Issues in Legal Scholarship CATASTROPHIC RISKS:PREVENTION,COMPENSATION, AND RECOVERY Article 2 Options Contracts for Contingent Takings Carolyn Kousky∗ Sam Walsh† Richard Zeckhauser‡ ∗Harvard University, carolyn
[email protected] †United States Court of Appeals for the District of Columbia Circuit,
[email protected] ‡Harvard University, richard
[email protected] Copyright c 2007 The Berkeley Electronic Press. All rights reserved. Options Contracts for Contingent Takings∗ Carolyn Kousky, Sam Walsh, and Richard Zeckhauser Abstract Disasters are low-probability situations with high potential losses. Shortly before and during some disasters, government use of private property may reduce losses to others that strongly out- weigh the costs imposed on the property owner, implying significant net benefits. Coercive takings or attempts to contract at the time of the emergency will frequently be defeated by transactions costs. We propose a policy tool to realize the available net benefits: options contracts for contin- gent takings. Such contracts between the government and private parties allow the government to take property in the event of a low-probability event that would make the property much more valuable in government hands. In exchange for such use, the property owner is compensated, in part up front and in part when the option is exercised. Setting the exercise payment equal to the cost of losses promotes efficiency in both risk spreading and the incentives for exercise. Options contracts of this form will be valuable in a range of settings, from improving disaster response by guaranteeing a flow of needed supplies, to reducing potential damages by diverting floodwaters to low-value lands, or even to helping ensure the survival of some endangered species.