Economics of Punitive Damages

Compensatory vs. Punitive Damages• Compensatory damages

are meant to return the victim to the pre-injury state

• Punitive damages are meant to deter the tortfeasor from injuring others

Two questions posed by Cooter & Ulen Under what conditions are

punitive damages be awarded?

How is the amount of punitive damages determined?

General guidelines for punitive damages• Punitive damages are

awarded when the defendant’s behavior is malicious, oppressive, gross, willful and wonton, or fraudulent.

• Punitive damages should– Bear a reasonable relationship to

compensatory damages– Depend on the defendant’s

ability to pay

Economic view of punitive damages• There is no need for

punitive damages if the tort system is perfect

Compensatory damages will internalize all external social costs.– All victims receive perfect

compensation

Possible imperfections in the tort system• Not every victim brings

suit• Not every victim can

prove their damages• Perfect damages are not

always awarded.

Suppose the injurer receives a net benefit from the costs imposed on others?

Profit maximizing manufacturer may choose less than optimal precaution

Enforcement error can be corrected by offsetting compensatory damages with punitive damages

Economic model of punitive damagesx = precautionp = probability of harmA = harm caused by the

accidentL = injurer’s liability m = punitive multiplee = enforcement error

Economic model of punitive damages

Social optimum

Defendant’s optimum

With enforcement error

Axpwx )(min

Lxpwx )(min

AeL

Economic model of punitive damages

ThereforeResult is too little careThis can be adjusted by

using a multiple m

To correct the error set

If e = .1 then m = 10

Aexpwx )(min

Aemxpwx )(min

em /1

Related problems

• Correctly estimating e– What percent of injured parties did not collect

damages?– What jurisdictions are to be considered?

• Correctly estimating optimal level of precaution• Possibility of multiple punitive damage awards• Social policy determined by a small group of

individuals who do not have the ability to engage in fact finding

• Punitive damages have an impact on the incentive to bring suit– The damages do not need to go to the plaintiff for

optimal deterrence– Represents a windfall gain for the defendant

BMW v Ira Gore (1996) Nationwide policy that cars which were damaged in

the course of manufacture or transportation to dealers would be repaired and sold as new, without advising buyers that any repairs had been made, if the repair costs did not exceed 3 percent of the suggested retail price

Gore’s car had been partially repainted at a cost of $ 601.37, which was about 1.5 percent of the car's suggested retail price

The customer drove the car for approximately 9 months without noticing any flaws

When he took the care for detailing the shop detected evidence that the car had been repainted and informed Gore

BMW v Ira Gore (1996)

• At trial before a jury, the customer claimed that – His actual damages were $ 4,000, in that the

value of one of the manufacturer's repainted cars was approximately 10 percent less than the value of a new car that had not been damaged and repaired; and

– A punitive damages award of $ 4 million would provide an appropriate penalty, using the $4,000 actual damages estimate, in that since 1983, the manufacturer had sold as new 983 cars which had been repainted at a cost of more than $ 300 per vehicle, including 14 in Alabama.

BMW v Ira Gore (1996)

The jury--based on its determination that the nationwide policy of nondisclosure constituted gross, oppressive, or malicious fraud for purposes of Alabama statutes which authorized punitive damages--returned a verdict which awarded the customer $ 4,000 in compensatory damages and $ 4 million in punitive damages.

BMW v Ira Gore (1996)

• The Supreme Court of Alabama expressed the view that – A jury could not use the number of

similar acts that a defendant had committed in other jurisdictions as a multiplier when determining the dollar amount of a punitive damages award,

– A constitutionally reasonable punitive damages award in the case at hand was $ 2 million

BMW v Ira Gore (1996)• The United States Supreme Court reversed and remanded.

– The $ 2 million punitive damages award was grossly excessive and hence exceeded the limit under the due process clause of the Federal Constitution's Fourteenth Amendment, in that

– There were none of the aggravating factors associated with particularly reprehensible conduct was present.

• Harm was purely economic in nature. • BMW was not a recidivist who knew that what it was doing was wrong. • There were no false statements made by BMW. • BMW did not violate any state law requiring disclosure. • The jury cannot punish BMW for actions that did not harm Alabama residents. • May not impose sanctions to deter conduct that is legal in other jurisdictions.

– The award was 500 times the amount of the customer's actual harm as determined by the jury, and there was no suggestion that the customer or any other purchaser was threatened with any additional potential harm by the distributor's nondisclosure policy. There was a lack of proportionality between the actual harm and the punitive damages.

– The sanction imposed on the distributor was substantially greater than the statutory fines available in Alabama and elsewhere for similar malfeasance.

BMW v Ira Gore (1996)

• Possible implications– Damages must be local– Statutes determining fines and penalties

may provide guidelines– When harm is purely economic punitive

damages may be limited to single digit multipliers

Punitive damage concerns

• Do juries have adequate information?

• Do juries apply a proper methodology?

• Should juries set public policy?

Viscusi – punitive damages• Large awards are

unpredictable and are weakly correlated with compensatory damages

• Juries are more likely to may awards and larger awards than judges

• Huge unpredictable awards may deter innovation or lead to withdrawal of products from the market out of concern for potential punitive damages awards.

Viscusi – punitive damages

• Juries are able to target unpopular defendants, penalize unorthodox or controversial views, and redistribute wealth

• Uncertain damages have no deterrent effect