Efficiency Effects of Punitive Damages

Posted: 3 Dec 1998

See all articles by Peter A. Diamond

Peter A. Diamond

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: September 1997

Abstract

This paper develops a typology of different behaviors that might be viewed as outrageous by a jury and subjected to punitive damages. The paper derives the level of punitive damages for achieving economic efficiency in four different situations ?malice and three settings where a jury might find reckless disregard- a rational response to insufficient compensatory damages, a nonrational disregard of risk, and a rational response when compensatory damages are adequate. Since efficient deterrence is reached in very different ways in situations of malicious intent and reckless disregard, jury instructions should differ in these different situations. With malicious intent, the jury should be instructed to focus on the preferences of the defendant. With reckless disregard, the jury should be instructed to focus on the circumstances leading to the accident, particularly the inadequacy of attention to a cost falling on the plaintiff. Inadequate attention could come from a rational disregard of costs that the tort system will not assess or from a nonrational disregard of the costs that the tort system will assess. Jury instructions with reckless disregard should focus on the costs that are not adequately represented in the defendant?s decision process. This focus is naturally stated in terms of a ratio of punitive to compensatory damages, or equivalently the ratio of the sum of compensatory and punitive damages to the level of compensatory damages. The goal is to pay appropriate attention to accident costs, not to have a zero accident risk. Therefore, in the absence of malice, the court should determine if an underassessment of tort liability was anticipated or if decision-making was nonrational. In the absence of malice, underassessment of liability, and nonrationality, punitive damages should not be allowed.

It is argued that in some situations of malicious intent, courts should allow arguments that encourage the setting of damages proportional to the wealth of the defendant, but not in situations of reckless disregard. Civil and criminal fines are also part of the expected costs of the defendant, and should be deducted from the punitive damages that would give efficient incentives with zero fines. The analysis of insufficient compensatory damages is extended to a situation with defendants who differ, but in ways the court can not distinguish.

JEL Classification: K13

Suggested Citation

Diamond, Peter A., Efficiency Effects of Punitive Damages (September 1997). Available at SSRN: https://ssrn.com/abstract=140065

Peter A. Diamond (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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