Thus, the employer chooses a< l to reduce liability, but at the same time. diminishes productive effort(Gans, 2000) Corporate liability distorts incentives inside the corporation. From a policy view, in this context, corporate liability should not be introduced. Thus from the set of possible policies we have considered before, we should have =H/o and sn=0 Consider again a binding liquidity constraint so that sa =a<H/o. Then we need sp= H/o-d to fully internalize the externality. Management limited wealth generates the need of corporate liability to internalize social damage. However, note that there is a loss of efficiency because of incentives being distorted. As a consequence, the policy should be to fix corporate liability such that< Sp Ho-a. In general, the social damage in not fully internalized because of the loss of efficiency due to the distortion of incentives(Polinsky and Shavell, 1993) 4 Model with reputational sanctions Suppose the employer suffers a loss of reputation if found liable for involve- ment in socially harmful activities. Denote this loss of reputation by a mon- etary measure A. The agent's choice of effort (m, n)is the same as before since nothing changed for the agent The optimal contract is described as before by maximizing the expected profits of the owners of the firm subject to the participation constraint, U>k, and to the incentive compatibility constraint, (n, n. Rearranging expected profits, we can write V=m+n+E()-C(n, m)-P(n)o( +入)-k Notice that the loss of reputation A plays the role of a penalty The first-order condition of the problem is Va= vmma tanno= o (12) where 1-Cm(m)=1-aThus, the employer chooses α < 1 to reduce liability, but at the same time, diminishes productive effort (Gans, 2000). Corporate liability distorts incentives inside the corporation. From a policy view, in this context, corporate liability should not be introduced. Thus, from the set of possible policies we have considered before, we should have sa = H/σ and sp = 0. Consider again a binding liquidity constraint so that sa = ¯ω < H/σ. Then, we need sp = H/σ − ω¯ to fully internalize the externality. Management’s limited wealth generates the need of corporate liability to internalize social damage. However, note that there is a loss of efficiency because of incentives being distorted. As a consequence, the policy should be to fix corporate liability such that 0 < sp < H/σ − ω¯. In general, the social damage in not fully internalized because of the loss of efficiency due to the distortion of incentives (Polinsky and Shavell, 1993). 4 Model with reputational sanctions Suppose the employer suffers a loss of reputation if found liable for involve￾ment in socially harmful activities. Denote this loss of reputation by a mon￾etary measure λ. The agent’s choice of effort hm, ˆ nˆi is the same as before since nothing changed for the agent. The optimal contract is described as before by maximizing the expected profits of the owners of the firm subject to the participation constraint, U ≥ k, and to the incentive compatibility constraint, hm, ˆ nˆi. Rearranging expected profits, we can write: V = ˆm + ˆn + E(ˆn) − C(ˆn, mˆ ) − P(ˆn)σ(sa + sp + λ) − k Notice that the loss of reputation λ plays the role of a penalty. The first-order condition of the problem is: Vα = Vmmˆ α + Vnnˆα = 0 (12) where Vm = 1 − Cm( ˆm) = 1 − α 9