Imperfect Observability and Incentive for Care under the Negligence Rule

This paper studies an economic model of the Negligence rule and considers litigation between a defendant and a plaintiff, under the assumption that the plaintiff may not perfectly observe the defendant’s action ex post. We consider the noiseless case as a benchmark that the plaintiff perfectly observes the defendant action ex post. We show in the noiseless case that the defendant surely takes care and in the noiseless case that there is no equilibrium in which the defendant surely takes care. This result implies that even if the noise is sufficiently small, the situation can not be approximated by the noiseless model. Moreover, we show that punitive damages induce the defendant to make overdeterrence.