, Mary F. and Gilpatric, Scott M., Abatement, Care, and Compliance by Firms in Financial Distress (February 19, 2011). Claremont McKenna College Robert Day School of Economics and Finance Research Paper No. 2011-02. Available at SSRN: https://ssrn.com/abstract=1767433 or http://dx.doi.org/10.2139/ssrn.1767433

Mary F. Evans (Contact Author)

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States
909.607.3423 (Phone)

Scott M. Gilpatric

University of Tennessee ( email )

508 Stokely Management Center
Knoxville, TN 37996-0550
United States
865-974-1696 (Phone)

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