Abstract

the Wharton Risk Management and Decision Processes Center and the Columbia University Earth Institute. We are particularly grateful to Richard Zeckhauser for helpful discussion and comments on an earlier draft. Mark Broadie, Ido Erev, Victor Goldberg, Daniel Kahneman, Paul Kleindorfer and Yechiam Yemini and participants in the NBER Insurance Project Workshop, where this paper was presented, also provided useful insights. 1 Do firms have adequate incentives to invest in anti-terrorism mechanisms? This paper develops a framework for addressing this issue when the security choices by one agent affect the risks faced by others. We utilize the airline security problem to illustrate how the incentive by one airline to invest in baggage checking is affected by the decisions made by others. Specifically if an airline believes that others will not invest in security systems it has much less economic incentive to do so on its own. Private sector mechanisms such as insurance and liability will not necessarily lead to an efficient outcome. To induce adoption of security measures one must turn to regulation, taxation or institutional coordinating mechanisms such as industry associations. We compare the airline security example with problems having a similar structure (i.e., computer security and fire protection) as well as those with different structures (i.e., theft protection and vaccinations). The paper concludes with suggestions for future research.

Citations