“I hear in some places, you need one form of ID to buy a gun, but two to pay for it by check. It’s interesting who has what incentives to care about what mistakes.”
- XKCD
1

 We’ve discussed a bunch of liability rules…



No liability
Strict liability
Various versions of a negligence rule
 …and the effect of each rule on incentives for:


Injurer precaution
Victim precaution


Injurer activity level
Victim activity level
2

 Also examined how legal standard for negligence is set


Hand Rule: efficient precautions are required
Other ways: safety standards, industry norms
 …and the effect of errors in implementing each rule


Strict liability rule: random errors in calculating damages have no effect, systematic errors do
Negligence rule: small errors in damages have no effect; errors in standard for negligence have strong effect; uncertainty in legal standard leads to overprecaution
3

 What factors/complications has our simple model been leaving out?
 How much money is your life worth?
 But first…
4

5

6

 So far, our model has assumed:
 People are rational
 Injurers pay damages in full

They don’t run out of money and go bankrupt
 There are no regulations in place other than the liability rule
 There is no insurance
 Litigation is costless
 We can think about what would happen when each of these assumptions is violated
7

 Behavioral economics: people systematically misjudge value of probabilistic events
 Daniel Kahneman and Amos Tversky, “Prospect Theory: An
Analysis of Decision under Risk”
 45% chance of $6,000 versus 90% chance of $3,000






Most people (86%) chose the second
0.1% chance of $6,000 versus 0.2% chance of $3,000
Most people (73%) chose the first
But under expected utility, either u(6000) > 2 u(3000), or it’s not
So people don’t actually seem to be maximizing expected utility
And the “errors” have to do with how people evaluate probabilities
8

 People seem to overestimate chance of unlikely events with well-publicized, catastrophic events
 Freakonomics: people fixate on exotic, unlikely risks, rather than more commonplace ones that are more dangerous
9

 People seem to overestimate chance of unlikely events with well-publicized, catastrophic events
 Freakonomics: people fixate on exotic, unlikely risks, rather than more commonplace ones that are more dangerous
 How to apply this: accidents with power tools


Could be designed safer, could be used more cautiously
Suppose consumers underestimate risk of an accident


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Negligence with defense of contributory negligence: would lead to tools which are very safe when used correctly
But would lead to too many accidents when consumers are irrational
Strict liability would lead to products which were less likely to cause accidents even when used recklessly 10

 Another type of irrationality: unintended lapses
 “Many accidents result from tangled feet, quavering hands, distracted eyes, slips of the tongue, wandering minds, weak wills, emotional outbursts, misjudged distances, or miscalculated consequences”
11

 Strict liability: injurer internalizes expected harm done, leading to efficient precaution
 But what if…
 Harm done is $1,000,000
 Injurer only has $100,000




So injurer can only pay $100,000
But if he anticipates this, he knows D << A…
…so he doesn’t internalize full cost of harm…
…so he takes inefficiently little precaution
 Injurer whose liability is limited by bankruptcy is called judgment-proof
12

 Owner of an oil tanker
 Any accident would be an environmental catastrophe, doing $50,000,000 of harm
 Upgraded navigation system would cost $225,000, and reduce likelihood of an accident from 1/100 to 1/500

 If company would be forced to pay $50,000,000 after an accident, then under strict liability, would choose to buy new nav system
 Suppose the business is only worth $5,000,000
 If there’s an accident, pay the $5,000,000 and go out of business

Precaution reduces expected harm from $500,000 to $100,000, costs $225,000, so efficient to take precaution

Now nav system reduces expected damages from $50,000 to
$10,000 – not worth the cost
So judgment-proof business would take too little precaution
13

 What stops me from speeding?


If I cause an accident, I’ll have to pay for it
Even if I don’t cause an accident, I might get a speeding ticket
 Similarly, fire regulations might require a store to have a working fire extinguisher
 Regulations supply additional incentive to take precaution
14

 We saw, if business is only worth $5,000,000, liability does not create enough incentive to upgrade nav system
 Now suppose government passes regulation requiring modern navigation systems on all oil tankers
 If business doesn’t upgrade, 1 in 5 chance of being caught by safety inspector and having to pay a $1,000,000 fine
 Now, combining liability with regulation…



Upgrade: cost of new nav system is $225,000, expected damages are $10,000  private cost is $235,000
Don’t upgrade: expected damages are $50,000, expected government fine is $200,000  private cost is $250,000
Liability + regulation gives enough incentive to take precaution, even though either one alone would not be enough
15

 When liability > injurer’s wealth, liability does not create enough incentive for efficient precaution
 Regulations which require efficient precaution solve the problem
 Regulations also work better than liability when accidents impose small harm on large group of people
16

 We assumed injurer or victim actually bears cost of accident
 When injurer or victim has insurance, they no longer have incentive to take precaution
 But, insurance tends not to be complete
17

 Insurance reduces incentive to take precaution
 Moral hazard
 Insurance companies have ways to reduce moral hazard


Deductibles, copayments
Increasing premiums after accidents
 Insurers may impose safety standards that policyholders must meet
18

 If litigation is costly, this affects incentives in both directions




If lawsuits are costly for victims, they may bring fewer suits
Some accidents “unpunished”  less incentive for precaution
But if being sued is costly for injurers, they internalize more than the cost of the accident
So more incentive for precaution
 A clever (unrealistic) way to reduce litigation costs





At the start of every lawsuit, flip a coin
Heads: lawsuit proceeds, damages are doubled
Tails: lawsuit immediately dismissed
Expected damages are the same  same incentives for precaution
But half as many lawsuits to deal with!
19

20

 Vicarious liability is when one person is held liable for harm caused by another


Parents may be liable for harm caused by their child
Employer may be liable for harm caused by employee
 Respondeat superior – “let the master answer”
 Employer is liable for unintentional torts of employee if employee was acting within the scope of his employment
21

 Gives employers incentive to...


 be more careful who they hire be more careful what they assign employees to do supervise employees more carefully
 Employers may be better able to make these decisions than employees…
 …and employees may be judgment-proof
22

 Vicarious liability can be implemented through…


Strict liability rule : employer liable for any harm caused by employee (as long as employee was acting within scope of employment)
Negligence rule : employer is only liable if he was negligent in supervising employee
 Which is better? It depends.


If proving negligent supervision is too hard, strict vicarious liability might work better
But an example favoring negligent vicarious liability…
23

 Suppose you were harmed by accident caused by two injurers
 Joint liability : you can sue them both together
 Several liability : you can sue each one separately
 Several liability with contribution : each is only liable for his share of damage
 Joint and several liability : you can sue either one for the full amount of the harm
 Joint and several liability with contribution : the one you sued could then sue his friend to get back half his money
24

 Joint and several liability holds under common law when…
 Defendants acted together to cause the harm, or…
 Harm was indivisible (impossible to tell who was at fault)
 Good for the victim, because…


No need to prove exactly who caused harm
Greater chance of collecting full level of damages
 Instead of suing person most responsible, could sue person most likely to be able to pay
25

 Negligence with a defense of contributory negligence was dominant liability rule in common law countries
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
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Negligent injurer is liable, unless victim was also negligent
Example: a car going 60 mph hits a car going 35 in a 30-mph zone
Since victim was also negligent, injurer is not liable
 Last 40 years, most U.S. states have adopted a comparative negligence rule
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

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Usually through legislation, sometimes through judicial decision
Appealing from fairness point of view
But any negligence rule leads to efficient precaution
So how do we explain the move?
26

 Evidentiary uncertainty
 Given a legal standard for negligence, x n …
 …and an actual level of precaution taken, x…
 still uncertainty in whether the court will find negligence
 Evidentiary uncertainty, like random errors in setting x n , leads to overprecaution…
 …but comparative negligence partly mitigates this
27

$ wx + p(x) A wx p(x) A x* x
 Comparative negligence mitigates effect of evidentiary uncertainty
28

29

 Perfect compensatory damages (D = A)



Returns victim to original level of well-being
(Works like insurance)
And sets correct incentive for injurers

 Might be no price at which you’d be willing to give up a leg
 Certainly no price at which a parent would be indifferent toward losing a child
30

 Recommended jury instructions, Massachusetts:
 “Recovery for wrongful death represents damages to the survivors for the loss of value of decedent’s life. There is no special formula under the law to assess the plaintiff’s damages…


It is your obligation to assess what is fair, adequate, and just .
You must use your wisdom and judgment and your sense of basic justice to translate into dollars and cents the amount which will fully, fairly, and reasonably compensate the next of kin for the death of the decedent.
 You must be guided by your common sense and your conscience on the evidence of the case…”

 “…You should award reasonable compensation for the loss of love, companionship, comfort, affection, society, solace or moral support.”
31

 Most people would rather be horribly injured than killed
 Which means killing someone does more damage than injuring someone
 But compensatory damages tend to be lower for a fatal accident than an accident which crippled someone



When someone is badly injured, may require huge amount of money to compensate them
In wrongfuldeath case, damages compensate victim’s loved ones, but no attempt to compensate victim
So these damages tend to be smaller
32

33

 Assessing damages in a wrongful death lawsuit requires some notion of what a life is worth
 Safety regulators also need some notion of what a life is worth
 Kip Viscusi, The Value of Risks to Life and Health
Regulation
Airplane cabin fire protection
Car side door protection standards
OSHA asbestos regulations
EPA asbestos regulations
Proposed OSHA formaldehyde standard
Estimated cost per life saved
$ 200,000
$ 1,300,000
$ 89,300,000
$ 104,200,000
$72,000,000,000
 Regulators need to decide “where to draw the line”
34

The Value of Risks to Life and
Health
 Let w be starting wealth, D death, p probability
 There might be some amount of money M such that p u(D) + (1 – p) u(w + M) = u(w)




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When p = 1, this breaks down not because you can’t equate death with compensation, but because the second term vanishes
So how do we find M?
Ask a bunch of people how much money they would need to take a
1/1000 chance of death?
Can’t do a lab experiment where you actually expose people to a risk of death!
Clever trick: impute how much compensation people require from the real-life choices they make
35

The Value of Risks to Life and
Health
 Lots of day-to-day choices increase or decrease our risk of death



Choose between Volvo and sports car with fiberglass body
Take a job washing skyscraper windows, or office job that pays less
Buy smoke detectors and fire extinguishers, or don’t
 “Hand Rule Damages”




Hand Rule: precaution is cost-justified if cost of precaution < reduction in accidents X cost of accident
Suppose side-curtain airbags reduce risk of fatal accident by 1/1000
If someone pays $1,000 extra for a car with side-curtain airbags, it must mean that
$1,000 < 1/1000 * value of their life or, they value their life more than $1,000,000
36

The Value of Risks to Life and
Health
 Viscusi surveys lots of existing studies which impute value of life from peoples’ decisions
 Many use wage differentials
 How much higher are wages for risky jobs compared to safe jobs?
 Others look at…


Decisions to speed , wear seatbelts , buy smoke detectors , smoke cigarettes
Decision to live in very polluted areas (comparing property values)
 Prices of newer, safer cars versus older, more dangerous ones
 Some used surveys to ask how people would make tradeoffs between money and safety
 Each paper reaches some estimate for implicit value people attach to their lives
37

38

20,000,000
15,000,000
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5,000,000
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39

Nature of Risk,
Year
Highway speed-related accident risk, 1973
Automobile death risks, 1972
Fire fatality risks without smoke detectors, 1974-1979
Mortality effects of air pollution,
1978
Cigarette smoking risks, 1980
Fire fatality risks without smoke detectors, 1968-1985
Automobile accident risks,
1986
Component of the
Monetary Tradeoff
Value of driver time based on wage rates
Estimated disutility of seat belts
Purchase price of smoke detectors
Property values in Allegheny
Co., PA
Estimated monetary equivalent of effect of risk info
Purchase price of smoke detector
Prices of new automobiles
Implicit Value of life
($ millions)
0.07
1.2
0.6
0.8
0.7
2.0
4.0
40

Nature of
Risk
Survey
Methodology
Improved ambulance service, post-heart attack lives
Willingness to pay question, door-to-door small (36) Boston sample
Airline safety and locational life expectancy risks
Job fatality risk
Motor vehicle accidents
Mail survey willingness to accept increased risk, small (30) U.K. sample, 1975
Willingness to pay, willingness to accept change in job risk in mail survey, 1984
Willingness to pay for risk reduction, U.K. survey, 1982
Implicit Value of Life
($ millions)
0.1
15.6
3.4 (pay),
8.8 (accept)
3.8
Automobile accident risks
Traffic safety
Interactive computer program with pairwise auto risk-living cost tradeoffs until indifference achieved, 1987
Series of contingent valuation questions,
New Zealand survey, 1989-1990
2.7 (median)
9.7 (mean)
1.2
41

The Value of Risks to Life and
Health
 Wide range of results
 Most suggest value of life between $1,000,000 and $10,000,000
 Many clustered between $3,000,000 and $7,000,000
 Even with wide range, he argues this is very useful:
 “In practice, value-of-life debates seldom focus on whether the appropriate value of life should be $3 or $4 million…




However, the estimates do provide guidance as to whether risk reduction efforts that cost $50,000 per life saved or $50 million per life saved are warranted.”
“The threshold for the Office of Management and Budget to be successful in rejecting proposed risk regulations has been in excess of $100 million.”
C&U: NHTSA uses $2.5 million for value of traffic fatality
Current: EPA $9.1 MM, FDA $7.9 MM, Transpo Dept $6 MM
42

43

 Damage awards vary greatly across countries, even across individual cases
 We saw last week:
 As long as damages are correct on average , random inconsistency doesn’t affect incentives (under either strict liability or negligence)
 But, if appropriate level of damages isn’t well-established, more incentive to spend more fighting
44

 What we’ve discussed so far: compensatory damages
 Meant to “make victim whole”/compensate for actual damage done
 In addition, courts sometimes award punitive damages


Additional damages meant to punish injurer
Create stronger incentive to avoid initial harm
 Punitive damages generally not awarded for innocent mistakes, but may be used when injurer’s behavior was
“ malicious, oppressive, gross, willful and wanton, or fraudulent ”
45

 Calculation of punitive damages even less well-defined than compensatory damages
 Level of punitive damages supposed to bear “ reasonable relationship ” to level of compensatory damages
 Not clear exactly what this means
 U.S. Supreme Court: punitive damages more than ten times compensatory damages will attract “close scrutiny,” but not explicitly ruled out
46

 Stella Liebeck was badly burned when she spilled a cup of
McDonalds coffee in her lap
 Awarded $160,000 in compensatory damages, plus $2.9 million in punitive damages
 Case became “poster child” for excessive damages, but…
47

 Stella Liebeck dumped coffee in her lap while adding cream/sugar


Third degree burns, 8 days in hospital, skin grafts, 2 years treatment
Initially sued for $20,000, mostly for medical costs
 McDonalds offered to settle for $800
 McDonalds serves coffee at 180-190 degrees




At 180 degrees, coffee can cause a third-degree burn requiring skin grafts in 12-15 seconds
Lower temperature would increase length of exposure necessary
McDonalds had received 700 prior complaints of burns, and had settled with some of the victims
Quality control manager testified that 700 complaints, given how many cups of coffee McDonalds serves, was not sufficient for
McDonalds to reexamine practices
48

 Rule in place was comparative negligence



Jury found both parties negligent, McDonalds 80% responsible
Calculated compensatory damages of $200,000 times 80% gives $160,000



Added $2.9 million in punitive damages
Judge reduced punitive damages to 3X compensatory, making total damages $640,000
During appeal, parties settled out of court for some smaller amount
 Jury seemed to be using punitive damages to punish
McDonalds for being arrogant and uncaring
49

 We’ve said all along: with perfect compensation, incentives for injurer are set correctly. So why punitive damages?
 Example…


Suppose manufacturer can eliminate 10 accidents a year, each causing $1,000 in damages, for $9,000
Clearly efficient





If every accident victim would sue and win, company has incentive to take this precaution
But if some won’t, then not enough incentive
Suppose only half the victims will bring successful lawsuits
Compensatory damages would be $5,000; company is better off paying that then taking efficient precaution
One way to fix this: award higher damages in the cases that are brought
50

 Punitive damages should be related to compensatory damages, but higher the more likely injurer is to “get away with it”
 If 50% of accidents will lead to successful lawsuits, total damages should be 2 X harm



Which requires punitive damages = compensatory damages
If 10% of accidents lead to awards, damages should be 10 X harm
So punitive damages should be 9 X compensatory damages
 Seems most appropriate when injurer’s actions were deliberately fraudulent, since may have been based on costbenefit analysis of chance of being caught
51

52

 In 1990s, tort cases passed contract cases as most common form of lawsuit


Most handled at state level: in 1994, 41,000 tort cases resolved in federal courts, 378,000 in state courts in largest 75 counties
Most involve a single plaintiff (many contract cases involve multiple plaintiffs)
 Among tort cases in 75 largest U.S. counties…




60% were auto accidents
17% were “premises liability” (slip-and-fall in restaurants, businesses, government offices, etc.)
5% were medical malpractice
3% were product liability
53

 Punitive damages historically very rare
 1965-1990, punitive damages in product liability cases were awarded 353 times


Average damage award was $625,000, reduced to $135,000 on appeal
Average punitive damages only slightly higher than compensatory
 In many states, punitive damages limited, or require higher standard of evidence


Civil suits generally require “ preponderance of evidence ”
In many states, punitive damages require “ clear and convincing ” evidence
54

 Medical malpractice



New York study in 1980s: 1% of hospital admissions involved serious injury due to negligent care
Some estimates: 5% of total health care costs are “defensive medicine” – procedures undertaken purely to prevent lawsuits
Some states have considered caps on damages for medical malpractice
55

 Product liability
 Recent survey of CEOs: “liability concerns caused 47% of those surveyed to drop one or more product lines, 25% to stop some research and development, and 39% to cancel plans for a new product.”
 Liability standard for productrelated accidents is “strict products liability”
 Manufacturer is liable if product determined to be defective



Defect in design
Defect in manufacture
Defect in warning
56

 Most vaccines are weakened version of disease itself
 Make you much less likely to acquire the disease


But often come with very small chance of contracting disease directly from vaccine
Salk polio vaccine wiped out polio, but caused 1 in 4,000,000 people vaccinated to contract polio
 1974 case established maker had to warn about risk



Since then, some people were awarded damages after their children developed polio from vaccine
If liability can’t be avoided, built into cost of the drug
And discourages companies from developing vaccines
57

 Since health risks of asbestos understood, over 600,000 people have brought lawsuits against 6,000 defendants
 DES (drug administered to pregnant women in 1950s)


Impossible to establish which firm produced dose given to a particular woman
California Supreme Court introduced “market share liability”
 Class action lawsuit
 Small, dispersed harms – no plaintiff might find it worthwhile to sue



Class action suits allow large lawsuits with lots of plaintiffs
Give more incentive for precaution against diffuse harms
But…
58

 Critics claim juries routinely hand out excessive awards and tort system is out of control…
 …but actually it functions reasonably well
 Outside of occasional, well-publicized outliers, damage awards are generally reasonable…
 …and liability has led to decreases in accidents in many industries
59

“A tort plaintiff succeeded in collecting a large damage judgment.
The defendant’s attorney, confident that the claimed injury was bogus, went over to the plaintiff after the trial and warned him that if he was ever seen out of his wheelchair he would be back in court on a charge of fraud.
The plaintiff replied that to save the lawyer the cost of having him followed, he would be happy to describe his travel plans.
He reached into his pocket and drew out an airline ticket – to Lourdes, the site of a Catholic shrine famous for miracles.”
60