Bargaining Power, Judgement-Proofness, and the Impact of Vicarious Liability

In response to the judgement-proofness problem many countries consider the extension of liability for environmental damages to lenders to wealth-constrained, environmentally risky businesses. We analyze a simple model of vicarious liability and show that using the deep pockets of lenders for liability enhances safety only if the lender has high bargaining power when bargaining with a ̄rm about a loan, but not otherwise. Although an optimal vicarious liability may exceed actual damage costs, it may not mitigate the judgement-proofness problem in the sense that more safety could be induced if the ̄rm did not depend on a loan and were liable only with its own limited capital.