Should managers be liable for ill-conceived business decisions? One answer is given by U.S. courts, which almost never hold managers liable for their mistakes. In this paper, we address the question in a theoretical model of delegated decision making. We find that courts should indeed be lenient...

A principal's production decision imposes a negative externality on an agent. The principal may be a pollution-generating firm, the agent may be a nearby town. The principal offers a contract to the agent, who has the right to be free of pollution. Then the agent privately learns the disutility...