Lessons from America
New Horizons in Law and Economics series
Edited by Jürgen G. Backhaus, Alberto Cassone and Giovanni B. Ramello
Francesco Parisi and Marta Silvia Cenini 1. INTRODUCTION Punitive damages (or exemplary damages, as they are called in the United Kingdom) are damages that are awarded in excess of the plaintiff’s actual harm when compensatory damages are insufficient to deter and redress wrongdoing. The law and economics literature (Polinsky and Shavell 1998; Shavell 2004) usually suggests that punitive damages1 should be awarded when a tortfeasor has a significant chance of escaping liability for the harm caused. The economic function of punitive damages is that of deterring undetectable torts and tortfeasors that strategically rely on imperfect enforcement. These conditions are often found when litigation costs are very high or when it is difficult for victims to identify who injured them. Punitive damages should offset the deterrence-diluting effect of the chance of escape from liability. Given this function, punitive damages should be determined by multiplying the harm caused by the reciprocal of the probability of being found liable. Mathematically, let’s consider the case of a unilateral accident and define the level of precaution undertaken by the prospective tortfeasor as x, which imposes a linear unitary cost w. As usual, p is the probability of creating an accident of gravity A. The probability of an accident is a function of x, with p' < 0 and p' > 0. The tortfeasor’s liability when the accident actually occurs is L. Given any potential accident situation i, the social objective is to minimize the social cost function, given by the sum of precaution costs and expected accident...
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