Strategic Bilateral Exchange with Joint Harm: a Comparison of Three Liability Sharing Rules

This paper analyzes the emission levels of firms competiting a la Stackelberg when producing the manufactured good generates environmental externalities. We investigate and compare the consequences of three out-of-contract civil liability mechanisms in terms of incentives to reduce pollution, when firms generate indivisible harms. The first liability rule, referred to as market share rule, divides harm according to the firms' market shares. The second liability rule, referred to as uniform or per capita rule, divides harm equally between the two firms, irrespective of their market shares. The third rule combines the previous two in the sense that part of the harm is equally divided while the other part depends on the market shares. We go further than previous studies in this areas, as we (i) consider an exchange economy with productive sector, (ii) propose a sequential game where producers are also consumers, and (iii) allow for an endogenous market price and a dominant firm, to study the way each (or a combination) of these three policies is more effective. We show that environmental harm is lowest with the market share rule, followed by the combination of both rules and by uniform rule. We also show that, with the exception of the mixed apportionment mechanism, the variation in the sum of utilities of productive firms is higher without a leader than in the presence of a leader.