Efficiency Characterization of Liability Rules When Liability Payments Differ from the Actual Harm

By now, it is well known that damage awards under a liability rule affect the efficiency of the rule. Due to variety of reasons, damage awards fixed by courts can be different from the actual harm suffered by victims. In the standard analysis of liability rules many such factors are assumed away. This paper aims to provide an efficiency characterization of the entire class of liability rules, when there are factors present due to which liability payments made by injurers differ from the actual harm. Among other things, our analysis shows that the presence of such factors has important implications for the validity of the efficiency-equivalence theorem. © 2005, The Indian Econometric Society.