Scholars have often conceived the core difference between property rules and liability rules as the difference between protecting by deterrence and protecting by compensation. Property rules protect legal entitlements by deterring non-consensual takings, while liability rules compensate entitlement holders if a non-consensual taking occurs. This chapter reorients the debate by showing how the various forms of liability rules are allocative devices that harness the litigants' private information when a court is imperfectly informed as to their valuations. This “harnessing” result clarifies and formalizes the pioneering work of Guido Calabresi and Douglas Melamed. It overthrows one of the most basic tenets of law-and-economics scholarship—the idea (distilled from Calabresi and Melamed) that property rules are presumptively more efficient than liability rules when transaction costs are low. This chapter first distinguishes the empirical and theoretical aspects of the tangibility thesis. It then argues that George Akerlof's celebrated “lemons” model shows how correlated values can inefficiently strand legal entitlements protected by property rules with low-value owners and how the lemons (correlated-value) problem might be mitigated by liability rules.
Keywords: correlated values, liability rules, property rules, legal entitlements, Calabresi, transaction costs, tangibility, lemons model, private information, George Akerlof