New Working Paper Proposes Liability Structure to Limit Environmental Disasters

July 8, 2011
by Doug Gavel, Harvard Kennedy School Communications

An explosion on British Petroleum’s Deepwater Horizon platform in April 2010 killed 11 workers and resulted in the leaking of almost 5 million barrels of oil into the Gulf of Mexico, costing billions of dollars to clean up. The incident also raised many questions about the U.S. regulatory regime for oil companies operating off the nation’s coastlines. A new Harvard Kennedy School Faculty Working Paper recommends a novel approach for calculating corporate liability for risky environmental ventures with the goal of helping to prevent future such disasters, and providing appropriate compensation when they do occur.

“Deterring and Compensating Oil Spill Catastrophes: The Need for Strict and Two-Tier Liability” is co-authored by W. Kip Viscusi, University Distinguished Professor of Law, Economics, and Management, Vanderbilt University; and Richard J. Zeckhauser, Frank P. Ramsey Professor of Political Economy at Harvard Kennedy School.

In the paper, the authors propose a two-tier liability approach for deep-sea drilling and for catastrophic risks in general.

“The first tier would impose strict liability up to the firm’s financial resources plus insurance coverage,” the authors write. “The second tier would be an annual tax equal to the expected costs in the coming year beyond this damages amount. A single firm will be identified as responsible for generating the risk. It would be required to demonstrate substantial ability to pay in the first tier before being permitted to engage in the risky activity.”

Viscusi and Zeckhauser contend that the proposed liability model would more directly link corporate risk taking with financial liability, thereby spurring companies to mitigate risks up front and reducing the chances of major disasters later on.

“Our package of policy reforms will rectify the major shortcomings of current arrangements by ensuring that firms undertaking activities with catastrophic risks can pay for the damage should there be an accident, and will in fact be responsible for the full economic value of the costs their activities generate,” they write. “This structure in turn will create incentives for companies to achieve an efficient level of safety.”

Richard Zeckhauser is the Frank P. Ramsey Professor of Political Economy. Much of his conceptual research examines the potential for effective decentralized incentives in situations where uncertainty prevails. Many of his policy investigations explore ways to promote the health of human beings, to help markets work more effectively, and to foster informed and appropriate choices by individuals and government agencies. In 2011, he published “Collaborative Governance: Private Roles for Public Goals in Turbulent Times,” coauthored with John Donahue, Raymond Vernon lecturer in public policy, Harvard Kennedy School.

Read the paper on the Harvard Kennedy School Faculty Working Papers website.

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Photograph of Professor Richard Zeckhauser

Richard Zeckhauser, Frank P. Ramsey Professor of Political Economy

“Our package of policy reforms will rectify the major shortcomings of current arrangements by ensuring that firms undertaking activities with catastrophic risks can pay for the damage should there be an accident, and will in fact be responsible for the full economic value of the costs their activities generate,” the authors write. “This structure in turn will create incentives for companies to achieve an efficient level of safety.”

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