An Experimental Investigation of Liability Rules and Damage Measures
Posted: 1 Oct 1996
Date Written: July 1997
This paper reports the results of an experiment designed to investigate the social welfare implications of two liability rules (negligence and strict liability) and two damage measures (out-of-pocket and independent-of-investment damages). We focus on information production strategies (i.e., the level of effort undertaken by the auditor- subjects to determine and report on the state of nature), and investment choices made by the user of the information (i.e., the level of investment made by the investor- subjects). We investigate four legal regimes, with each regime consisting of one liability rule and one damage measure. The liability rule identifies the auditor's standard of conduct (i.e., effort level) that triggers liability, while the damage measure defines the level of compensation that must be paid to the investor by the auditor if liability is triggered.
The experiment is based on the model from Schwartz  that provides equilibrium predictions under the four legal regimes that we investigate. One focus of the experiment is on the result from the Schwartz  model that some legal regimes can induce investment levels that exceed the socially optimal level of investment, thus decreasing the efficiency of the economy. The results of the experiments support the qualitative predictions of the model.
JEL Classification: C92, K22, M41
Suggested Citation: Suggested Citation