Efficient Compensation: Lessons from Civil Liability

This paper deals with compensation requirements ensuring efficient incentives in a setting with two active parties whose decisions affect a third party through an external effect. To achieve efficient incentives under civil liability, expectation damages should be based on a reasonable-person standard, and enrichments due to deviations from obligations may have to be returned. Adapting these lessons to the takings interpretation of the model would require unusual steps, unheard of in actual compensation practice. Yet, if taking decisions are reached in line with theories of public choice, an externality is implicitly present that, if neglected, tends to distort incentives.