Optimal Agency Contracts: The Effect of Vicarious Liability and Judicial Error

22 Pages Posted: 5 Apr 2006

See all articles by Albert H. Choi

Albert H. Choi

University of Virginia School of Law

Juan Carlos Bisso

University of Virginia - Department of Economics

Date Written: September 3, 2007

Abstract

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.

JEL Classification: K12, K13, K31, K32

Suggested Citation

Choi, Albert H. and Bisso, Juan Carlos, Optimal Agency Contracts: The Effect of Vicarious Liability and Judicial Error (September 3, 2007). Available at SSRN: https://ssrn.com/abstract=894903 or http://dx.doi.org/10.2139/ssrn.894903

Albert H. Choi (Contact Author)

University of Virginia School of Law ( email )

580 Massie Road
Charlottesville, VA 22903
United States

Juan Carlos Bisso

University of Virginia - Department of Economics ( email )

2015 Ivy Road, Room 312
Charlottesville, VA 22904-4182
United States

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