Ambiguity and Accident Law

• Author: DAVID KELSEY,SURAJEET CHAKRAVARTY
• Published date: 01 February 2017
• Date: 01 February 2017
• DOI: http://doi.org/10.1111/jpet.12160

AMBIGUITY AND ACCIDENT LAW

SURAJEET CHAKRAVARTY

University of Exeter

DAVID KELSEY

University of Exeter

Abstract

Environmental accidents often involve ambiguous risks, i.e., the rele-

vant probabilities are unknown. This paper studies how liability rules

are affected by ambiguity. The injurer and the victim choose a level

of care, which is observable, and an unobservable action. Both actions

may affect the size and/or likelihood of loss. We analyze the welfare im-

plications of tort rules. First, we show that with ambiguity, negligence

is likely to perform better than strict liability. Second, we propose a

tort rule of negligence and punitive damages, which gives the efficient

levels of both care and unobserved actions.

1. Introduction

1.1. Background

Many environmental disasters are the result of accidents, for instance, the Union Car-

bide gas leak at Bhopal, the Exxon Valdez oil spill, or the British Petroleum (BP) Deep-

water Horizon oil spill. Such events are governed broadly by law of tort.1The aim of

tort or liability law is to give agents an incentive to internalize the externalities caused

by their actions.2A significant part of the literature has focused on the efficiency impli-

cations of different tort rules, like negligence and strict liability. This paper studies how

tort law is affected by ambiguity.

1Tort law decides the liability in case of private harm due to act of negligence or lack of duty of care by

the injurer. Environmental accidents can cause both public and private harm. For the purpose of our

analysis, we are going to ignore the difference between private and public harm. Victims are assumed

to suffer damage and we are going to model them as a single representative agent.

2See Calabresi (1970), Calcott and Hutton (2006), Posner (2007), and Shavell (1980).

Surajeet Chakravarty, Department of Economics, University of Exeter, Rennes Drive, Exeter EX4

4PU, UK (S.Chakravarty@exeter.ac.uk). David Kelsey, Department of Economics, University of Exeter,

Exeter, UK (D.Kelsey@exeter.ac.uk).

This research was supported in part by a Leverhulme Research Fellowship. We would like to thank

Jayant Ganguli, Tigran Melkonyan, Joshua Teitelbaum, seminar audiences at the Universities of Birm-

ingham, Exeter, and Liverpool; Warwick Business School; FUR, Newcastle, 2010; the Royal Economic

Society Conference, Cambridge, 2012; ESEM Malaga 2012; SAET Paris 2013; the referees; and the edi-

tor of this journal for helpful comments.

Received April 28, 2015; Accepted June 5, 2015.

C2016 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 19 (1), 2017, pp. 97–120.

97

98 Journal of Public Economic Theory

Risks with unknown probabilities are called ambiguous. We believe that agents may

often perceive accidents as ambiguous, since they may not have sufficient information

or time to assign precise probabilities. This is especially true of major accidents likely

to cause environmental damage, since they are almost always rare events. Hence, there

may not be enough observations to base subjective probabilities on relative frequencies.

Agents involved are likely to have poor information about the probability of disaster,

since such accidents often have unique circumstances. Complexity can also make it hard

to assign probabilities. Moreover,the chance of an accident often depends on the behav-

ior of other people, something which is intrinsically hard to predict. These issues seem

to be relevant to the BP oil spill. There was little previous experience of drilling at these

depths and it involved new and highly advanced technology. The operation involved a

complex interaction between a number of companies. Even now responsibility for the

accident has not been allocated between them. In this paper, we study the implications

of ambiguity for tort.

Our motivation for this analysis comes from environmental accidents. However am-

biguity may also be a factor in other cases. Examples include firms using new machinery

or procedures and road accidents in the case of drivers who do not have enough expe-

rience of driving in certain roads or conditions.

The law and economics literature usually models agents as subjective expected util-

ity (SEU from now on) maximizers (Savage 1954). We relax this assumption by allowing

agents to perceive ambiguity, which we argue is relevant for many environmental acci-

dents.3Since ambiguity may cause agents to behave differently, it is desirable that tort

rules be robust. We show that negligence is likely to perform better than strict liability

in the presence of ambiguity.

Ellsberg (1961) argued that individuals avoid risks with unknown probabilities. This

has been confirmed by the subsequent experimental literature(see Camerer and Weber

1992). In case of unawareness of the probabilities, individuals may respond pessimisti-

cally by overweighting bad events or optimistically by overweighting good events com-

pared to an individual who followed SEU. We shall model ambiguity using neoadditive

preferences (explained below), which are introduced and axiomatized in Chateauneuf,

Eichberger, and Grant (2007) (henceforth CEG).

1.2. Liability and Ambiguity

This paper studies accident law in the presence of ambiguity. As usual we assume that

it is clear who is the injurer and who is the victim. We shall adopt the convention that

male pronouns, for example he, him, etc., refer to the injurer and female pronouns,

she, her, and so on, refer to the victim.

Teitelbaum (2007) has previously studied the impact of ambiguity in the context of

unilateral accidents. In this model, the injurer may reduce the loss by taking precautions

but the victim has no influence on the likelihood or amount of damage. We begin by

extending Teitelbaum’s analysis to the bilateral accident model, in which both agents

are able to choose an observable action and an unobservable action.4The observable

action may be the investment in care, for example safety standards on the drilling rig,

and the unobservable action could be quality of cement used in drilling. A consequence

3Shuman (1993) argues that we may not be able to provide a complete analysis of tort rules with the

standard assumptions that agents are rational and are fully aware of the probability of an accident.

4Observability here means that the action is observable and verifiable by a third party like a court

of law.