Environmental risks,the judgment-proof problem and financial responsibility

This paper examines a setting in which a firm is liable to pay environmental damages caused by its activity but may not have sufficient wealth for repair of damages. In order to induce the full internalization of the environmental cost, the firm is required to demonstrate a financial guarantee from a solvent party that covers this cost. Since the firm and the guarantor are joint liable for the harm caused by the firm, it is in the interest of the guarantor to design the guarantee contract in order to induce the firm to take an adequate level of prevention. First, I show that financial responsibility regime may achieve the social optimum. Secondly, I identify a particular form of contract in the set of contracts which induce the socially optimal level of prevention. This contract is closed to an alternative risk transfer product referred to as the spread loss treaty.