Regulating Judgment-Proof Firms: Information or Extended Liability?

Abstract

The literature on the optimal regulation of judgment-proof firms has tended to focus on ex post policies such extended liability. But in the recent past information disclosure has emerged as an alternative or a complementary risk mitigation strategy. This paper uses a model of entrepreneurial firm's financing to study the complexities that are brought about by the interaction between extended liability and environmental information disclosure. In the model, lenders not only provide credit services, they also screen projects for their environmental riskiness prior to advancing credit. Thus, environmental quality is directly determined by the lenders' action choices. It is shown that screening is more intense and environmental quality is higher when the two policies are used together rather than singly. Comparative static impacts of regulatory reforms are examined.

Keywords: Environmental information disclosure, extended liability, lender screening, judgment-proofness

JEL Classification: D82, K13, K32, Q38, G33