DECLARE VALUE TRANSPORTATION

An Incomplete Contracting View

Ren Ying and Wang Qingyun

School of Economics and Management, Beijing Jiaotong University, Beijing, China

Keywords: Declare value transportation, Incomplete contract, Investment incentives.

Abstract: Declare value transportation is a necessary part of carrier liability regime. In this paper, we perform in-depth

analysis of limited liability regime. Using the incomplete contracting theory, we examine the relation that

between declare value transport and security investment incentives. Our analysis shows that the declare

value transport play an active role in prompting security investment and improving the safety level of

transport.

1 INTRODUCTION

Written in "Hague Rules" in 1921, declare value

transportation has become common international

practice in the transport industry, used by a variety

of means of transportation. Attempted to use the

analysis framework of incomplete contracting theory,

this paper analyses the necessity of the existence of

declare value transportation and its basic functions,

and puts forward recommendations for its

development based on the comprehensive

understanding of its essential attributes.

2 BACKGROUND OF DECLARE

VALUE TRANSPORT

If the value of goods after reaching its destination is

higher than its current value and the shipping fee,

there is a need to transport goods, and thus the

expected value of the carried goods must be higher

than the freight charged by carriers. Because the

transport process contains a variety of risks leading

the loss or delay of goods, if the carriers bear the

financial liability if those occurred during the

transportation, the carriers may take liabilities far

beyond its actual economic income. Conversely, the

owners would suffer the financial loss. How to

resolve this contradiction in order to protect the

economic interests of both sides? Declare value

transportation come into people's mind.

Declare value transportation is a special mode of

transportations that confirmed between the carriers

and the consignors, which recognizes the value of

goods declared by consignors is the basis of

compensation. By this way, the consignors should

pay the basic transportation costs, in addition, and

pay preservation surcharge according to the value of

goods. After that, if the carriers are responsible for

causing the damage, they will compensate within the

limit of declared value of goods in accordance with

actual loss.

Originated in shipping industry in 19th century,

declare value transportation is the product of world's

maritime trade and economic development. Before

19th century, by the limitations of the

communication technology, the consignors lost

contact and control of the goods after delivery, and

the carriers were effectively able to control and

grasp the specific circumstances happened during

the transportation, thus the law was very strict with

common carriers. For example, English law set: for

the loss due to natural disasters, acts of public

enemy, freight shipper, inherent defects of goods

and damage caused by consignors' fault, common

carriers may be exempted from liability, apart from

that, they must bear the responsibility for all damage

and loss of goods in transit. As a balance, English

law allowed the carriers based on principle of

"contractual freedom" to include exemption clauses

in the bills of lading to release their duty for goods

in sea transit. After 19th century, England

monopolized shipping industry. Under the strong

pressure of owners' forces, shipping capitalists used

principle of "contractual freedom" to declare

373

Ying R. and Qingyun W..

DECLARE VALUE TRANSPORTATION - An Incomplete Contracting View.

DOI: 10.5220/0003585103730377

In Proceedings of the 13th International Conference on Enterprise Information Systems (SSSCM-2011), pages 373-377

ISBN: 978-989-8425-54-6

 2011 SCITEPRESS (Science and Technology Publications, Lda.)

exemption clauses in the bills of lading, and thus the

owners were forced to bear most risks of goods

during the transportation. This behaviour of the

carriers damaged the interests of owners, banks and

insurance companies which business had be related

to the bills of lading, affecting the circulation of

bills, and made contradictions between the trading

and shipping industry more acute. To change this

situation, "Hague Rules" provided the limited

responsibility of the carriers in 1921, limited the

abuse practice of exemption clause using in bills of

lading, and made the policy of the carriers' limited

liability for compensation to protect all shippers'

interests, on this basis, the law used declare value

transportation to meet the actual needs of shippers

and carriers. Since then, the policy of the carriers'

limited liability for compensation in shipping

industry became the reference in railway transport,

while air transport and road transport, and declare

value transportation became a common practice of

cargo transportation. Chinese four modes of

transports, civil aviation, railway, highway and

waterway, provide declare value transportation.

"Civil Aviation" and "maritime law" refer to the

term as declare value transportation, while "Railway

Law" and the motor transport, water transport

regulations refer to the term as the insured transport.

They are the same concepts in fact.

If the owners can realize the economic

compensation from insurance, why do they need

declare value transportation? The reason is that the

essential attributes of insurance is to pay financial

compensation by small probability event, and

insurance helps economic agents get back to the

state before loss occurred as soon as possible, which

would help to maintain the normal order of the

operation of social economy. The insurance industry

follows the basic principle of subrogation. In

property insurance, if insurance loss caused by a

third party, insurers have rights to recovery through

the compensation from the third party after

performing compensative liability according to the

insurance contracts. Therefore, if the loss of goods at

transport caused by carriers' liability, the insurers are

entitled to ask the carriers to pay the compensation.

So, given the negligence liability as the classical

theory, no matter whether the consignors or the

owners buy cargo insurance, the carriers shall be

responsible for the fault by their negligent actions.

In a word, under the law of low-fare and high

responsibility, the key issue of the carrier liability is

the arrangement of economic interests, namely, how

to ensure realization of the economic interests of

consignors and carrier? The evolution process of the

policy of the carriers' limited liability for

compensation and the declare value transportation is

illustrated by the following picture.

3 TRANSPORT CONTRACT IS A

TYPICAL INCOMPLETE

CONTRACT

The evolution process of declare value

transportation system matches the analysis paradigm

of incomplete contracting theory. Emerged in the

late 20th century, incomplete contracting theory

generates two major branches thought along the

Coase theory: one is transaction cost economics

(TCE), whose main representative is Williamson;

another is property rights theory (PRT), whose

representative is Hart. Both hold bounded

rationality, opportunism and asset specificity as the

main reasons for incomplete contract, but there are

significant differences between the key issues and

ideas in the analysis: transaction cost economics

holds that the transaction costs in the context of

incomplete contracts should be adjusted mainly after

the transportation, therefore, the key point is to

choose a best system to save transaction costs by

comparing different governance structures; property

rights theory, in a relatively narrow definition of

transaction costs, holds that the main problem

caused by incomplete contracts is the effects exerted

on the specific investment incentives, so it advocates

to protect the investment incentives by designing a

mechanism. Cargo transport contract is the contract

concerned with carriers shipping fee and

transportation goods from one location to another,

the existence of the following reasons lead to the

incompleteness of transport Contract: The document

margins should be the following:

Figure 1: Limitation liability and declare value transport.

Carrier liability regime

Declare value transport

Low-fare and high responsibility

Limitation Liability

ICEIS 2011 - 13th International Conference on Enterprise Information Systems

374

3.1 Transaction Costs is the

Fundamental Reason

Transportation is a complex system. Even under

current level of technology, the process of

transportation and production still exists many

probabilistic factors, such as external factors during

transport and inherent defects of transport system,

which makes the parties unable to predict all of the

contingent conditions. Besides, the delaying or loss

of goods would bring damage to owners' economic

interests, and can only be observed after the

transport process. Second, even if the party can

foresee probabilistic state, it is still difficult or too

expensive for two sides to write into contract

without dispute. One classic example is the

evolution process of carriers' liability provisions: at

that time, high-risk of maritime transport has

become widely recognized, and shippers and carriers

can expect the possibility of loss in transit, but the

trading and shipping industry experienced an

extremely long process of negotiation arguing who

should bear the loss in the contract. Third, transport

process involves the collaboration between carriers

and consignors. For the information of the goods

inherent quality, the true state at the shipment time,

the case of the goods in transit, the carriers or

consignors can master to some extent, which means

the two sides can observe some important

information in the contract. For the third party, such

as the consignee or the court and the arbitral

institution, it can not be confirmed, which can be

demonstrated by the history that litigation cases

related to transport compensation were numerous.

3.2 Bounded Rationality and

Opportunism

Simon proposed the concept of bounded rationality

to modify the fully rational assumptions about

people in traditional economics. He believed that

due to limitations in the ability of neuropsychology

and language and the external affairs' uncertainty,

complexity, people in economic activities pursue

rationality, but they only do this limitedly, which

means human rationality is limited. Williams held

that people are economically self-interested, and

they are not only self-interested, but also without

hesitation to harm others if it is good for themselves.

In the contract signed by consignors and carriers,

limited rationality, opportunistic tendency and

complexity and uncertainty of the objective

environment make it impossible to predict all

possible future contingencies, not to say the

determination of the appropriate countermeasures

and calculation of the effectiveness of the contract

after results for a variety of possible events. When

shipping fee is certain, the carriers tend to reduce the

input and fulfil the contract of carriage at the

minimum cost, while consignors tend to pay less

shipping fee and want more services. That means

both parties want to maximize own interests.

Without appropriate incentives, they tend to be lack

of willingness to invest in transportation and

production.

3.3 Asymmetric Information

Asymmetric information is the core concept of

information economics, one party of the contracts

holds some information that the other party does not

know, especially when the other party can not verify

the information, which may be caused by

inefficiency or impracticability in economic matters.

As mentioned before, there are serious problems of

information asymmetry during the conclusion and

implementation of the contracts. Consignors know

the value of their cargo better than the carriers do

before the contracts are concluded, for instance.

Those hided information tend to be mixed, leading

to the incompleteness of the contracts' provisions.

Apart from that, both parties may take the advantage

of the information asymmetry to lower their risks as

well as responsibilities. Therefore, the contracts of

carriage are always problematic in terms of its

incompleteness.

In short, the characteristics of transport activity

lead to the incompleteness of the contracts of

carriage. Both parties can only negotiate after the

loss, rather than make the provisions in respect of all

the possible cases. The rights and the arrangements

predetermined are the most concerned.

3.4 An Effective Way to Amend the

Incompleteness of the Contracts of

Carriage

Using the analysis frame of the incomplete

contracting theory, the article proves the

reasonableness of the declare value transportation.

The in completeness of the contracts of carriage

hampers the specific investment. For this reason, a

mechanism should be designed, for example,

protecting the investment incentives by law,

avoiding the inefficiency by legislation or by judicial

procedures. The production of the declare value

transportation system is a classic example of

avoiding the inefficiency through legal intervention.

DECLARE VALUE TRANSPORTATION - An Incomplete Contracting View

375

There are many uncertainties during the transport

process. We could investment more in some aspects,

such as transport facilities and the packaging quality,

to avoid the uncertainties to a certain extent and

enhance the safe levels. However, as some

uncertainties are unable to eliminate, there is no easy

way round the difficulty——the compensation to the

parties for loss. Which party should bear the

responsibilities, if the security investment and

financial compensation are regarded as specific

investment?

Since the incompleteness of the contracts of

carriage, the carriers and the consignors would not

take the initiative to invest, and they would be

inclined to minimize the cost of signing and keeping

the agreements to achieve their maximum benefit.

Therefore, with the accumulation of a large number

of homogeneous precedents, the law defined the

provision of carriers' closed compensation and fault

liability, that is, enterprises are required by law to

achieve some certain safety level of production. If

the carriers breached the rule, they would be viewed

as the erring party and bear proper share of the

responsibility. By this means, the carriers are

encouraged to make some investment to ensure the

safety of transportation. At the same time, the

provision of closed compensation is required to

ensure the carriers' residue rights of control. If the

carriers satisfied the basic requirement for safety,

they would hold the liability for compensation

within the limit. With the declare value

transportation, which encourages the consignors to

invest for the cargo's safety, if the consignors

demand a higher level of safety, they would be

better-served by targeted services in terms of

reducing the probability of loss, after they pay the

declare value transportation fee according to the

value of the cargo.

4 THE FUNCTION AND

NECESSITY OF THE DECLARE

VALUE OF TRANSPORTATION

The declare value transportation is an effective

mechanism to encourage the consignors to make

security investment. The effectiveness of the

mechanism is based on the fact that the consignors

possess the residual rights of control, which consists

of the rights of requiring the cargo's safety as well as

economic compensations after the losses, that is, the

declare value of transportation should include two

basic functions: loss prevention and loss

compensation. Thus, targeted security services and

high-quality claim settlement services are the

fundamental functions of the declare value

transportation. The consignors can not fully

participate in the transport activities; therefore, it is

unable to grasp the information of goods' statement

during the transportation and the quality of the

carriers' service. As the quality of the claim

settlement services plays an essential role in the

consignors' assessment of the carriers' service as a

whole, it is better to let the consignors attend the

claim settlement by themselves.

In summary, the declare value transport and the

carrier liability limitation are effective mechanisms

to deal with the incompleteness of transport

contracts by law，play an active role in prompting

the consignors to make security investment and

improving the safety level of social production. As

long as there is incompleteness in contracts of

carriage, carriers would take the responsibility for

fault of concluding, which leads to the necessity of

the existence of the declare value transportation.

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