Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Ius Commune Conference Leuven
Workshop Liability and Insurance
November 26, 2010
Louis Visscher
Rotterdam Institute of Law and Economics (RILE)
Erasmus School of Law
Visscher@frg.eur.nl
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Outline
• Introduction
• Economic goals of tort law and damages
• Economic reasons for punitive damages in tort law
• Intentional torts; losses or gains; insurance
• Economic goals of contract law
• Economic analysis of puntive damages for deliberate breach
• Conclusions
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Introduction
• Many elements from the ‘call for papers’ return in the economic
approach:
• Why punitive damages?  goals of law are important
• Public versus Private Enforcement  ‘optimal enforcement’
• Divide between private and penal law  punishment goal?
• Deliberate breach and punitive damages
• Debunking the myth?
• To start with the last point:
• Enormous amounts are often reduced by court;
• Punitive damages in <5% of cases where victim prevailed;
• Generally not very high amounts;
• Positively correlated with compensatory damages.
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Economic goals of tort law and damages
• Legal view: compensation
• Economic view: deterrence and risk spreading
• Compensation is not a goal, but a means
• Damages are the instrument
• Threat of liability gives incentives  ‘full compensation’
• Several problems frustrate deterrent potential of tort law 
punitive damages as possible way to solve these problems!
• Punishment as goal in tort law?
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Economic reasons for punitive damages in tort law (I)
1. Too low probability of being held liable
• Basic model: full expected liability
• But:
• problems of proof;
• rational apathy;
• injurer may try to avoid detection (intentional torts!)
• Punitive damages to offset this  ‘damages multiplier’
• Example: intentional torts; double/treble damages in antitrust
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Economic reasons for punitive damages in tort law (II)
2. Underestimation of Harm
• Esp. with subjective and immaterial losses  underdeterrence!
• Punitive damages as solution. But:
• Same problems of estimation;
• Less fine-tuned rules for calculation;
• Some losses may be deliberately excluded!
3. Socially unaccepted costs/benefits
• Compensatory damages may then be too low to deter
• Punitive damages as solution. But:
• How relevant? (rare situation);
• Assuming the conclusion
• Intentional torts often are undesirable!
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Economic reasons for punitive damages in tort law (III)
4. Encourage voluntary transfers
• Voluntary transfers are preferred (subjective valuations included)
• If low transaction costs: do not accept involuntary transfers
• Punitive damages make involuntary unattractive
Question: punishment as goal of punitive damages?
• Most literature: deterrence (even punishment arguments aim at
deterrence)
• But: punishment as such can be a goal: desire to see blameworthy
people adequately punished  reprehensibility and wealth matter
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Specific topics
1. Intentional torts
• Injurer lowers probability of being held liable;
• Often in settings of low transaction costs;
• Almost by definition undesirable:
• Gains smaller than losses (sometimes even illicit!)
• ‘Negative care costs’
• No risk of overdeterrence  punitive damages warranted
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Specific topics
2. Gains or losses?
• Many European countries allow gain-based damages
• L&E: preference for loss-based  internalization (goal: give
correct care and activity incentives)
• However: if losses are underestimated or other social losses exist
 deter behavior altogether  gain-based
3. Insurance against punitive damages?
• Punishment goal: no!
• Deterrence goal: yes
• Moral hazard?
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Economic goals of contract law
• Facilitate voluntary transfers, because they increase welfare:
• Lower transaction costs (default rules; standard terms; good
faith)
• Solve problem of sequential contracts  remedies for nonperformance
• ‘Complete contract’: everything is agreed upon, also when the
debtor does not have to perform (plus price to pay)
• Real contracts: incomplete. Law should mimic the complete
contract
• Therefore: allow ‘efficient breach’  expectation damages
• Both parties benefit from this!
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Economic analysis of punitive damages for deliberate breach
• Efficient breach is often deliberate  punitive damages would
result in excessive performance
• Expectation damages may be too low (subjective; uncertain) 
too little performance. But: punitive damages are not a good
solution (just as in torts)
• If ‘willful’ etc. only includes inefficient behavior  punitive
damages possible. But: mistakes lead to excessive performance!
• Standard reasons (rational apathy and obscure wrongdoing) not
relevant for deliberate breach  no punitive damages!
• Recent paper: wilfull breach shows opportunistic nature. Punitive
damages sanction for the undetected behaviour. Problematic
calculation!
Rotterdam Institute of Law and Economics
The Law and Economics of Punitive Damages
Conclusions
• Punitive damages in torts may correct several problems:
• Too low probability of being held liable;
• Too low compensatory damages (problematic);
• Socially unaccepted costs/benefits (problematic);
• Induce voluntary transfers.
• Punitive damages for intentional torts makes sense;
• Damages based on losses for internalization; damages based on
gains for totally deterring the behaviour;
• Insurability: tension between punishment and deterrence;
• Punitive damages for intentional breach not desirable