Punitive Damages

An Economic Approach
• In some tort cases, plaintiffs are awarded punitive damages or
damages above those that would compensate them for the harm
suffered
• From the standpoint of minimizing accident costs and implementation
of the Hand Formula, punitive damages appear to introduce the
possibility that potential injurers will take inefficiently high levels of
care
• If there is some likelihood that punitive damages will be awarded, the
injurer must compare the avoidance costs with the total award
including punitive damages
• It is important to note that the over-investment danger is not present
if it already makes economic sense for the injurer to take
precautionary action
• Thus, if the burden of avoiding the accident is less than the expected
harm, the injurer will take steps to avoid the harm
• Adding more to the expected recovery would not change this
outcome
• Consequently, the effect of punitive damages will only be to
encourage investment in avoidance efforts that are not justified by
the harm to be avoided
• In the latter case, over-investment still may not occur
• The basic model employed here includes the assumption that
everyone harmed will bring an action and prevail against the injurer
• If the injuries to the injured parties are relatively small compared to
the costs to bring suit, the injured persons may just internalize the
cost of the injuries by not bringing suit
• This may be the case even though several people are similarly injured
and, from an economic perspective, it would be efficient for the
injurer to take precautionary action
• In the above instances, the effect of punitive damages is to provide an
incentive to plaintiffs to file an action
• To the extent that the expected award, inclusive of all the punitive
damages, approaches the harm to all victims by the defendants
conduct, punitive damages may encourage more efficient behaviour
and lower primary accident costs
• This is not, however, an outcome that can be depended upon, it is
more likely a result of coincidence
• The US supreme court has taken a non economic approach to punitive damages
• The enforceability of punitive damages depends on the reprehensibility of the
defendants conduct, whether the award bears a reasonable relationship to the
actual and potential harm caused by the defendant to the plaintiff, and the
difference between the award and sanctions authorized of imposed in
comparable cases
• The key idea is “to the plaintiff”
• Consequently, in Philip Morris USA v Williams, the court ruled that a jury
instruction under which a plaintiff was awarded $80 million in connection with
harms from smoking and deception by a tobacco company had to be
reconsidered
• The reconsideration was required because the instruction allowed the jury to
award damages based on the harm to parties other than the plaintiff
• By taking damages to others off the table, the court drove a wedge between
the economists notion of punitive damages and what courts may legally
award
• The economic theory of punitive damages runs into additional problems
• For eg if punitive damages were used to require firms to internalize the full
cost of its activities, what happens to subsequent law suits by additional
victims?
• To the extent that they recover when punitive damages have already been
awarded, the level of internalization is inefficiently high
• A second issue arises with respect to the proper recipient of the
punitive damages
• Except to the extent necessary to motivate the plaintiff to bring an
action, there is no economic reason for the plaintiff to keep all of the
punitive damages awarded
• Although economic analysis cannot provide an answer to the question
of how the award should be distributed, there may be good policy
reasons for the award to be distributed more broadly