A Behavioral Account of Compensation Awarding Decisions

Abstract

Suppose an individual loses an irreplaceable object and someone else is at fault. How much should he be compensated? Normatively, compensation should equal the value (utility) to the victim. Our experiments demonstrate that compensation decisions often ignore value and are instead based on cost (how much the victim originally paid for the item) except when cost is zero. For example, we found that people awarded $200 for a destroyed item worth $500 to the victim if the cost was $200; however, they awarded $500 if the original cost was zero. We explain these phenomena in terms of lay scientism (the tendency to base decisions on objective factors) and discuss how the prevalent cost-based compensation rule hurts consumer welfare. Copyright # 2008 John Wiley & Sons, Ltd.

Keywords: compensation, rationale, lay rationalism, rule, consumer welfare

JEL Classification: D81. D11, D12, D91