Instantaneous Liability Rule Auctions: the Continuous Extension of Higher-order Liability Rules

A “higher-order” liability regime—in which a plaintiff and a defendant have a sequence of alternating options to take (or to put) a disputed entitlement —can enhance allocative efficiency by harnessing the private information possessed by both litigants. Indeed, infinite order liability regimes can, as a theoretical matter, assure first-best efficiency. Such iterated taking regimes have, however, been criticized as (i) generating excessive (and debilitating) taking costs, and (ii) being infeasible with regard to intangible entitlements. This Paper shows that courts can replicate the first-best efficiency of infinite-stage liability rule via an instantaneous auction mechanism. This instantaneous mechanism avoids the excessive taking cost criticism (because the disputants merely submit a single report of value). Unlike many auctions, the mechanism also allows courts to pursue equitable goals by dividing the bulk of expected gains to either plaintiff or defendant (without undermining the first-best allocative efficiency). A derivation is given of the explicit formula for the basic element of the procedure, which we call the “damage curve” and which determines the amount of damages that the winner of the auction must pay the loser. This formula holds for arbitrary joint probability distributions of the valuations of the asset, whether correlated or uncorrelated. Explicit damage curves are calculated for several concrete examples, illustrating both correlated and uncorrelated cases.