ABSTRACT
This paper uses a signaling game model to address the debate between limited liability rule and unlimited liability rule in the context of the case of Hadley v Baxendale (1854). This paper compares the levels of net social surplus obtained by the two legal rules under different sets of parameter values. The parameters investigated are the level of transaction cost in communicating the private information regarding the valuation of the contract, the proportion of low valuation versus high valuation promisees, the extra cost of achieving a high performance of contract relative to a low performance by promisors and, the gap between high valuation and low valuation of contract performance. The paper finds that the optimal liability rule depends on the parameter values. When there are many low valuation promisees and transaction cost is low, limited liability rule is better. When there are many low valuation promisees and transaction cost is high, both rules perform equally well. When there are many high valuation promisees, unlimited rule is better irrespective of the level of transaction cost. Finally, when there is high valuation differential relative to performance cost differential, the set of parameter values under which the unlimited rule performs better becomes larger.
Teng, Jimmy, Optimal Liability Rule in the Context of Hadley v Baxendale (November 25, 2017).
First posted 2019-12-13 06:59:46
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