Optimal Liability for Terrorism∗

This paper analyzes the appropriate normative role for civil liability in aligning terrorism precaution incentives when the perpetrators of terrorism are themselves beyond the jurisdiction of courts or regulators. We consider the strategic interaction among the targets, subsidiary victims, and terrorists within a sequential, game theoretic model. Analysis of the model reveals that, while an ‘optimal’ liability regime indeed exists, its features appear somewhat peculiar when compared to conventional legal templates. For example, it frequently prescribes decoupled damages, and sometimes even damages payments from seemingly unlikely defendants. As such, practical implementation of such a system may present a significant challenge. Consequently, we suggest that the provision of precaution incentives in the case of terrorism may be best solved through alternative policy mechanisms, such as a mutual public insurance pool for potential targets of terrorism, coupled with direct compensation to victims of terrorist attacks. ∗PRELIMINARY DRAFT (do not cite or circulate without permission) †Economist, RAND Corporation, 1700 Main Street, Santa Monica, CA 90407. [email protected] ‡Ivadelle & Theodore Johnson Professor of Law and Business, University of Southern California; Senior Economist, RAND Corporation. Email: [email protected]