punitive damages: an economic justification
TRANSCRIPT
Punitive Damages: An Economic Justification
Cedric Duvinage
July 17, 2009
This is a Bucerius/WHU MLB thesis 14.047 words (excluding footnotes) Supervisor 1: Prof. Dr. Peter-J. Jost Supervisor 2: Dr. Carsten Jungmann
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TableofContents
1.Introduction..................................................................................................................................1
2.AnIntroductiontoPunitiveDamages..................................................................................42.1.WhatarePunitiveDamages? ........................................................................................................ 42.2.WhencanPunitiveDamagesbeAwarded?AndHowMuch? ............................................. 52.3.ArePunitiveDamagesOutofControl? ...................................................................................... 92.4.TheMcDonald’sHotCoffeeCase................................................................................................10
3.TheDeterrenceFunctionofPunitiveDamages ............................................................. 133.1.TheBasicDeterrenceTheoryofTortLaw .............................................................................133.1.1.Whatiseconomicallyefficientintortlaw?.....................................................................................133.1.2.Doesthestrictliabilityruleleadtoefficiency?.............................................................................173.1.3.Doesthenegligencerulepromoteefficiency?...............................................................................19
3.2.RelatingPunitiveDamagestotheDeterrenceTheory.......................................................223.2.1.Whatiftheharmisnotcorrectlyinternalized?............................................................................223.2.2.Whytheprerequisiteofa“willful,malicious,wantonorreckless”conduct? .................243.2.3.Whatiftheinjurer’sgainsaresociallyillicit?................................................................................263.2.4.Whatiftheinjurercanescapeliability?...........................................................................................283.2.5.WhatwouldhavebeenefficientintheMcDonald’sHotCoffeeCase? ................................33
4.ThePunishmentGoalofPunitiveDamages .................................................................... 374.1.WhatistheRoleofPunishmentinTortLaw? .......................................................................374.2.WhoisBeingPunished?................................................................................................................38
5.TheBehaviorofAmericanJuries........................................................................................ 415.1.HowDoJuriesPerforminAwardingPunitiveDamages? .................................................415.2.WhereDoesThisLeavePunitiveDamages? ..........................................................................43
6.Conclusion .................................................................................................................................. 45Bibliography................................................................................................................................... 47
Annex................................................................................................................................................ 51
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1.Introduction
The imposition of punitive damage awards is one of the most controversial
featuresoftheUnitedStateslegalsystem.Duetoitsdivisivecharacter,punitivedamage
awards are not observed inmany other countries, especially not in civil law systems.
Indeed,thewidemediacoverageofsomeseeminglyexcessivelyhighpunitivedamages
initiallyawardedtoindividualplaintiffs1hasestablishedanimpressionofanunreliable,
unfair and inefficient American legal system among the public. As courts have yet to
comeupwitharationalandconsistentwayofcomputingtheirexactamount,punitive
damages generate a significant financial risk for American defendants. Arbitrary
punitive damages make precise predictions about the outcome of court trials nearly
impossiblesothatdefendantshaveahighinterestinavoidingthem.However,plaintiffs
areawareofthedefendants’concernandcanthereforeexploittheirstrongbargaining
positiontoobtainhigherout‐of‐courtsettlements.2
Commentators use the uncertainty associated with punitive damages as their central
point of attack in their attempt to realize a statutory limitation, or even banning, of
punitive damages.Most commonly, antagonists try to build a case on the grounds of
constitutionality. Such objections generally focus on the Excessive Fines Clause of the
EighthAmendmentand/ortheDueProcessClauseoftheFourteenthAmendmenttothe
United States Constitution.3 Thus, without doubt punitive damages have to stand up
againstarangeofstrongbutyetmostlyunsuccessfulcounterarguments.
Inorder tounderstandwhypunitivedamagesstillprevailoveralldisagreements, this
paperwill lookattheothersideofthestory.Morespecifically, itwill lookattheissue
from an efficiency perspective to arrive at an economic justification for punitive
damages in tort liability cases. Following an explanatory methodology, it will be
discussedwhycertain cases require the impositionofpunitivedamagesandwhat the
optimalamountofpunitivedamagesshouldbetopromoteeconomicefficiency.1Seee.g.BMWNorthAmericaInc.v.Gore,No.94‐896,517U.S.559,116S.Ct.1589,134L.Ed.2d809(May
20, 1996);State FarmMutualAutomobile Ins. Co. v. Campbell,No. 01‐1289, 538U.S. 408, 123 S.Ct.1513,155L.Ed.2d585(April7,2003);orLiebeckv.McDonald’sRestaurants,P.T.S., Inc.,No.CV‐93‐02419,1995WL360309(Judgment,BernalilloCounty,N.M.Dist.Ct.Aug.18,1994)
2CooterandUlen(2007),pp.393‐3943WangandPeterson(2000),p.5
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Based on established models in the literature, this paper will present its own
comprehensive approach. The aim is to clarify that it is not the punitive damages in
themselves that are problematic. In fact, the opposite is true. In some circumstances
punitive damages are needed to support the efficiency of the American legal system.
Instead,aswillbeillustrated,themainproblemlieswithanothercharacterizingfeature
oftheU.S.judicialsystem:TheAmericanjury.
Following this introduction, the paper will explain in Section 2 the rationale behind
“punitive”damages.Thefirstsubsectionclarifieswhat ismeantby“punitive”damages
and identifies two main objectives of punitive damages: Deterrence and punishment
(2.1).Afterwards,somegeneralrulesonwhenandhowmuchpunitivedamagescanbe
awarded in the United States are reviewed (2.2). Only under special circumstances
punitivedamagesareableandnecessarytoachievetheirintendedpurpose.Thepaper
isthengoingtolookatsomeempiricalevidenceregardingthelikelihoodandtheextent
of punitive damages (2.3). This subsection ismeant to review the rightfulness of the
notionofanarbitraryandinefficientAmericanlegalsystem.Thereafter,thefactsofthe
case Liebeck v. McDonald’s Restaurants, P.T.S, Inc. (hereinafter also referred to as the
“McDonald’sHotCoffeeCase”)willbeintroduced(2.4),asitwillbeusedforillustrative
purposesthroughoutthediscussion.TheMcDonald’sHotCoffeeCaseisoneofthemost
controversialcasesknownthatantagonistsofpunitivedamagesliketorefertoinorder
toargueforanabolishmentofpunitivedamages.4
Section 3 of this paper will then establish the economic reasoning behind punitive
damages.Attheoutset,twobasicassumptionswillbemadeinordertoinitiallyplacethe
economicanalysistofollowinanidealworldoftortlaw.Inthissetting,anexplanation
of the basic deterrence theory in tort law will set the economic foundations of this
analysis. Itwill be clarifiedwhat economic efficiencymeans in tort law, and how the
incentives for precautions are affected under a strict liability rule aswell as under a
negligencerulebecausethesearethetwomostprominentrulesusedintortcases(3.1).5
Having laid out the economic ground works, the discussion will then point out why
punitivedamages can indeedbeefficiencyenhancingby relaxingoneassumptionat a
4http://www.arktimes.com/blogs/hoglawyer/2007/11/tort_reform_and_mcdonalds_coff.aspx5CooterandUlen(2007),pp.333‐334
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time (3.2). In this process, the paper will outline a simple method of computing an
efficientlevelofpunitivedamages,whichwasfirstintroducedbyBecker6inacriminal
law context and which has been widely analyzed by scholars.7 The McDonald’s Hot
Coffee Case will then be used to apply this theory in a real setting, where a few
additionalproceduralsuggestionswillbemade.
Section 4 will provide some comments on the punishment objective of punitive
damages, even though the emphasis of this paperwill be on the deterrence function.
Aftertheroleofpunishmentintortlawisbrieflydiscussed(4.1),selectedobservations
will be made regarding how punishment affects companies compared to individuals
(4.2).
Section5willprovideashortreviewofhowthebehaviorofAmericanjuriesaffectsthis
analysis.ThisdiscussionwillbebasedonanexperimentalstudyconductedbyProfessor
Viscusi showing how American juries grant punitive damages in a real setting (5.1).
Finally, a few commentswill bemade onwhat the results of this study imply for the
impositionofpunitivedamagesinpractice(5.2).
ThepaperwillendwithsomeconcludingremarksinSection6.
6SeeBecker(1968)7Seee.g.PolinskyandShavell(1998),Sharkey(2003)orHylton(1998)
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2.AnIntroductiontoPunitiveDamages
2.1.WhatarePunitiveDamages?
Inordertofullycomprehendthemeaningandpurposeof“punitive”damages,it
isfirstnecessarytodistinguishthemfrom“compensatory”damages.
Compensatorydamagesareawardedtomakethevictimwhole.That is, thewelfareof
the injuredparty is toberestoredascloselyaspossibletothe levelatwhich itwould
havebeenwithouttheillicitactofthedefendant.Suchcompensatorydamagesinclude
two kinds of damages: (1) “Economic” damages, such as past and future medical
expenses,past lostwagesandthe future lostearningcapacity;and(2) “noneconomic”
damages, meaning past and future mental and physical pain, disfigurement and
disability,andtheplaintiff’slostabilitytoenjoysomeaspectoflife.8Thus,compensatory
damagesareawardedwheneveraplaintiffharmedbythedefendantprevailsincourt.
Punitivedamages,on theotherhand,area formof “tort fine”9awarded inaddition to
compensatory damages. They may therefore be interpreted as “extra‐compensatory”
damages.Itisimportanttorecognize,however,thattheyarenotgrantedtomakeupfor
intangiblelossesandtherebytoreplacenoneconomiccompensatorydamages,whichis
sometimessimplyassumedtobe themainobjectiveofpunitivedamages.Moreover,a
mere look at the terminology of “punitive” damages does not suffice to identify the
whole rationale behind punitive damages. This is because punitive damages are
designedonlypartly,andfromtheeconomist’spointofviewnotevenmainly,topunish.
Thesecond,andforthiseconomicanalysisthemorerelevantgoalofpunitivedamages,
isdeterrence.10
Thetwoobjectives,punishmentanddeterrence,refertotwoverydifferentpurposes.By
the“punishment”objectivewegenerallymeantheimpositionofappropriatesanctions
onsocialwrongdoersfortheharmthattheirillicitconductcauses.“Deterrence”,onthe
otherhand,referstosanctioningdefendantsinordertopreventthem(andothers)from
8Clurg,KoyuncuandSpriovieri(2007),pp.169‐1709Calabresi(2005),p.33710PolinskyandShavell(2000),p.764
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doing similar acts in the future. In other words, deterrence is used to optimize the
individual behavior so that social welfare – the defendant’s benefits obtained from a
wrongful conductminus the costs of precautions, the cost of the harm, and the legal
expenses–ismaximized.11Asmentionedabove,themainfocusofthiseconomicanalysis
will be the deterrence objective. Nevertheless, a few remarks on the punishment
objectivewillalsobemade.
2.2.WhencanPunitiveDamagesbeAwarded?AndHowMuch?
Allbutfourofthe50U.S.statesallowtheimpositionofpunitivedamagesunder
state law. Louisiana (unless expressly authorized by statute),Nebraska,Michigan and
Washington(alsounlessexpresslyauthorizedbystatute)aretheonlyfourstatesthatdo
notallowforpunitivedamagestobeawarded.12Amongthosestatesthatpermitpunitive
damages, the specific rulesprescribingwhenandhowmuchpunitivedamages canbe
awardedintortlawvaryfromstatetostate.Yet,generallyspeaking,thedefendantmust
have acted more than “grossly negligent” before punitive damages are justifiable. In
most states the plaintiff has to prove some type of “willful, malicious, wanton or
reckless” conduct by the defendant in order to be able to ask for punitive damages.13
Thus,therequiredminimumstandardofconduct,forpunitivedamagestobeawarded
atall, is setatahigh level.However, theseareonlyguidelines thathavenotbeenput
within a defined frame of precise rules.14 Thus, there still remains some uncertainty
aboutwhenpunitivedamagesmaybeawarded.
Inordertodeterminewhetheranindividualcasefulfillstheaforementionedminimum
standard, the reprehensibility of the defendant’s actmust first be evaluated. The U.S.
Supreme Court proposed in State Farm Mutual Automobile Ins. Co. v. Campbell the
followingaspectstobeconsideredintheassessmentofthedefendant’sreprehensibility:
(1)Whethertheharmwasphysicaloronlyeconomic;(2)whetherthedefendant’sact
showedan indifferencetoorarecklessdisregardof thehealthorsafetyofothers;(3)
whethertheinjuredpartywasfinanciallyvulnerable;(4)whethertheconductinvolved
11PolinskyandShavell(2000),p.76512WilsonElser(2006),pp.I,53,76,81,13113WilsonElser(2006),p.III14Cooter(1989),pp.1145‐1146
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a repeatedactionorwasan isolated incident; (5)whether theharmwas the resultof
intentionalmalice,trickeryordeceit,ormerelyanaccident.15
The burden of proof respectively usually lies with the party that wants to rely on a
particularelementofevidence.16Itisworthmentioning,however,thatpunitivedamages
areacivilremedyandarenottobeconfusedwithcriminalcharges.Whilecriminalcases
require proof “beyond a reasonable doubt”, for civil law cases “clear and convincing
evidence”orinsomestatesa“preponderanceofevidence”,suffices.17
Once it has been established that punitive damages may be granted, the question of
“Howmuch?”stillremains:
In general, before punitive damage awards are granted, states require that
compensatory damages be awarded first. This in turn means that the plaintiff must
prove actual damage. In addition, U.S. states usually require a “reasonable relation”
betweencompensatorydamagesandthepunitivedamageaward.Butstatelawdoesnot
prescribeaspecificratioofpunitivedamagestocompensatorydamages.18
Besides,somestateshavenowintroducedcapsonpunitivedamages,whileothersstill
prescribe no limits. NewMexico, for instance,where theMcDonald’s Hot Coffee Case
was filed in 199319, has not yet instituted a cap on punitive damages.20 On the other
hand,Arkansas,forexample,leviedalimitonpunitivedamagesin2003,whichcapsthe
award at the greater of $250,000 or three times the compensatory damages, where
punitivedamagescangenerallynotexceed$1million.21
Another ongoing discussion that ultimately affects the limitation of punitive damages
concerns the constitutionality of punitive damage awards. The two most important
15 State Farm Mutual Automobile Ins. Co. v. Campbell, No. 01‐1289, 538 U.S. 408, 123 S.Ct. 1513, 155
L.Ed.2d585(April7,2003),p.616Clurg,KoyuncuandSpriovieri(2007),p.10017WilsonElser(2006),p.III18WilsonElser(2006)pp.1‐139,seee.g.‘NewMexico’pp.86‐88;‘California’pp.12‐1519 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1993WL 13651163 (Trial Pleading,
BernalilloCounty,N.M.Dist.Ct.Oct.5,1993)20WilsonElser(2006)pp.86‐8821WilsonElser(2006)p.11
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casesofthemorerecenttimesregardingthis issuewereBMWNorthAmericav.Gore22
andthealreadymentionedStateFarmMutualAutomobileIns.Co.v.Campbellcase.23In
BMWNorthAmericav.Gore, the jury initiallyawardedpunitivedamagesof$4million
together with $4,000 in compensatory damages. Even though the Alabama Supreme
Courtreducedthesepunitivedamagesto$2million,whichstillreflectsaratioof500to
1,theUnitedStatesSupremeCourtclassifiedthisadjustedamountas“grosslyexcessive”
andthereforeasaviolationoftheDueProcessClauseoftheFourteenthAmendment.24
Consequently, the Alabama Supreme Court further reduced the punitive damages to
$50,000onremand.25 InStateFarmMutualAutomobile Ins.Co. v.Campbell, theUnited
StatesSupremeCourtfurtherclarifiedtheguidepoststhatithadputforthinitsrulingof
BMWNorthAmericav.Gore.26
TheDueProcessClauseoftheFourteenthAmendmentrequiresthatnoperson“[...]shall
be deprived of life, liberty or property without due process of law […]”.27 Courts
frequentlyassessdueprocess jointlywith theExcessiveFinesClause imbedded in the
EighthAmendment to theUnitedStatesConstitution,whichstates that “excessivebail
shallnotberequired,norexcessivefinesimposed,norcruelandunusualpunishments
inflicted”.28
In order to base an argument on the Eighth Amendment, however, one first has to
determineatwhatpointafinebecomes“excessive”:
Arguing in State Farm Mutual Automobile Ins. Co. v. Campbell that “few awards [of
punitive damages] exceeding a single‐ratio between punitive damages and
22BMWNorthAmerica Inc. v.Gore,No.94‐896,517U.S.559,116S.Ct.1589,134L.Ed.2d809 (May20,
1996)23 State Farm Mutual Automobile Ins. Co. v. Campbell, No. 01‐1289, 538 U.S. 408, 123 S.Ct. 1513, 155
L.Ed.2d585(April7,2003)24BMWNorthAmerica Inc. v.Gore,No.94‐896,517U.S.559,116S.Ct.1589,134L.Ed.2d809 (May20,
1996),pp.1,2225See______‘AlabamaCourtSlashesPunitiveAwardinCaseInvolvingRepaintedBMWCar’,TheWallStreet
Journal,May12,199726 State Farm Mutual Automobile Ins. Co. v. Campbell, No. 01‐1289, 538 U.S. 408, 123 S.Ct. 1513, 155
L.Ed.2d585(April7,2003),pp.6‐7,1427TheConstitutionoftheUnitedStates,Amendment1428TheConstitutionoftheUnitedStates,Amendment8
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compensatory damages, to a significant degree,will satisfy due process”29, the United
StatesSupremeCourtproposedthatanyratioequaltoandabove10:1betweenpunitive
damagesandcompensatorydamagesmaybedeemedunconstitutional.However,asthe
SupremeCourtitselfrecognized,thisshouldonlyserveasaguidancesince“theprecise
award in any case, of course,must be based upon the facts and circumstances of the
defendant’sconductandtheharmtotheplaintiff.”30Ahigherratiomay,forexample,be
justifiable in cases where “a particularly egregious act has resulted in only a small
amount of economic damages”31 or where the defendant’s conduct was extremely
reprehensible.32
Nevertheless,theU.S.SupremeCourtwentevenfurtherinPacificMutualLifeIns.Co.v.
Haslip arguing that punitive damages amounting to four times the compensatory
damagesmaycomeclosetotheboarderlineofconstitutionality.33Thus,thejointreview
of whether punitive damages are in accordance with the Eighth and the Fourteenth
Amendmentcanultimatelyalsohavealimitingfunction.Evenafterajuryhascalledits
verdict,thetrialjudgeandappellatecourtscantherebyreducethefinalaward.34
Note, however, that the guidance of a single‐digit ratio by theUnited States Supreme
Court does not entirely protect defendants from arbitrarily high awards. A jury that
insists on levying high punitive damages on a defendant could simply raise
compensatorydamagestoahigherlevelsothatthesingle‐digitratiostandardcanstill
besatisfiedevenwithalargepunitivedamageaward.35
Eventhoughpunitivedamagesmaybelimitedthroughcapsbystatelaw,orreadjusted
bythetrialjudgeoronappealtoaccordthemwiththeUnitedStatesConstitution,there
29 State Farm Mutual Automobile Ins. Co. v. Campbell, No. 01‐1289, 538 U.S. 408, 123 S.Ct. 1513, 155
L.Ed.2d585(April7,2003),p.730 State Farm Mutual Automobile Ins. Co. v. Campbell, No. 01‐1289, 538 U.S. 408, 123 S.Ct. 1513, 155
L.Ed.2d585(April7,2003),p.1331 State Farm Mutual Automobile Ins. Co. v. Campbell, No. 01‐1289, 538 U.S. 408, 123 S.Ct. 1513, 155
L.Ed.2d585(April7,2003),p.1332WilsonElser(2006)p.IV33 See e.g.PacificMutual Life Ins. Co. v. Haslip, No. 89‐1279, 499U.S. 1, 111 S.Ct. 1032, 113 L.Ede.2d 1(March4,1991),pp.6‐7
34Seee.g.StateFarmMutualAutomobileIns.Co.v.Campbell,No.01‐1289,538U.S.408,123S.Ct.1513,155L.Ed.2d585(April7,2003);orBMWNorthAmericaInc.v.Gore,No.94‐896,517U.S.559,116S.Ct.1589,134L.Ed.2d809(May20,1996)
35WilsonElser(2006),p.V
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areyetnoformalstandardsprescribingthecomputationofpunitivedamagesappliedby
American courts. Surprisingly enough, courts that claim to know when awards are
excessive cannot come upwith a clear standardizedway of computing them. In fact,
typicaljuryinstructionsdonotatallinformjurorshowtocalculatepunitivedamages.36
Given that juries donot have to provide any explanation for their verdicts, juries can
freelydecideonanyamount,whichevertheyspontaneouslythinkisappropriateinthe
particularcase.37
The fact that there are no common legal standards for computing punitive damages
considerably contributes to their arbitrariness. Yet, does this justify an elimination of
punitivedamagesthemselves?Theanswershouldbe“No”.Wecanstillplayagameof
basketballwithoutrules,althoughsuchagameplayedbyself‐interestedindividualscan
be spiteful. But if everyone would agree on consistent rules, a great game could be
playedproperly. The same applies to punitive damages. Juries have imposedpunitive
damageswithoutrules.Theunsatisfyingresultsarethereforenotsurprising.
Theuncertaintyassociatedwithpunitivedamagesneedstobe(andcanbe!)mitigated
byaclearsetofrules.Onlywhensuchrulesare inplace,punitivedamageawardscan
fulfilltheireconomicallyusefulpurposeofdeterrence.Ifitisunclearhowillegalactswill
be remedied, how should the rational individual/entity determine how to behave
optimally?Therefore,asimplewayofcomputingtheoptimalamountofdamagesthatis
widelyacceptedamongeconomistswillbediscussedinthelatersectionofthispaper.
2.3.ArePunitiveDamagesOutofControl?
Many people seem to think that the U.S. tort liability system is anarchic and
unjust.Variousmediareportsaboutplaintiffscollectingmillionsofdollarsintheformof
punitive damages keep growing newwaves of hypes among critics. Critics argue that
punitive damages are granted too easily and too generously. But their evidence is
anecdotalatbest,eventhoughatfirstsightsuchevidencecanbepersuading.38InBoeken
36CooterandUlen(2007),p.39537Clurg,KoyuncuandSpriovieri(2007),p.5938CooterandUlen(2007),p.398
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v.PhilipMorris,Inc.39,forexample,theplaintiffofatobaccolawsuitintheyearof2001
was initially granted $3 billion in punitive damages. However, what the layperson is
probablynotawareofisthatthisamountwasreducedto$50millionintheend,roughly
8.5 times thecompensatorydamagesof$5.5million.Thus,eventhough$50million is
stillalargeamount,theultimateawardwasmerely1/60thofwhatthepublicheardofin
thenews.40
Punitivedamages in theUnited States are in fact the exception rather than thenorm.
The empirical data shows that punitive damages were awarded in only about five
percentofallstatetortlawcasesin2001,andthisnumberhasnotchangedmuchover
theyears.41Ofallproduct liability casesbetween1965and1990, inonly353of them
punitive damages were awarded, where these awards averaged $625,000 in 1990
dollars.Aftertheadjustmentsbyappellatecourtsthisaveragewasreducedto$135,000.
Furthermore, closer investigations revealed that the ratio of punitive damages in
product liability cases at the trial level was approximately 1.2 to 1. Besides,
compensatory damages exceeded punitive damages in more than one third of the
cases.42Thus,acloserlookattheempiricalevidenceonpunitivedamagesshowsthatthe
excitementaboutexcessivepunitivedamagesislargelyunjustified.
2.4.TheMcDonald’sHotCoffeeCase
The notorious product liability case of the mid‐1990s Liebeck v. McDonald’s
Restaurants,P.T.S., Inc.,alsowidelyknownas“TheMcDonald’sHotCoffeeCase”, isone
that many critics view as the perfect illustration of the “American run‐away tort
system”43.Thus,itwasfrequentlyusedtoprovokeatortsystemreform.44Atitssurface,
itdoesindeedseemoutrageousthatawomanmakesalmost$3milliononlybecauseshe
39Boekenv.PhilipMorris,Inc.,26Cal.Rptr.3d638(Cal.Ct.App.2005)40Clurg,KoyuncuandSpriovieri(2007),p.15641Clurg,KoyuncuandSpriovieri(2007),p.15642CooterandUlen(2007),p.398‐40043JohnsandPerschbacher(2002),p.21744http://www.arktimes.com/blogs/hoglawyer/2007/11/tort_reform_and_mcdonalds_coff.aspx
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burned herself by spilling herMcDonald’s coffee on herself.45 But a closer look at the
factsofthecaseputsthecaseintoadifferentlight.
On February 27, 1992, the plaintiff,Ms. Stella Liebeck ‐ a 79 years oldwoman –was
sittingonthepassengerseatofhergrandson’scarafterhergrandsonboughthera¢49
coffee fromthedrive‐throughwindowofa localMcDonald’s restaurant.Hergrandson
pulledthecarovertoaparkinglotsothatMs.Liebeckcouldaddsomecreamandsugar
tohercoffee.Sincetherewasnocoffeecupholderinhergrandson’sFordProbeandshe
needed both hands to remove the plastic lid from the coffee cup, she placed the cup
between her knees to keep it steady. While she was attempting to remove the lid,
however, the coffee spilled onto her lap.46 The coffee soaked itself into her cotton
sweatpants and severely burned her skin within seconds. After her grandson
immediatelydrovehertothehospital,shewasdiagnosedwithsecondandthird‐degree
burns over four percent of her body causing permanent injuries on her inner thighs,
buttocks and genital area.47 She had to undergo several skin grafts causing great
consciouspainandlossoflife’senjoyment.48
McDonald’s required its franchisees to sell their coffeeat a temperatureof180‐190°F
(~82‐88°C). This, as McDonald’s admitted, is about 40°F (~24°C) hotter than fit for
human consumption49, and at least 30°F (~18°C) hotter than the industry average of
147.25°F (~64°C). McDonald’s claimed that the high temperature was required to
maintain optimal taste.50 The twelve jurors were presented evidence that a coffee at
185°F (~85°C) could cause third‐degreeburnswithin3 to10 seconds.51Furthermore,
45Liebeckv.McDonald’sRestaurants,P.T.S.,Inc.,No.CV‐93‐02419,1995WL360309(Judgment,Bernalillo
County,N.M.Dist.Ct.Aug.18,1994)46 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994 WL 16777831 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.July13,1994),pp.1‐247Liebeckv.McDonald’sRestaurants,P.T.S.,Inc.,No.CV‐93‐02419,1997WL34674058(ExpertReportand
Affidavit,BernalilloCounty,N.M.Dist.Ct.Jan.19,1997),p.2‐348 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1993WL 13651163 (Trial Pleading,
BernalilloCounty,N.M.Dist.Ct.Oct.5,1993),p.349 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994 WL 16777831 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.July13,1994),pp.2‐650 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994 WL 16777828 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.Sept.12,1994),pp.7‐851 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994 WL 16777828 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.Sept.12,1994),p.12
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McDonald’sadmittedthat,eventhoughthecorporationwaswellawareoftherisk,itdid
notwarnthegeneralpublicofthenatureandtheextentoftherisk.52
Ms.Liebeck,whohadnevergonetocourtbefore,askedMcDonald’stosettlefor$20,000.
This amount was meant to recover her medical bills of $10,000 and out of pocket
expensesaswellaslostwagesofherdaughterwhotooktimeoffherjobtotakecareof
Ms.Liebeck.ButMcDonald’swasonlywillingtogiveher$800atmost.53Consequently,
Ms.LiebeckfiledsuitinaNewMexicoDistrictCourtclaimingthatMcDonald’sisacting
grosslynegligentlybyselling“unreasonablydangerous”and“defectivelymanufactured”
coffee.54 The evidence showed that between 1982 and 1992McDonald’s had received
about 700 complaints by peoplewho suffered varying degrees of burns from the hot
coffeesoldbyMcDonald’s.55ButMcDonald’sdidnotreacttoanyofthesecomplaints.
Thus, the jury awarded Ms. Liebeck compensatory damages of $200,000 and $2.7
million (equaling two days of McDonald’s coffee revenues) in punitive damages.
However,asMs.Liebeckwasfoundtohavebeen20percentatfault,thecompensatory
damageswerereducedbythispercentageto$160,000.56Thefollowingday,McDonald’s
reduced the temperature of its coffee by 30°F (~18°C). Furthermore, the trial judge
reduced the punitive damage award to $480,000, a ratio of 3 to 1,which in factwas
neverreportedinthemedia.57Thus,thefinaldecisionoftheMcDonald’sHotCoffeeCase
isnotasunjustifiedascriticsmightthinkatfirst.
52 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994 WL 16777828 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.Sept.12,1994),pp.4‐653JohnsandPerschbacher(2002),p.21754 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1993WL 13651163 (Trial Pleading,
BernalilloCounty,N.M.Dist.Ct.Oct.5,1993),p.255 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994 WL 16777828 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.Sept.12,1994),p.1456Liebeckv.McDonald’sRestaurants,P.T.S.,Inc.,No.CV‐93‐02419,1995WL360309(Judgment,Bernalillo
County,N.M.Dist.Ct.Aug.18,1994)57JohnsandPerschbacher(2002),pp.217‐218
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3.TheDeterrenceFunctionofPunitiveDamages
3.1.TheBasicDeterrenceTheoryofTortLaw
Thefollowingsubsectionswilloutlineandexplainthebasicdeterrencetheoryof
tort law, on which the economic justification of punitive damages builds. Two basic
assumptions are made. First, it will be assumed that an injurer has to pay damages,
wheneverheinflictedharmonsomeoneelse.Inotherwords,wrongfulactsareperfectly
enforced.Second,avictimthatprevailsincourtwillbefullycompensated.Accordingly,
the totaldamageawardwillexactlyequal theharmincurredby thevictim.These two
assumptionsplacetheanalysisintoanidealworld,inwhichavictimwillbeindifferent
astowhetheranaccidentoccursornot.Indeed,thisshouldbetheultimategoaloftort
law.Nevertheless,suchaperfectworlddoesnotexistinpractice.Thus,asthediscussion
progresses, these two assumptions will be relaxed in order to reveal the economic
reasoningbehindpunitivedamages.
3.1.1.Whatiseconomicallyefficientintortlaw?
In a tort law context, an economically efficient legal system is a system that
minimizesthetotalsocialcostsofallaccidents.Thisideacanbeillustratedinasimple
model.58Inthismodel,itwillbeassumedthatthereareonlytwobasiccostelementsof
accidents: the cost of harm inflicted on the plaintiff by the defendant and the cost of
precautionstakentoavoidtheaccident.59Eventhoughat firstsight thisseemstobea
strong assumption, itwill not influence the conclusions thatwill be derived from the
followinganalysis.
Let p be the probability that an accident occurs. This probability depends on two
variables:(1)Thelevelofprecautionexertedtoavoidanaccident,and(2)the levelof
activity. The term “precaution” canbe interpreted inmanyways. Onemight think of
precautionasdrivingmoresafely,usingconsumerproductsintheapprovedmanneror
conducting quality controls in a pharmaceutical company, for example. The level of
58Theanalysisbuildson theeconomic theoryof tort lawas it isdescribed in:CooterandUlen (2007),
Chapter8,pp.336‐337,andCooter(1983),pp.79‐8659CooterandUlen(2007),p.336
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“activity”, on the other hand, refers in this framework to the extent that parties
participateinactivitiesthatimposerisksonothers.60Itwillfurtherbeassumedthatthe
levelsofprecautionandactivitycanbemeasuredinunits.
Thus,lettheamountofprecautionberepresentedbyxjandthelevelofactivitybyaj,so
that the levelofprecautionperunitofactivity isdenotedbyxj/aj.61Notethatxjandaj
haveseparateandoppositeeffectsontheprobabilityofanaccidentp.Thegreaterthe
levelofriskyactivitiesaj, thehigherwillbetheprobabilityofanaccident.Conversely,
thehigher the levelofprecaution, the lowerwillbe the likelihoodofanaccident.This
meansthattheprobabilityofanaccidentisadecreasingfunctionintheprecautionper
unitofactivity,i.e.p(xj/aj).62
Now, assumean accident causes a harmof amonetary valueH to theplaintiff,which
includes both economic and noneconomic damages. Consequently the expected harm
causedbytheaccidentisrepresentedbyp(xj/aj)H.Forthesakeofsimplicity, itwillbe
assumed that the harm H remains constant for every accident and is thereby
independentofthelevelofprecaution.63
Inaddition,precautionispresumedtobecostly,whichwillbereflectedintheunitcost
cj.Again,inordertokeepthisanalysisassimpleaspossible,itwillbeassumedthatthe
cost of precautioncj remains constant for allmarginal units of precaution.64Thus, the
totalcostofprecautionperunitofactivitycjxj/ajisalinearfunctionofxj/aj,asillustrated
inFigure1.
60PolinskyandShavell(2000),p.765‐76661j∈{i,v}={injurer,victim}62Intechnicalterms,p’(x/a)<0;p’’(x/a)>0;CooterandUlen(2007),p.33663CooterandUlen(2007),p.33664CooterandUlen(2007),p.336
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Figure1–TotalExpectedSocialCost65
Giventheassumptionthattherearenoothersocialcostsofaccidents,thetotalexpected
socialcostE(SC)isthesumofthetotalcostsofprecautionperunitofactivitycjxj/ajand
theexpectedharmp(xj/aj)Hthatisinflictedontheplaintiffbytheaccident.Inthegraph,
this is illustrated by the U‐shaped curve E(SC) that is derived by adding the curve
p(xj/aj)H and the straight line cjxj/ajvertically.66 As the precaution per unit of activity
increases, theE(SC)curve initiallyslopesdownwards indicatingthatthecostsofmore
precaution is less than the reduction in costs due to fewer accidents. However,
eventuallydiminishingreturnskickinsothatafterreachingaminimum,theE(SC)curve
startsslopingupwardsagain.Thismeansthatatthatpointthecostofanextraunitof
precaution per unit of activity exceeds its benefit from fewer accidents.67 The level of
precaution (xj/aj)* is the level minimizing the expected social costs. In other words,
(xj/aj)*isthesociallyefficientcombinationofprecautionandactivity.68
Themathematical rationale behind Figure 1 is also known as the “Hand Rule”.69 It is
helpful inprovidingmoresophisticatedinsightsaboutrationaldecision‐makingintort
law.
65ThegraphillustratesamodificationofthefigureinCooterandUlen(2007),p.33666CooterandUlen(2007),p.33767Cooter(1989),p.116268CooterandUlen(2007),p.33769FormulatedbyJudgeLearnedHandinUnitedStatesv.CarrollTowingCo.,159F.2d169(2dCir.1947).
ForamoredetaileddiscussionoftheHandRule,seee.g.CooterandUlen(2007),pp.349‐353
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Wealreadyknowthateveryotherunitofprecautionhasamarginalcostofcj.Similarly,
one more unit of precaution reduces the expected harm p(xj/aj)H by lowering the
likelihood of an accidentp(xj/aj). The reduction inp(xj/aj)H is therefore themarginal
benefit of precaution.70 Taking the first derivative of the expected social costE(SC) =
cjxj/aj+p(xj/aj)Hwithrespecttoxj/ajandsettingitequaltozerominimizesthisfunction.
Thisresultsinthefollowingequation:
€
dE(SC)
dx j
a j
= c j − p'x j
a j
*
H = 0 (1)
Remember that the expected harm p(xj/aj)H is decreasing in xj/aj, so that its first
derivativeisnegative.Rearrangingequation(1)gives:
€
c j = p'x j
a j
*
H (2)
Thesolutionofthisequationresultsin(xj/aj)*.71
Equation (2) illustrates that the optimal level of precaution sets themarginal cost of
precautionequaltoitsmarginalbenefit.Whenprecautionxj/ajisbelowitsoptimallevel
(xj/aj)*, themarginal costwillbe lower than themarginalbenefit. Inotherwords, the
benefitofincreasingtheamountofprecautionbyonemoreunitisgreaterthanitscost.
Conversely,ifxj/ajisabove(xj/aj)*,efficiencyrequirestotakelessprecautionsincethe
marginalcostexceedsthemarginalbenefit.Therefore,fromanefficiencypointofview
taking more units of precaution per unit of activity is required and justified until
Equation2issatisfied.72
Notethat,asindicatedbythesubscriptj73,theremaybecircumstancesinwhichboth‐
thepotentialinjurerandthepotentialvictim‐cantakeprecautionandtherebyinfluence
the probability of an accident (“bilateral accidents”), and other situationswhere only
70CooterandUlen(2007),p.33771CooterandUlen(2007),p.33772CooterandUlen(2007),p.33773Recallj∈{i,v}={injurer,victim}
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one party can take the necessary precaution (“unilateral accidents”).74 Every timewe
participate in public traffic, for example, we can exert care and choose the level of
activityourselves,althoughwealsorelyontheprecautiontakenbyothers. Whenthe
dentist operates on an anaesthetized patient, on the other hand, only the dentist can
operatewiththenecessarycare.Itisworthmentioning,however,thateveninbilateral
accidents the legallyrequiredprecautionmaysometimesbehigher foroneparty than
fortheother.Inproductliabilitycases,forinstance,theproducersareofteninabetter
positiontotakesuchprecautionbecausetheconsumermaynotbeawareofthehidden
risksofaproduct.Dependingonthesituation,differentlegalrulesmaybeapplied.Due
tothelargevarietyofpossiblecircumstances,Americancourtscanmakeuseofseveral
variationsoflegalrulescombinedwithlegaldevicesthatshifttheburdenofproof,such
asresipsaloquitur.75
Forthepurposeofthisanalysis,however,afeweconomicinsightstothestrictliability
(3.1.2) and thenegligence rule (3.1.3)will suffice.The following sectionsdiscusshow
thesetwoindividuallegalrulesaffectbehavioralincentives.
3.1.2.Doesthestrictliabilityruleleadtoefficiency?
Thestrictliabilityrule,oftenappliedbyAmericancourtsinmanufacturingdefect
cases,holdsthattheinjurerisliablewheneverhecausesharmtothevictim.Thevictim
doesnothavetoprovethattheinjurerwasatfault.Therefore,thelevelofprecautionis
irrelevant for the determination of fault under the strict liability rule. Instead, it is
sufficient to prove a causal link between the defendant and the harm inflicted on the
plaintiff.Inmanufacturingcases,forexample,theplaintiffwouldhavetoprovethatthe
product was defective, that this defect caused the injury and that the defect existed
beforetheproductleftthecontrolofthedefendant.76However,especiallythelastaspect
maysometimesbeverydifficulttoprovefortheplaintiff.Consequently, insuchacase
thecourtmaydecideunderthegivencircumstancestoshifttheburdenofprooftothe
defendant.74Foradetailedanalysisofunilateral accidentsandbilateral accidents, see alsoe.g. Shavell (2004),pp.
177‐20775Formoredetailsonlegalrulesandlegaldevices,seee.g.Clurg,KoyuncuandSpriovieri(2007),Chapter
8,pp.107‐11876Clurg,KoyuncuandSpriovieri(2007),pp.111‐112
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Howdoesthisruleaffectbehavior?First,lookatthesituationfromtheperspectiveofa
potential victim. Recall the assumption that the prevailing plaintiff fully recovers
wheneverheincursharm.Ifthedamageawardreceivedbythevictimisrepresentedby
D,thissuggeststhatD=H.Consequently,thecostofanaccidentforthevictimchoosing
aprecautionperunitofactivityxv/avatthecostofcvcanbeexpressedas
€
cvxvav
+ p xvav
H − p xv
av
D =
cvxvav
. (3)
Therationalvictimthereforemerelyminimizeshistotalcostofprecautioncvxv/av.Asa
result,thevictimwillnevertakeanyprecautionwhateverhislevelofactivity,i.e.xv/av=
0.77
However,theoppositeistrueforinjurers.Theinjurercanchoosehisprecautionperunit
ofactivityxi/aiatacostofci.Giventheassumptionthatdamagesequalharm,theinjurer
expects liability damages equal to the total expected harm p(xi/ai)H so that his total
expectedcostsofanaccidentarerepresentedby
€
cixiai
+ p xiai
H . (4)
Following the rationale leading to a socially efficient level of precaution per unit of
activity(xi/ai)*,asdescribedintheprevioussection,theinjurerwillalwayschoosehis
levelofprecautionsuchthatthemarginalcostofprecautionequalsthemarginalbenefit:
€
ci = p' xiai
*
H . (5)
Thus,iftheinjureralwayshastoperfectlycompensatethevictim,wheneveranaccident
happens, the injurer will choose an efficient level of precaution per unit of activity
(xi/ai)*. If damages would exceed harm, precautions taken by the injurer would be
excessiveand/orhisactivitylevelwouldbetoolow.Equally,ifdamagesarelowerthan
77CooterandUlen(2007),pp.338‐339
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theharmcaused,theinjurerwouldtaketoolittleprecautionand/orengageintoomany
riskyactivities.78
As a result, the injurer will internalize all marginal costs and benefits of precaution
leading tosociallyefficient incentives for the injurer to takeprecautionandengage in
risky activities. The victim, on the other hand, has no incentive to take precaution
because,knowingthathewillbeperfectlycompensatedunderthestrictliabilityrule,he
hasnoreason to incur theextracostofprecaution.Thismeans that thestrict liability
rule is optimally applied only in situations where solely the injurer is able to take
precautions,orat leastwherethevictim’spossibleprecautionsareminimalcompared
to those of the injurer. This explains why American courts so often apply the strict
liabilityruleinmanufacturingdefectcases.
3.1.3.Doesthenegligencerulepromoteefficiency?
Thenegligenceruleisafault‐basedrule,wheretheinjurerisonlyheldliableifhe
failedtofulfillthelegalstandardofcare.Thus,thenegligencerulerequirestheplaintiff
toproveessentiallyfouraspects:(1)Thatthedefendantowedtheplaintiffalegalduty;
(2)thatthedefendantbreachedthatduty;(3)thatthisbreachwasthefactualandlegal
causeof theharm inflictedon theplaintiff; (4) that theplaintiffwas in fact harmed.79
This makes it more difficult for the plaintiff to deliver the necessary proof under a
negligencerulethanunderthestrictliabilityrule.
Thesecondofthefouraspectslistedabove,i.e.whenthedefendantbreachedhisduty,is
for this analysis the important criterion.80 The question is whether the defendant
compliedwiththe legalstandardofcare, tobedeterminedbythecourtof jurisdiction
for each individual case.Onlywhen thedefendant fulfills this standardhe can escape
liability.Suchlegalstandardwillberepresentedby(xj/aj)S.
Theexpectedcostsunderanegligencerule,again inasettingwhere the liable injurer
hastopaydamagesequaltoharm,areillustratedinFigure2.
78CooterandUlen(2007),pp.339‐34079Clurg,KoyuncuandSpriovieri(2007),p.10980Allothercriterionsareforthefollowinganalysisassumedtobesatisfied.
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Figure2–ExpectedCostsundertheNegligenceRule81
ThesolidlinesinFigure2showthatiftheinjurer’slevelofprecautionfallsshortofthe
requiredlegalstandard(xi/ai)S,hewillhavetopayforhisowncostsofprecautionplus
theexpectedharmto thevictim.On theotherhand, if the injurer’sprecautionexactly
matchesorexceedsthelevelrequiredbylaw,hewillonlyhavetopayforhisowncosts
ofprecautioncixi/aisinceheisnotheldliable.82
Thus, the injurer faces a jump in expected costs at the legal requirement equal to the
expected harm still existing when the legal standard is satisfied, i.e. p((xi/ai)S)H.
However, if the assumption, that the total social costs of accidents only includes the
costsofprecautionandtheexpectedharmcausedbytheaccident,isrelaxed,therecan
alsobeothercoststhatcontributetothisjumpinexpectedcosts.Thismay,forexample,
includelitigationcoststhataremorelikelytoariseifthedefendantfallsbelowthelegal
standard, or the negative publicity for a blameworthy defendant. This can especially
play a big role for corporationswhose profitswill be adversely affected if themedia
reports to the public that the company sells products that can be dangerous for
consumers.83 As a result, the injurer has efficient incentives to exactly fulfill the legal
requirement of care, i.e. (xi/ai)* = (xi/ai)S. Intuitively, it does not make sense for the
81ThisgraphillustratesamodificationofthefigureinCooterandUlen(2007),p.34282CooterandUlen(2007),p.35683Cooter(1989),p.1156
PunitiveDamages:AnEconomicJustificationCedricDuvinage
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injurer to take more precaution than necessary in order to escape liability because
precautioniscostly.
Now, what does this imply for the victim’s incentives under a negligence rule? The
rationalvictimknowsthattheinjurerhasefficientincentivestofulfilltherequiredlegal
standard. Therefore, the victim recognizes that if an accident occurs, he will not be
compensated because the injurer cannot be held liable. Hence, the victim also has
efficientincentivesforprecaution,leadingtoanoverallsociallyefficientoutcomeinthe
caseofbilateralaccidents.84
However,suchasociallyefficientoutcomeisconditionedonthecourt’sabilitytosetthe
legalstandardatasociallyefficient level.AsshowninFigure2, this iswherethetotal
expected social costs curve E(SC) is minimized. If the court does not set the legal
standard at this level, the levels of precaution chosen by the respective parties will
resultinasociallyundesirableoutcome.85
As pointed out earlier, courts sometimes apply variations of the negligence rule.
Especially in bilateral accidents, as for instance in product liability cases, the courts
oftenapplya“comparativenegligencerule”thatismeanttoprotectcompaniesfromany
misuseoftheirproducts,forwhichthecompanyshouldnotbeheldliable.Ifbothparties
arefoundtohaveactednegligently,thecompensatorydamagesawardedtotheplaintiff
canthenbereducedbythepercentageoftheplaintiff’sfault,asitwasestimatedtohave
contributed to the accident.86 Since a negligence rule results in efficient incentives to
takereasonablecarenotonlyby the injurerbutalsoby theplaintiff, suchruleshould
bestbeapplied insituationswhere the injurerandtheplaintiffbothareable toavoid
accidentsbytakingprecautions.
ThiswasalsothecaseinLiebeckv.McDonald’sRestaurants,P.T.S.,Inc.,wherebyspilling
hercoffeeonherselfMs.Liebeckwasfoundtohavebeen20%atfault.Asaresult,her
compensatory damage awards were reduced by this percentage from $200,000 to
84CooterandUlen(2007),p.34485CooterandUlen(2007),p.35686Clurg,KoyuncuandSpriovieri(2007),p.142‐144
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$160,000.87However,eventhoughMs.Liebeckcouldpresumethatthecoffeeishot,she
should not have been required to anticipate the unreasonably dangerously high
temperature of the McDonald’s coffee. Due to this hidden risk that only McDonald’s
knewabout,thejuryassignedmostoftheresponsibilityfortheharmtoMcDonald’s.
3.2.RelatingPunitiveDamagestotheDeterrenceTheory
3.2.1.Whatiftheharmisnotcorrectlyinternalized?
Theprecedinganalysisshowsthatthestrictliabilityruleandthenegligencerule
(assuming that the legal standard is set at the socially efficient level) lead to efficient
incentives.However,rememberthatthisresultisbasedontwonecessaryprerequisites,
theassumptionsofperfectcompensationandperfectenforcement.
With these assumptions in mind, the foregoing discussion provides a fundamental
insightforthecomputationofliabilitydamages:Iftheinjurerisalwaysfoundliablefor
hiswrongful act the optimal amount of total damages should equal harm in order to
achieve efficiency.88 However, perfect compensation is not always realistic. Often, for
example,informationnecessarytocomputetherightamountofdamagesisunavailable;
theexactamountoffuturemedicalexpensesmaybeunknown,oritmaybeunclearhow
to assign a monetary value to a victim’s future pain and suffering. Therefore, when
decidingonhisoptimalbehavior,therationalinjurermightnotinternalizethefullharm
causedbyhismisbehavior.Howdoesthisimpacttheincentivestotakeefficientcare?
Underthestrictliabilityruleitwasestablishedthattheinjurerchoosesanefficientlevel
of precaution where its marginal cost equals its marginal benefit. Recall that the
marginalbenefitwasthereductionintheexpectedharmbyonemoreunitofprecaution.
Therefore,iftheexpectedharmisnotcorrectlydetermined,itwillimmediatelyimpact
the level of precaution taken by the injurer. Suppose the courts repeatedly
underestimate the level of damagesH incurred by the plaintiff. Thiswould lower the
expectedharmp(xi/ai)Hinternalizedbytheinjurerandthereforetheinjurer’smarginal
87Liebeckv.McDonald’sRestaurants,P.T.S.,Inc.,No.CV‐93‐02419,1995WL360309(Judgment,Bernalillo
County,N.M.Dist.Ct.Aug.18,1994)88PolinskyandShavell(1998),p.886
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benefitofprecaution.Asa result, the injurerwouldreducehis levelofprecautionper
unit of activity below the efficient level. Similarly, if the court keeps overestimating
damages,theinjurerwillincreasehislevelofprecaution.Thus,ifthecourtconsistently
errsinsettingthecorrectamountofdamagesunderthestrictliabilityrule,theinjurer’s
precautionwilladjustinthesamedirectionasthecourt’serror.89Thiswouldleadtoa
sociallyinefficientoutcome.
Underanegligencerule,thisisnotnecessarilythecaseduetothecostthresholdalready
pointedout inFigure2. Suppose, for example, the courtsunderestimatedamages just
moderately.ThiswouldcauseadownwardshiftinthesocialcostcurveE(SC)toE(SC)’,
asillustratedinFigure3.
Figure3–IncorrectDamageEstimates90
Inthatcase,theinjurerstillminimizeshisexpectedcostsofanaccidentbychoosingan
efficientlevelofprecautionat(xi/ai)*=(xi/ai)S.However,ifthecourt’serrorissolarge
thattheminimumofthetotalexpectedcostsofanaccident,e.g.E(SC)’’,islessthanthe
totalcostsofprecautionatthelegalstandard,cj(xj/aj)S,theinjurerwillchoosealevelof
precaution that falls farbelow the legal standard, e.g. (xi/ai)’’.91Thiswouldbe socially
undesirable.
89CooterandUlen(2007),p.35490ThisgraphillustratesamodificationofthefigureinCooterandUlen(2007),p.35591Cooter(1983),pp.84‐85
PunitiveDamages:AnEconomicJustificationCedricDuvinage
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Thus,anyerrorcausingtheinjurernottointernalizetheentirecostsofanaccidentwill
immediatelyimpacthisincentivesunderastrictliabilityrule.Thisiseventrueforsmall
deviations fromsocial efficiency.Underanegligence rule,however, theerrormustbe
sufficientlylargeinordertoaffecttheinjurer’sincentives.Thismeansthatanegligence
rule can be efficiency enhancing even though the injurer internalizes only part of the
total harm. This is an important insight that justifies the relatively high threshold of
recklessnessthatthedefendant’sunlawfulacthastoovercomebeforepunitivedamages
maybeawarded.
3.2.2.Whytheprerequisiteofa“willful,malicious,wantonorreckless”conduct?
The analysis on efficient incentives under the negligence rule revealswhy tort
law generally requires a “willful, malicious, wanton or reckless” conduct by the
defendant before punitive damages can be imposed.92 Itwas established that the cost
threshold,asitwasdescribedabove,generallyensuresthatthepotentialinjurerhasan
incentive to adhere to the legal standard. If the injurer nevertheless decides not to
complywith the law,his level ofprecautionwill fall far short of the legal standardof
care.
What does this observation imply with regard to when punitive damages should be
imposed? Imagine a situation where court errors are minimal but the injurer
nevertheless chooses a level of care far below the legal standard of care. Thiswould
meanthattheinjurermustattainagreaterbenefitbybreachingthelegalstandardthan
the jump incostshe incurs through thecost threshold.Even thoughwrong intentions
mightbedifficult toprove incourt, socialbehavioralguidelinesmayhelpdetermining
whether a conduct was intentional or unintentional. Whereas unintentional behavior
generallyonlycausesasmalldeviationfromthelegalstandard,intentionalwrongdoing
usuallyinvolvesaconsiderablenoncompliance,whichcanonlybedeterredbypunitive
damagesinadditiontocompensatorydamages.93
It is easy tounderstand,whypunitivedamages shouldnotbe imposedondefendants
that unintentionally failed to comply with the legal requirement of precaution. An
92WilsonElser(2006),p.III93Cooter(1983),p.86
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injurermayunintentionallybeatfault,forexample,ifhewasmistakenaboutthelegal
standard (xi/ai)S. This may not be so unusual given the generally vague standard of
“reasonablecare”intortlaw.94
Economistsrefertosuchsituationasagameof“incomplete”information,meaningthat
oneplayerofthegamedoesnotknowthebasicconditionsofthegame.95Thiscanleadto
aneconomicdisequilibriumsincetheunintentionalinjurerwouldchangehisbehaviorif
hewerecorrectlyinformedabouttherulesandthereforeabouttheconsequencesofhis
actions.Theuninformedinjurerbelievesthatheiscomplyingwiththelaw,butfindsout
attrialthat infacthewasnot.Suchmistakesgenerallyonlyresult inminordeviations
from the legal standard. Such an economic disequilibrium can easily be corrected by
merely awarding compensatory damages. This will give sufficient incentives to the
unintentionalwrongdoertoaccordhisbehaviortothe law.The impositionofpunitive
damagesinsuchacasewouldnotonlybeunjustbutalsoineffectiveinachievingtheir
aimoffuturedeterrence.Awrongfulactofapotentialinjurercannotbedeterredifthe
injurerisnotawareofthefactthathisbehaviorisunlawful.96
In Liebeck v. McDonald’s Restaurants, P.T.S., Inc. it would be difficult to argue that
McDonald’sreallyintendedtohurtMs.Liebeckbysellinganextrahotcoffeetoher.The
intention of McDonald’s was to make profits, not to cause harm on their customers.
However,McDonald’scouldneitherhaveclaimedthatitwasuninformed.Thefast‐food
restaurantchainwaswellawareoftherisksthattheirexcessivelyhotcoffeeimposedon
customers due to themore than 700 previous complaints between 1982 and 1992.97
McDonald’srefusaltoadjustitspolicydespitethisknowledgemustthereforeadequately
be classified as reckless behavior. A testimony by the McDonald’s safety consultant
Robert Knaff, stating that the number of burned victims was “statistically trivial”98,
thereby further validating McDonald’s disregard of the health and safety of its
94Cooter(1983),p.8595HargeavesHeapandVaroufakis(1995),p.6296Cooter(1983),pp.85‐8697 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994 WL 16777828 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.Sept.12,1994),p.1498 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994 WL 16777828 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.Sept.12,1994),p.11
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customers99, must have sent an alarming message to the twelve jurors. Thus, even
thoughMcDonald’sbehaviorfellsomewhereinbetweenthetwoextremesof intention
andmistake,itseemsmuchclosertotheintentionalend.
Asaresult,thecostthresholdimpliesthatifinjurerschoosetoexertlessthanthelegal
standardof “reasonable care”, injurersdo so at least consciously.The rational injurer
wouldneverwillfullychoosealevelofcarejustbelowthestandardofprecautionsince
the marginal costs of doing so would dominate the marginal benefit. Certainly, the
“willful,malicious,wanton or reckless” ‐ standard applied by courts does not draw a
bright line that clearly defines the behavior deserving the imposition of punitive
damages.Butitprovidesaguidepostthathelpstoensurethatpunitivedamagesareonly
appliedtogrosslynegligentdefendants,andnottodefendantsthatwereunintentionally
atfault.
3.2.3.Whatiftheinjurer’sgainsaresociallyillicit?
Asjustpointedout,aninjurerwhoconsciouslybreacheshislegaldutydoessoto
obtainabenefitfromhiswrongfulact.Thereare,forexample,someunusualindividuals
who see some type of personal, not necessarily economic, benefit by intentionally
harmingsomeoneelse.Whenan individualpunchesanother inthe facehemost likely
has noneconomic reasons for doing so. Such a person deliberately exposes himself to
liabilitymeaning thatmerelyhaving topaycompensatorydamageswillnotcomeasa
surpriseforhim.100
Until now, it was implicitly assumed that all the injurer’s benefits attained from his
unlawfulconductwereincludedintheoverallsocialwelfare.However,thegainthatan
individual gets from intentionally harming someone else is typically considered to be
“socially illicit”.101Thepublicsocietydoesnotvaluethepleasurethatonememberhas
fromhurtinganother.Therefore,society’swelfareonlytakesthesocialcostsbutnotthe
personal benefits of a socially illicit act accruing to the injurer into account. In other
words,thesocialcostsexceedthepersonalcostsfortheinjurer.
99 Recall the Supreme Court’s guidelines regarding the assessment of reprehensibility in State Farm
MutualAutomobileIns.Co.v.Campbell,seeaboveSection2.2,pp.5‐6100Cooter(1983),p.86101PolinskyandShavell(2000),p.770
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Let b(xi/ai) be the socially illicit benefit of the injurer. The injurer’s illicit gain is a
decreasingfunctionoftheprecautionperunitofactivity.Recallthattheexpectedsocial
costsofanaccidentisE(SC)=cjxj/aj+p(xj/aj)H.Now,takingaccountofthesociallyillicit
benefit,thecostfromtheinjurer’sperspectiveequalscixi/ai–b(xi/ai)+p(xi/ai)H.102This
isillustratedinFigure4.
Figure4–SociallyIllicitGains103
Ifthesociallyillicitgainb(xi/ai)issolargethattheinjurerhasanincentivenottocomply
with the legal standard,hewill fall far shortofhis legalduty.This is the resultof the
discontinuityofthecostfunctionatthelegalstandardduetothecostthreshold.Thus,
punitivedamagesinadditiontocompensatorydamagesareneededinordertorestore
thestatewherecompliancebecomestheinjurer’soptimalbehavior.104
NotethatFigure4suggestsasimilarconclusionasFigure3.However,thederivationof
theconclusiondiffers.Figure3denotedadownwardshiftintheexpectedcostcurvedue
toanimperfectinternalizationofthecostsofanaccidentbytheinjurerbecauseofcourt
errors, for example. Figure 4, on the other hand, emphasizes a shift in the injurer’s
expected cost curve due to the socially illicit gain that the injurer values, but not the
society.Hence,theshiftofthesocialcostcurveinFigure4couldalsooccurifthereare
nocourterrorsso.
102Cooter(1983),p.87103ThisgraphillustratesamodificationofthefigureinCooter(1983),p.88104Cooter(1983),pp.88‐89
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Whatshouldtheamountofpunitivedamagesinthiscasebe?Lookingatthecauseofthe
inefficiency, namely the socially illicit gain, the answer to this question is
straightforward.Inordertore‐aligntheinjurer’scostcurvewiththeoriginalsocialcost
functionE(SC),asshowninFigure2,punitivedamagesequaltotheillicitbenefitb(xi/ai)
mustbeimposed.Thisamountwillaccomplishcompliancebyensuringthattheinjurer
minimizes his cost function at the legal standard. This also implies that punitive
damagesmustbelargebecausetheillicitbenefithastobelargefortheinjurertobreach
his duty in the first place.105 Thus, the minimum amount of punitive damages is
determined by the size of the cost threshold because the illicit benefit must at least
coverthisthresholdfortherationalbreachingdecisionmaker.
This discussion on socially illicit gains also requires a qualification of the earlier
established conclusion that punitive damages should only be levied on reckless and
intentionalwrongdoing.106 From the economic point of view punitive damages should
only be imposedwhen the social costs of intentionalwrongdoing outweigh the social
benefits.Therefore,aslongassocietydoesnotweightthebenefitofnoncompliance,as
in the case of socially illicit gains, punitive damages need to be imposed to deter
unlawfulbehaviorandtherebyrestoreefficiency.However,ifanindividualperformsan
unlawful actwhere its social benefit exceeds its social cost, levying punitive damages
would be undesirable. This may be the case, for example, when the situational
circumstancesgivetheindividualnochoicebuttobreachhislegalduty.Forinstance,a
lost individualwhopurposely breaks into a cottage somewhere in thewoods tokeep
himselffromstarvingshouldnothavetoexpecttopaypunitivedamages.107Thebenefit
ofsavinghislife,whichcertainlyisnotconsideredtobesociallyillicit,clearlyoutweighs
the cost of the food he ate to do so. Thus, compensatory damages to compensate the
ownerofthecottageforthefoodwillsuffice.
3.2.4.Whatiftheinjurercanescapeliability?
Rememberthat intheprecedinganalysison incentivestwostrongassumptions
were made. One of them was already relaxed, namely that victims are always fully
105Cooter(1983),p.89106SeeaboveSection3.2.2,p.24107Cooter(1983),p.89
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compensated.Thissectionwillnowturntothesecondassumption,whichsupposedthat
theinjurerhastopaydamageswheneverhecausesharm.
Inpractice, itmayhappenthataninjurerwhotechnicallyshouldbeheldliableforthe
harm inflicted on a victim nevertheless escapes his liability. There are a number of
possible reasonswhy thismightbe the case: (1) Itmightbehard for thevictim tobe
abletoprovewhoreallycausedtheharm.Afrequentlyobservedexampleinpracticeisa
case of hit‐and‐run driving. The victim knows his car was damaged but without a
witness he cannot identify the injurer. (2) The victimmight not be able to determine
whether the harm sufferedwas the result of someparty’swrongful act or simply the
resultofbadluck.Foranindividualwhodevelopedcanceritmaybeimpossibletotell
whether thecancerdevelopednaturallyorwhetheran injurerwhoreleasedsynthetic
carcinogeninthevictim’senvironmentcausedthecancer.(3)Evenifthevictimknows
whocausedtheharmhemightnonethelessbeunwillingtosuetheinjurerbecausethe
costsoflitigationoutweighthepotentialbenefitsofgoingtocourt.108Thisisparticularly
true forminor harms incurred. (4) The victimmay not prevail in court because it is
difficult forhim toprove important aspectsnecessary to trigger the injurer’s liability.
For example, a victim might be unable to prove that the injurer violated his legal
standardofcareiftheexactstandardisnotclearlyidentified.109
Havingthispossibilityoftheinjurerbeingabletoescapeliabilityinmind,whatshould
now be the optimal amount of total damages? It is important to understand that the
rational injurerwill include thispossibilityofescaping liability inhisdecisionmaking
process.Forthisreason,damagesequalingtheharmcannotleadtoefficientincentives
fortakingprecautionsandparticipatinginriskyactivitiesanymore.Inordertomitigate
this incentive problem the computation of total liability damages has to incorporate
such “enforcement errors”.110More specifically,when injurers are indeed found liable,
damagesmustbesufficientlyhighsothatinjurersindirectlyalsopayforallharmsthey
108PolinskyandShavell(2000),p.768109Cooter(1989),p.1149110CooterandUlen(2007),p.396
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have not been held liable for. In other words, total damages should equal the harm
dividedbythelikelihoodthattheinjurerisheldliable.111
Thus, letq be theprobability that the injurer canescape liability, i.e. theenforcement
error.Generally,thecourtshouldbeabletoderivethisprobabilityfromtheevidenceof
the case, expert opinions or the number of similar previous victim complaints, for
example. Having established the enforcement error, the optimal amount of total
damages, D*, which is the sum of optimal compensatory damages, DC*, and optimal
punitivedamages,DP*,shouldbecomputedviathefollowingequation.
€
D* = H 11− q
=
H1− q
(6)
Theterm(1‐q) is the likelihoodthat the injurer is found liablesothat(1/1‐q)maybe
referredtoasthe“totaldamagesmultiplier”.112Forexample,assumetheprobabilityof
escaping liability equals 50%.This results in a total damagesmultiplier equal to 2 (=
1/1‐0.5).Consequently,aninjurerwhoinflictsaharmof$50,000ontheplaintiffshould
pay$100,000(=2x$50,000)intotaldamages.Thisinturnmeansthattheinjurerpays
$50,000incompensatorydamagesand$50,000inpunitivedamages.Thus, the injurer
indirectlyalsopays$50,000fortheotherstatisticalharmthatheisnotheldliablefor.
Aswell, note that under the assumption of perfect enforcement q= 0, so that under
perfectenforcementoptimaltotaldamagesequalharm,i.e.D*=H.113
The optimal level of punitive damages could be computed by subtracting the optimal
amount of compensatory damages from the optimal total damages. Alternatively, the
optimalamountofpunitivedamagesmaybedirectlycalculatedby
€
DP* =q1− q
H (7)
111PolinskyandShavell(2000),p.768112PolinskyandShavell(2000),p.768113Recall,thiswasthefirstfundamentalinsight(giventheassumptionofperfectenforcementandperfect
compensation)introducedinSection3.2.1,p.22
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where (q/1‐q) is the “punitive damages multiplier”.114 In the previous example, the
optimalpunitivedamagesof$50,000arederivedfromadamagesmultiplierequalto1
(=0.5/1‐0.5)multipliedbytheharmof$50,000.Similarly,iftheprobabilityofescaping
liabilitywere0.75,thepunitivedamagesmultiplierwouldbeequalto3(=0.75/1‐0.75).
Thisresultsinoptimaltotaldamagesamountingto$200,000(=$50,000/1‐0.75),where
$150,000 (= 3 x $50,000) of this amount comprises optimal punitive damages. These
examples illustrate that the higher the enforcement error, the higher should be the
amountofpunitivedamages.
Yet, recall that this computation of optimal punitive damages applies the harmof the
enforcedcasealsotoallotherunenforcedcases,inwhichtheinjurertechnicallyshould
havebeenliable.115Butthereisnoreasonwhythesamewrongfulconductshouldalways
causethesameharm.Therearetoomanyotherexternalfactorsthatcouldinfluencethe
extent of the harm. It would therefore be more accurate to use the average of the
individual harms as the basis for the punitive damage calculation.116 This, of course,
requires detailed information on individual cases, which the court might be able to
attainbyconsultinginsurancecompanies.
Nonetheless,byrelaxingthesecondassumptionofperfectenforcement, totaldamages
exceedingtheactualharmofthevictimarenotonlyjustifiedbutalsorequiredfroman
efficiencypointofview.Punitivedamagesarenecessary inorder toalignthe injurer’s
expected liabilitywith theactualharm inflicted.Onlywhen the injurer internalizesall
the harm he causes, he will have efficient incentives in choosing his optimal level of
precautionandactivity.Relatingthisresultwiththeearlierfindings,oneshouldbearin
mindthat theenforcementerrorhastobe largeenoughsothat the injurerwill find it
worthwhiletochoosealevelofprecautionbelowtheefficientlegalstandard.117
However, intuitively, if punitive damages are intended to make up for unenforced
harms, itshouldnotsolelybetheplaintiffcollectingallpunitivedamages.Whyshould
theplaintiffreceiveallthedamageawardsfortheharmthatwasinflictedonothers?A
114PolinskyandShavell(2000),p.768115RecalltheassumptionthattheharmHremainsconstantforeveryaccidentinSection3.1.1,p.14116PolinskyandShavell(1998),p.889117Cooter(1989),p.1148
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fractionof thepunitivedamageawards should insteadbepaid to the state. SomeU.S.
states suchasGeorgia, Illinois, Indiana,Missouri, Iowa,OregonandUtahhave for this
reason formulated so called “split‐award” statutes. Such statutes require a certain
fractionofpunitivedamageswonattrialtobeallocatedtothestate.118Analternativeto
such statutes would be to make punitive damages taxable under the ordinary tax
scheme, even for private individuals.119 However, to mitigate the plaintiff attorney’s
undesirableincentives,namelytosuesimplyinordertocollecthighwindfallprofits,itis
important thatattorneyscanonlybase theircontingency feeson the finalnetamount
received by the plaintiff, i.e. after split‐award deductions or after tax payments have
beenmadetothestate.
The state can then recycle these awards back into society in the form of welfare
payments, or it might even create certain funds accessible by victims of similar
unenforced harms. The result of split‐award statutes or a tax on punitive damages
would be that the expected plaintiff award at trial is reduced, but the defendant’s
damage payments are not. This lowers the number of trials by reducing the possible
windfall for plaintiffs while increasing the number of out of court settlements. In
addition,thesizeofsuchsettlementswillbereducedbecauseplaintiffsfindthemselves
inaweakerbargainingposition.120
However,due toa lower filing rateand lowerexpectedoutof court settlements, such
regulationsalsoreducetheexpectedcostsofaccidentsfordefendants.Thisiswhyonly
partofthepunitivedamagesshouldbepayabletothestate:Topreserveadefendant’s
efficientincentivestotakeprecaution.121Moreover,otherthanallthesilentvictims,the
plaintiff at trial also incurs the litigation costs. Even thoughpunitivedamages arenot
meanttocoverlitigationcosts,itisonlyamatteroffairnessthattheplaintiffreceivesan
extra amount for taking the financial risk of going to trial, which all other (future)
victimsessentiallybenefit from.Thus, the legislaturemust strikeanadequatebalance
betweenefficiencyandfairnessviasplit‐awardstatutesorthroughataxationscheme.
118DaughetyandReinganum(2000),p.5119Foramoredetaileddiscussionon taxingpunitivedamages, see e.g.PolinskyandShavell (1998),pp.
928‐931120LandeoandNikitin(2004),p.1121LandeoandNikitin(2004),pp.1‐2
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3.2.5.WhatwouldhavebeenefficientintheMcDonald’sHotCoffeeCase?
Having discussed the economic reasoning behind punitive damages it is
worthwhile‐withreferencetotheMcDonald’sHotCoffeeCase‐tonowlookathowthe
theoryestablishedabovecouldbeappliedinpractice.
Unfortunately, in the past courts have largely been economically inefficient in their
applicationofpunitivedamages.Asa result, importantaspects for thecomputationof
the right amount of punitivedamageshavebeenneglected andhave largely been left
unknown. Thus, a few informative assumptions have to be made. All the vital
information assumed here, however, should not be difficult for a court to acquire in
practice.
The protocols of the Liebeck v. McDonald’s Restaurants, P.T.S., Inc. trial reveal that
between 1982 and 1992 McDonald’s had received about 700 complaints of varying
degreeburns.122However,itisneitherdisclosedhowmanyoutofthe700actuallysued
McDonald’sfordamagesincourtnorhowmanysettledoutofcourt.Thisinformationis
required for the determination of the total damage multiplier. The ordinary person
would probably not think of suingMcDonald’swhen he spills his coffee over himself.
Due to thehidden risk, he typicallypresumes that the consequential harmof a coffee
spillisentirelytheresultofhisownfault.
Thus, letus firstassumethat1outof50hotcoffeevictimsactuallygo tocourt tosue
McDonald’s, which for coffee spills is believed to be a rather high number. The
probabilitythatMcDonald’sisbeingsuedforitsdangerouslyhotcoffeeistherefore2%
(=1/50).Accordingly,theprobabilityofescapingliabilityliesat98%(=1–0.02).
Remember,Ms.Liebeck initiallyasked forcompensatorydamagesof$20,000 tocover
hermedicalbills,outofpocketexpensesandlostwagesofherdaughterwhotooktime
122 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994WL 16777828 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.Sept.12,1994),p.14
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ofherjobtotakecareofher.123Ms.Liebeck’scontributoryfaultof20%would,however,
reduceherreceivablecompensatorydamagesto$16,000.124
Thequestionnowis:Shouldthecontributoryfaultbeincludedinthepunitivedamage
calculation?Theanalysisabovesuggests:“No”.Anythingthatcreatesuncertaintyforthe
injurer in the computation of punitive damages must be avoided to preserve the
deterrence effect. This also includes the contributory fault. For deterrence to be
effective,theinjurermustbeabletocomputetheexpectedamountofpunitivedamages
before any accident has occurred. The contributory fault by the victimwould for the
injurerbeanunknownvariableinhispunitivedamagecalculation.Besides,recallingthe
rationale of punitive damages, punitive damages are not imposed to reimburse the
victim for the incurred harm. The contributory fault only affects the compensatory
damages to be paid in the case at trial and not that of unenforced cases. In fact, the
contributoryfaultinunenforcedcasesistypicallyunknown.
Thus,inanycase,theactualharm,andnottheoptimalcompensatorydamages,mustbe
the basis for the punitive damages calculation.125 Accordingly, in this example, the
unreducedamountof$20,000reflectingtheactualharmofMs.Liebeckshouldbeused.
Since total damages include punitive damages the same holds true for the optimal
amount of total damages, D*, although courts eventually have to adjust optimal
compensatorydamages,DC*,bythecontributoryfault.Thiscanbeachievedbyadjusting
Equation6to
€
D* =11− q
− FC
H (8)
whereFc126representsthecontributoryfault.NotethatifFC=0,Equation8isequivalent
toEquation6,whichdidnotaccountforthepossibilityofcontributoryfault.
123JohnsandPerschbacher(2002),p.217124Liebeckv.McDonald’sRestaurants,P.T.S.,Inc.,No.CV‐93‐02419,1995WL360309(Judgment,Bernalillo
County,N.M.Dist.Ct.Aug.18,1994)125NotethatEquations6and7bothusetheharm,H, insteadofoptimalcompensatorydamages,DC*, to
prevent confusions in cases involving a contributory fault, FC, by the victim. In cases withoutcontributory fault, optimal compensatory damages equal harm; in cases with contributory fault,optimalcompensatorydamagesarelessthantheactualharm,i.e.DC*=H(1FC)
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Intheexample,whereonly1in50victimssue,thisaccordinglyresultsinoptimaltotal
damagesamountingto$996,000(=[(1/0.02)–0.2]x$20,000)127,$980,000(=0.98/0.02
x$20,000)128ofwhichmakeuppunitivedamages.
Yet,noticethatthecompensatorydamagesthatMs.Liebeckaskedforonlyincludedher
economiclosses.Thenoneconomiclossesoffuturepainandsufferingasaresultofher
permanent injuries have not been accounted for yet. If we used the unadjusted
compensatorydamagesincludingnoneconomiclosses,i.e.the$200,000awardedbythe
jury,theoptimalamountoftotaldamageswouldamountto$9.96million(=[1/0.02–
0.2]x$200,000)andoptimalpunitivedamagesto$9.8million(=0.98/0.02x$200,000).
Thus,if1in50victimswouldsue,efficiencywouldhaverequiredmorethan3.5times
the$2.7millionofpunitivedamagesinitiallyawardedbythejury.Now,ifsayonly1in
100 victims sue, the optimal amount of total damageswould even increase to $19.96
million (= [1/0.01 – 0.2] x $200,000) and punitive damages to $19.8 million (=
$19,960,000–$160,000)tomakeupfortheother99unenforcedcases,i.e.$200,000x
99=$19,800,000.Ofcourse,ifoutofcourtsettlementshavebeenpaidinearliercases,
thefinalpunitivedamageamountshouldbereducedbythesizeofthesesettlements.
Havingdeterminedwhat the injurershouldoptimallyhave topay toensureeconomic
efficiency, thenextquestion is,howmuchof the$19.96millionshouldMs.Liebeckbe
entitledtokeep?Asmentionedearlier,itwouldbeunjustifMs.Liebeckweretokeepall
thepunitivedamagesthatareactuallymeanttomakeupforallunenforcedharms.Thus,
suppose the state law of jurisdiction contains a split‐award statute that requires Ms.
Liebecktopay50%ofthepunitivedamages,i.e.$9.9million(=$19,800,000x50%),to
the state. Hence, Ms. Liebeck would get to keep the other $9.9 million of punitive
damages.
However, from the author’s point of view, social fairness requires to also apply the
contributory fault to thepunitivedamages thatMs. Liebeck receives andmaykeep.129
126WhereFCisapercentagenumber,i.e.0
€
≤ FC
€
≤1127ApplyingEquation8128 Applying Equation 7, or simply by subtracting optimal compensatory damages,DC* = H(1FC), from
optimaltotaldamages;notethat0.98/0.02=49,i.e.tomakeupforalltheother49unenforcedcases129 Under the assumptionsmade above, the amount of punitive damages thatMs. Liebeckmay keep is
differentfromtheamountofpunitivedamagestobepaidbytheinjurer.
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ThisisbecauseMs.Liebeckishypotheticallynotentitledtoanypunitivedamagessince
they are not meant to compensate for Ms. Liebeck’s harm. Thus, deducting the
contributory fault, Ms. Liebeck should only be allowed to keep $7.92 million (=
$9,900,000 x (1 – 20%)) of the $9.9million in punitive damages. But, unlike for the
compensatorydamages,thedifferenceof$1.98millionattributabletothecontributory
faultshouldbepayabletothestateontopofthesplit‐award,andnotforthedefendant
tokeep.Therefore,lettingSdenotethepercentageamounttobepaidtothestate130,the
finalawardthatMs.Liebeckisentitledtokeep,DV*,canbecalculatedbythefollowing
equation:
€
DV* =q1− q
1− S( ) +1
H(1− FC ) (9)
Summarizing, if 1 in 100 victims sued McDonalds, the corporation should have paid
$19.96million in total damages in order topromote economic efficiency, $160,000 in
compensatory damages and $19.8 million in punitive damages. This is more than 7
times the punitive damage amount initially imposed by the jury. However, under the
assumptionsmadeabove,Ms.Liebeckshouldonlybeentitled tokeep$8.08millionof
thetotalamount131,whereasthestateshouldreceivetheremaining$11.88million(i.e.
$11,880,000 + $8,080,000 = $19,960,000), which amounts to about 60% of the total
damagespaidbytheinjurer.132
Hence, the McDonald’s Hot Coffee Case that critics frequently use to argue against
punitive damages in fact illustrates the opposite: Some cases require large punitive
damages to enhance economic efficiency. This in turn suggests that limitations on
punitivedamagestoasingledigitpunitivedamagemultiplier,astheywereputinplace
insomeU.S.states,wouldclearlypreventefficiencyinthiscase.
130Eitherintheformofasplit‐awardorintheformofatax,where0
€
≤ S
€
≤1131DV=[(0.99/0.01)x(1‐0.5)+1]x$200,000(1–0.2)=$8,080,000132 For an overview of the important equations for the damages calculation established above, see the
Annex.
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4.ThePunishmentGoalofPunitiveDamages
4.1.WhatistheRoleofPunishmentinTortLaw?
As mentioned at the outset of this paper, the second objective of punitive
damages, aside from deterrence, is the punishment of the injurer for his reckless
behavior.133 From an economic point of view, however, punishment plays only a
secondaryroleintortlawbecauseitmerelyservesasadisciplinaryfunctionratherthan
as a deterring one. Recall that punishment refers to society’s objective to impose
reasonable sanctions on social wrongdoers as a penalty for a reckless unlawful
conduct.134
Punitive sanctions as disciplinary measures were originally only implemented in
criminal law. However, as Judge Posner in Mathias v. Accor Economy Lodging, Inc.
explained,punitivedamageswere introduced in common tort law inorder “to relieve
thepressuresonanoverloadedsystemofcriminaljusticebyprovidingacivilalternative
to criminal prosecution of minor crimes”.135 Thus, in connection with its punishment
objective, punitive damages may be interpreted as “semi‐criminal enforcement
penalties”136imposedonminoroffenses.Forinstance,knowinglyexposingitscustomers
totheriskofseriouslybeingburnedbyitsdangerouslyhotcoffeemerelyforanincrease
insales,asMcDonald’sargued137,madeMcDonald’ssubjecttoappropriatepunishment.
PunishmentinthetortlawcontexthasespeciallythreatenedU.S.corporatedefendants.
Plaintiffs in product liability cases or cases of fraud, for instance, are frequently
successful in contending that the defendant’swrongful conduct deserves punishment.
Mostcommonly,theplaintiffarguesthatthedefendant’srecklessconductcausedharm
notonlyonhimasanindividual,butmoreimportantlyalsoonthepublicinterest.The
plaintiff’sattorneytriestoexplaintothejurythattheplaintiffisonlyarepresentativeof
133SeeaboveSection2.1,pp.4‐5134PolinskyandShavell(1998),p.948135Mathiasv.AccorEconomyLodging,Inc.,Nos.03‐1010,03‐1078,347F.3d672(Ill.App.Ct.7thCir.2003),
p.7136Calabresi(2005),p.337137 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994WL 16777828 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.Sept.12,1994),p.8
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alargegroupofharmedindividuals.Thiswaytheplaintifftriestoconvincethejurythat
punitive damages should be imposed not only as ameans of deterrence but also for
punishment reasons.138 Consequently, corporate entities with a large customer base
havetobeparticularlyalerttotortlawliabilityissues.Thisisespeciallytruebecause,as
mentioned earlier, the standard of proof under tort law is much lower than under
criminallaw,makingpunitivesanctionsmorelikelyintortlaw.
However, the implicationsof imposingpunitivedamagesoncorporateentitieshaveto
becarefullyreviewed.This isbecause, ifpunitivedamagesare imposedona firm, it is
notalwaysclearwhoisreallybeingpunished.Consequently,thepunishmentobjective
maynotbereadilyachieved.Thisissueisbrieflyaddressedinthefollowingsection.
4.2.WhoisBeingPunished?
The ease of realizing the punishment objective varies considerably between
individualsandcorporateentities.
Generally, when the defendant is an individual, the punishment objective can be
achievedwithoutproblems.All it takes isanassessmentof thereprehensibilityof the
individual’s wrongful conduct and the imposition of suitable punishment. Yet, this
assumesthatthereisacorrectlevelofpunishmentthatdependsonthereprehensibility
ofthedefendant’sconduct.139
Achieving the same punishment effect on a corporate entity via punitive damages,
however, canbeproblematic forvarious reasons.Thesearemosteasilyunderstood if
weconsiderafirmasanexusofcontractsbetweendifferentgroupsofindividuals,each
ofwhichhasitsowninterestinthefirm:140
First,culpableemployeeswhoaredirectlyresponsiblefortheharmaremostlikelynot
goingtobedirectlypenalized.Oftentimes,firmsarenotabletoidentifytheresponsible
individuals, especially in larger entitieswith complex corporate structures. Themore
138Sharkey(2003),pp.357‐358139PolinskyandShavell(2000),p.772140 For a detailed discussion, see e.g. Jensen and Meckling (1976) and Alchian and Demsetz (1972),
viewing the firm as a set of contracts between its factors of production; and Bainbridge (2002)conceivingafirmasanexusofcontracts
PunitiveDamages:AnEconomicJustificationCedricDuvinage
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employeesafirmemploys,theharderitisfortheownersofthefirmtosuperviseeach
and every employee, who might have an incentive to behave opportunistically. This
reflects the adverse effect of separations between ownership and control. Due to
different risk attitudes and information asymmetries between the owners and the
employeesofafirm,employeesmayprioritizetheirowninterestsoverthoseofthefirm
asawhole.141
But even if a firm can identify the culpable individuals, the effectiveness of the
punishment of blameworthyparties depends on the efficacy of the corporate internal
sanctions implemented. The disciplinary effect on the individual employee who, for
example,isdismissedasaresultofhiswrongfulactisrelativelysmallwhencontrasted
withtheoccasionallysevereconsequencesofindividualmisbehavior.142
Furthermore,theadditionalmarginalpunishmentimposedbypunitivedamagesonthe
responsibleindividualwillbealmostnegligiblecomparedtothatonthefirmasawhole.
Theinternalcorporatesanctionsimposedontheculpableemployeewillmostlikelynot
be much greater, if the company has to bear punitive damages in addition to
compensatory damages, than if the company merely had to pay compensatory
damages.143
Moreover,theremaybesituationswheretherearenoindividualemployeestobeheld
liable.Corporatedecision‐makingprocessestodayofteninvolvemultipleindividualsso
thattheremaynotbeanindividualassuchtoblame.Inaddition,ifthefinaljudgmentis
calledalongtimeafterthemisconductoccurred,theblameworthyindividualsmayhave
gone into retirement, switched jobs, ordied in themeantime.Note, however, that the
former employermight still be able to sue an employeewho retired or changed jobs
afterwards.144
All these difficulties of identifying culpable individuals within a firm and effectively
achievingthepunishmentobjectiveposeadebatablequestiontobeconsidered:Instead
141 Polinsky and Shavell (1998), p. 950; For a detailed discussion of the agency theory, seee.g. Eugene
(1980)andalsoBainbridge(2002)142PolinskyandShavell(1998),p.950143PolinskyandShavell(1998),p.950144PolinskyandShavell(1998),p.951
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oftryingtopunishindividualemployees,shouldwepunishtheownersofafirmfortheir
failuretosupervisethem?
Interestingly enough, punitive damages already indirectly punish owners, i.e. the
shareholders, of corporate entities. If a firm has to pay large amounts of punitive
damages,thefirmvaluewillbereduced.Infact,themereexposuretotheriskofhaving
to pay punitive damages already reduces a firm’s value. This inevitably punishes the
shareholders being the residual claimants of the firm. Of course, shareholders may
actuallybetheblameworthypartiesthemselves.Iftheownershipstructureofthefirmis
concentrated and the major shareholder actively participated in the decision‐making
processthatledtothemisbehavior,theshareholdermustbetreatedasculpablehimself.
However,minorityshareholdersaretypicallynotinthepositiontobeabletoinfluence
the management of a firm. Thus, they neither have the incentive nor the power to
activelysupervisetheemployeesofthefirm.145
Hence, when the defendant is a corporate entity, imposing punitive damages as
punishmentposestechnicalproblems.Theeffectivenessofpunishingfirmsviapunitive
damages is clearly suboptimal.Thepunishmentobjectiveonlyprovideseagerplaintiff
attorneys another basis for arguing pro an imposition of punitive damages to collect
windfallprofitsunder theU.S. contingency fee system. Inany case, even though there
may be other social reasons for imposing punitive damages as punishment, the
punishmentobjectiveislargelyirrelevantfromaneconomicperspective.
145PolinskyandShavell(1998),pp.951‐952
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5.TheBehaviorofAmericanJuries
5.1.HowDoJuriesPerforminAwardingPunitiveDamages?
Another distinct feature of the American legal system is the jury. It reflects its
emphasisondemocraticvaluesandaself‐governing tenet. Indeed,with the first three
words of the United States Constitution “We the People […]” the Founding Fathers
prioritized this fundamental democratic principle in theU.S. legal system.146However,
thejuryasafactfinderhasbeenwidelycriticized,especiallywhenitcomestoawarding
punitive damages. Critics of jury trials have a common perception that juries tend to
have“[…]abiasagainstcorporateandotherdefendantscreditedwithdeeppockets”.147
This suggests that juries impose punitive damages arbitrarily and emotionally driven
ratherthanbasedonaconsistentlyobjectiveconstruct.
InaninterestingexperimentalstudyconductedbyProfessorViscusi,anumberofjury‐
eligiblecitizenswerepresentedwithdifferentcasescenarios.Theywerethenaskedto
decide foreachscenariowhether theywould imposepunitivedamages,and if sohow
much.Theresultsshowedthattheresponsesofthedifferentparticipantsagreedfairly
well regardingwhetherpunitivedamages shouldbe imposedat all.Thus, theaverage
jurorseemstobeabletoconsistentlyevaluatewhetherpunitivedamagesarenecessary.
However, theextentofpunitivedamages imposedby thedifferentparticipants lacked
coherency.148 Why might this be the case? A few answers can be derived from the
participants’responsestothedifferentscenarios.Theyprovideinterestinginsightsasto
what kindof factors typically drive a jury’s verdict onpunitivedamage amounts. The
maindrivingfactorsthatwereobservedareoutlinedbelow:
First, the study showed that jurors actually punish firms for conducting costs‐benefit
analyses. Juries tend to impose more punitive damages on firms that systematically
performed risk analyses to attain an efficient balance between risk and costs. This is
because juries tend toviewsuchanalysesasan indicator for recklessbehavior rather
146TheConstitutionoftheUnitedStates,Preamble147Fleming(1988),p.111148Viscusi(2002),p.157
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thanasa firm’seffort tomeet itsdutyof care.149 Supposeadetailed riskanalysiswas
carriedoutbeforeanaccidentoccurredandthefirmasaresultdecidedonanefficient
levelofrisk,i.e.wherethemarginalbenefitofreducingtheriskequalsthemarginalcost
ofdoingso.Itfollowsthatfirmstypicallyalwaysassumeatleastsomerisk,eventhough
itmaysometimesseem“statisticallytrivial”150,asintheMcDonald’sHotCoffeeCase.Yet,
oncethisremainingriskmaterializes,thejuryperceivesafirm’sconsciouschoiceofan
efficientriskasafundamentaldisregardofthecustomer’shealthandsafetybythefirm.
Thereasonisthatthefirmknewabouttheriskandunderstoodhowtoproduceasafer
product.151
This isalsowhatstruck the jury inLiebeckv.McDonald’sRestaurants,P.T.S., Inc..After
the trial, Jack Elliott, one of the jurors, remarked that McDonald’s demonstrated a
“callous disregard for the safety of the people”.152 Another juror, Betty Farnham,
commented“therewasapersonbehindeverynumberandIdon’tthinkthecorporation
wasattachingenoughimportancetothat”.153
However, it is important tonote that jurorsoften fail toput themselves into theante‐
accident position of the firm. Instead, they assess the reprehensibility of the firm’s
conductfromaretrospectiveview.Thus,ajury’sobjectiveviewisalreadyblindedbyits
hindsightbiasbeforeanyevidencehasbeenpresented.154
Moreover, theway a firmperforms its costs‐benefit analysis seems tomatter aswell.
Juriestendtobeparticularlyreceptivewithrespecttothevaluefirmsattachtoahuman
life intheirriskanalyses.However, juries irrationally imposehigherpunitivedamages
onfirmsthatuseahighervalueoflifethanonfirmsthatusealowervalueoflife.Thus,
ineffecta firmthatdemonstratesan increasedeffort tomoresafetybyusingahigher
149Viscusi(2002),p.140150 Liebeck v. McDonald’s Restaurants, P.T.S., Inc., No. CV‐93‐02419, 1994WL 16777828 (Trial Motion,
MemorandumandAffidavit,BernalilloCounty,N.M.Dist.Ct.Sept.12,1994),p.11151Viscusi(2002),p.144152http://www.arktimes.com/blogs/hoglawyer/2007/11/tort_reform_and_mcdonalds_coff.aspx153http://www.arktimes.com/blogs/hoglawyer/2007/11/tort_reform_and_mcdonalds_coff.aspx154Viscusi(2002),p.150
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valueoflife‐therebyhypotheticallymakingtheriskanalysismoreacceptabletojurors‐
willlikelyhavetopaymorepunitivedamages.155
In addition, a jury seems tobehighly influencedby informationpresentedduring the
trialthatismeanttoguidethejuryinthecomputationofpunitivedamages.Thus,ifthe
plaintiff’sattorney,forexample,suggestsacertainamountofdamagesthatheconsiders
to be appropriate, jurors typically base their damage awards on such extraneous
submissions. Consequently, it is questionablewhether attorneys shouldbe allowed to
advocatetheamountofdamagesthattheythinkisappropriatetothejury.156Especially
underacontingencyfeesystem,attorneyshaveanincentivetomaximizethefinalaward
intheirowninterest.
Finally, the experimental study shows that even if a jury was provided with specific
instructionsonhowtocomputeoptimaldeterringpunitivedamages,jurorsfailtoapply
themcorrectly,orevenrefusetodoso.Thus,asimplemathematicalformulaforoptimal
punitivedamages,astheonediscussedabove(Equation7),isunlikelytoleadtoefficient
punitive damage awards as long as punitive damages are solely the jury’s
responsibility.157 Especially when noneconomic harms are involved, such as losing a
child in an accident or the permanent injuries suffered byMs. Liebeck, juries tend to
becomeemotionallyattachedtoacase.Itrestsinourhumannaturethattheobjectivity
of our judgment on social norms deteriorates, as personal sentiment takes over. As
Cooter states, “peoplewho internalize socialnorms feel righteousangeragainst those
who violate them”.158 Consequently, jurors sometimes feel the need to send a clear
messageof disallowance to thedefendant andpotential future injurersby refusing to
applyaconventionaldeterrenceformula.
5.2.WhereDoesThisLeavePunitiveDamages?
TheresultsofViscusi’sbehavioralstudyclearlyshowthat,whilethejuryseems
to be able to tell when punitive damages are appropriate, it is by no means able to
155Viscusi(2002),p.157156Viscusi(2002),p.164157Viscusi(2002),p.163158Cooter(1997),p.82
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imposecoherentamounts.Ajurydoesnotappreciateafirm’sattempttomeetitslegal
duty as best as possible via costs‐benefit analyses, it puts too much weight on
extraneousinformationandittendstobecometooemotionallyinvolvedtoprovidean
objective verdict. Presumably, the main problem is that the average juror has no
experience as a fact finder.Therefore, hedoesnotknowhow to filter andadequately
weight the relevant information presented to him during a trial. So where does this
leavepunitivedamages?
Twoimportantpointsmustbemade:
(1) The image of an arbitrary, inefficient and unfair American legal system is not, as
criticsliketoclaim,theresultofpunitivedamages.Instead,itistheconsequenceofthe
fundamental principle of a democratic and self‐governing American legal system. In
otherwords,therealproblemrestswiththeirrationaljuriesthatareunabletocorrectly
apply an inherently efficient tool. Punitive damages only create a playground that, if
properly used, can improve society’swelfare. Unfortunatelymost critics only scratch
the surface of this playground and fail to identify the actual source of theproblem. It
wouldbeunwisetoeliminateawelfare‐enhancingtoolonlybecausecourtsdonotknow
howtouseitproperly.Itisthereforethelegislator’stasktomakesurethatsocietycan
benefitfromthislegalinstrumentbyensuringitsproperapplication.
(2)While juries should still be able to evaluatewhether punitive damages should be
imposed,thecomputationoftheoptimalamountofpunitivedamagesshouldbeleftto
the professional judges. Civil servant judges, who typically better understand the
economic implications of their judgments, aremore likely to compute consistent and
efficient punitive damage awards. Many scholars share this view arguing that tort
damages in civil law systems aremore consistent and objective than in common law
systems because in civil law systems experienced civil judges rather than a group of
laypersons are responsible for imposing damages.159 Transferring only some
responsibility from the jury to the judge will not onlymitigate the great uncertainty
aroundpunitivedamagesbutalsoformaneffectivecompromisebetweenademocratic
andaneconomicallyefficientlegalsystem.
159Markesinisetal.(2005),p.17
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6.Conclusion
Punitive damages have been widely disputed among legal commentators. This
paper took an efficiency point of view in this debate to arrive at an economic
justificationforpunitivedamages.
Byinitiallyposingtheassumptionsofperfectcompensationandperfectenforcement,it
wasdemonstratedthatinaperfectlegalworldpunitivedamageswouldbesuperfluous.
Compensatory damages equaling harm would suffice to ensure social efficiency.
However,therealworldisfarfrombeingperfect.Ifappliedcorrectly,punitivedamages
helptomitigatesuchlegalimperfectionsandrestoreeconomicefficiency,i.e.minimize
thesocialcostofallaccidents.
If individuals fail to internalize the full costs of an accident, individuals have under
certaincircumstancessuboptimal incentivesforprecaution.It isonlyworthwhilefora
party to breach his legal duty if it chooses a level of precaution far below the legal
standard, which typically requires a deliberate wrongful conduct. This explains why
punitive damages are reserved for “willful, malicious, wanton or reckless” conducts.
Since the benefit that the wrongdoer obtains from his unlawful conduct, whether
socially illicit or not,must be large, sufficiently large punitive damages in addition to
compensatorydamagesareneededtorestoreefficiency.
Besides, themerepossibilityofescaping liabilityalreadyleadsto inefficient incentives
forprecaution.Therefore,injurersmustbeinducedtoexpectthattheywillalsohaveto
pay for all other unenforced harms in order to restore efficiency. Compensatory
damages alone cannot do so. Again, economic efficiency requires total damages
exceeding compensatorydamages,meaningpunitivedamages.Efficient incentives can
onlybereinstatediftotaldamagesequaltheharminflicteddividedbythelikelihoodof
being held liable. The higher the probability of escaping liability, the more punitive
damagesarenecessarytoenforceefficiency.Thus,anystatutorylimitationsonpunitive
damagesleadtoaninefficientlegalsystem.
Yet, efficient incentives can only be re‐established if all uncertainties regarding the
computation of punitive damages are eliminated.Anything elsewoulddeteriorate the
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deterrence effect. Therefore, it is important to recognize that for the computation of
punitivedamagestobepaidbytheinjurerthecontributoryfaultmustnotbetakeninto
account.Onlythecompensatorydamagesportionoftotaldamagesawardedinthecase
attrialshouldbedeductedfromtheamountpayablebytheinjurerbythecontributory
fault percentage, not from the punitive damages to be paid. However, in order to
enhancesocialfairness,thecontributoryfaultcouldalsobedeductedfromtheamount
ofpunitivedamagesthatthevictimmaykeep.
Inanycase,itwouldbeadetrimenttosocialjusticeifonesuccessfulplaintiffcollectsall
thedamagesthatareactuallymeanttocompensateforunenforcedharms.Thus,someof
the punitive damages should be paid to the state to be redistributed to the general
societyviawelfarepayments,orwhereitispossiblethroughinstitutedfundsforsimilar
victims of unenforced harms. The state could collect these punitive damages either
throughstatutoryrequirements(“split‐award”statutes)obligingthesuccessfulplaintiff
topayacertainfractionofthepunitivedamageawardtothestate,orsimplybymaking
punitivedamagestaxable.
In thisway, fromaneconomicstandpointpunitivedamageshaveascertainedtobean
efficiencyenhancinglegal instrumentintort law.However,aslongasthecomputation
ofpunitivedamagesismoreorlesssolelyinthehandsofthejury,itisunlikelythatsuch
efficiencycouldbeimplementedinpractice.Whileitappearsthatjuriesareconsistently
abletotellwhetherpunitivedamagesaretobeimposed,theyillustratearatherrandom
choicewhenitcomestotheamountofpunitivedamages.Suchrandomawardsdonot
have the necessary deterring effect since potential future injurers cannot correctly
estimatethecostsofanaccidentiftheydonotknowhowlargetheirliabilitywillbe.
Asaresult,inordertobeabletobetterimplementtheefficiencyofpunitivedamagesin
practice,thelegislatorshouldtransferthequestionof“Howmuch?”totheexperienced
trial judges. Suchapolicy changewouldnotonlypromoteaproperapplicationof the
efficiency enhancing formulas (as summarized in the Annex of this paper) but also,
opposite to thecapsalready imposed insomeU.S. states, tackle thereal sourceof the
problem:TheAmericanrun‐awayjury.
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Annex
ToenhancetheeconomicefficiencyoftheU.S.legalsystem,thecomputationofoptimal
damagesistobetheresponsibilityofthetrialjudge.Basedontheanalysisofthispaper,
the trial judge should refer to the followingequations for the computationof efficient
damages:
Theoptimaltotaldamagestobepaidbytheinjureristobecomputedby:
€
D* =11− q
− FC
H
Thisamountshallinclude:
(a)Theoptimalpunitivedamagestobepaidbytheinjurer:
€
DP * =q1− q
H
(b)Theoptimalcompensatorydamagestobepaidbytheinjurer:
€
DC* = H 1− FC( )
andseparate:
(c)Thedamagesthatthevictimisentitledtokeep:
€
DV* =q1− q
1− S( ) +1
H(1− FC )
(d)Thedamagespayabletothestate:
€
DS* = D*−DV *
whereqistheprobabilitythattheinjurerescapesliability,Sthepercentagefractionto
bepaidtothestate(eitherintheformofasplit‐awardorintheformofordinaryincome
taxes),FCthepercentagecontributoryfaultbythevictimandHtheharminflictedonthe
victimbytheinjurer.