Second-Best Liability Rules, Loss-Prevention Incentives, and Efficiency

The paper compares two liability rules, strict liability and the negligence rule, in terms of loss-prevention investment and social welfare when individuals are risk-averse and policymakers do not have lump-sum transfers at their disposal. If the damage payment made by the injurer to the victim fully compensates for the loss, loss prevention is higher under the negligence rule but social welfare is higher under strict liability. If the damage payment partially compensates for the loss, loss prevention and social welfare both tend to be higher under the negligence rule.