Theoretical Framework and Empirical Analysis
Chapter 3: Condemnees: four types of incentives
Three theories can be found in the literature regarding how the amount of takings compensation affects condemnees’ investment incentives. The first theory supports a case for lower, even zero, compensation. On this view, compensation, especially full compensation and more-than-full compensation, induces owners to ‘overinvest’ (i.e., investing more than the socially optimal level) in their properties because compensation protects them from bearing the risk of condemnation (Blume, Rubinfeld, and Shapiro 1984: 72). This is often called the moral hazard problem (Kaplow 1986: 537–41). For reasons I have elaborated elsewhere (Chang 2012), this book will use the term ‘overinvestment problem’ instead of moral hazard problem in the takings context. The second and third theories support a case for more, preferably full (but not more-than-full), compensation. Specifically, less-than-full compensation will motivate some owners to overinvest in their properties to increase their value, because condemnors usually condemn low-value properties. That is, owners overinvest to avoid takings (Miceli 1991: 358; Innes 1997: 429; Miceli and Segerson 2007: 28). In addition, less-than-full compensation may also induce owners to ‘underinvest’ (i.e., investing less than the socially optimal level) to reduce losses if takings ultimately happen.
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