Efficiency of Liability-Sharing Rules: An Experimental Case

We investigate the relative performance of two liability-sharing rules for managing harms that are caused jointly by two firms. The firms can make investments to reduce the magnitude of the harm, but they face a limited solvency that can prevent them from paying for their share. We derive theoretical predictions, and compare them with observations made from a lab experiment. We show that insolvency leads to underinvestment, and that the relative performance of each rule depends on the relative degree of solvency of firms. From a social perspective, these results suggest that the liability-sharing rule should depend on the level of capitalization of firms.