Economic Analysis of Private Law:

New Frontiers
Lecture 4:
Liability and Compensation
Omri Ben-Shahar
Summer School in Law and Economics
University of Chicago, 2017

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 Punishment versus Compensation

Why are some violations subject to public

enforcement, and others subject to private
enforcement? Criminal versus Civil?

What is the principle underlying the distinction

between public and private law? When is an
infraction categorized as criminal v. private law?

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 Probability of Sanction
What is the probability that victim will recover in
a private action?
– Probability of detection
– Probability of successful legal action
– Probability of execution of judgment

Breach of contract: prob=1  private action

Homocide: prob=0  public action

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 Public enforcement
• Low probability of detection
– Investigation, collection of evidence
– Compelling witnesses to testify
• Low probability of successful legal action
– Many small stakes
– High litigation/attorney costs
• Low probability of execution of judgments
– Judgment proof defendant
– Use of non-monetary sanctions

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If it is hard to detect and sue the
wrongdoer, does the government have
to step in and be the enforcer? Can we
get deterrence without public
enforcement and without criminalizing
the act?

Punitive damages recoverable by plaintiff

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 Punitive Damages

Punitive damages are a public/private mix

– Private action, compensation to victim/plaintiff
– Sanction thought to be representing some social
interest/harm

When should punitive damages be awarded?

- Probability of detection theory
- (Polinsky & Shavell 1998)
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Example:
– harm=100
– Probability of recovery = 50%
 Damages = 200 (multiplier of 2)
Now, expected judgment is
50% x $200
= $100
= HARM

Generally: Damages = harm/prob

• This multiplier approach cannot work when the
problem is judgment-proof defendant 
criminal sanctions
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 Doctrine
Should an oil company pay punitive damages for
an oil spill?
– Do oil spill go undetected? Uncompensated?

Should a manufacturer pay punitive damages

for defective product? Coffee spill?
– Which product injuries go uncompensated?
– Do clients want to buy this kind of over-
compensatory insurance?

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 Willful breach of contract
Law: willful breach is more “reprehensible” and
should lead to higher damages:
– Bad faith denial of insurance claim punitive
damages
– Opportunistic breach: sale to a higher bidder 
disgorgement of damages

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 Two Opposite Views
– View 1: Fault is irrelevant
• Holmes (1881): The promisor has a right to breach; a
contractual obligation is an option – perform or pay
damages.
• Posner (2009): “Let Us Never Blame a Contract Breaker”
• Law and Economics: Efficient breach theory.
– View 2: Fault Matters
• Willful Breach doctrine
• Business community despises willful breach

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 Why does fault, willfulness, matter?

Traditional Explanation: Sanctity of Contract

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Why does fault, willfulness, matter?

An Information-Based Explanation
(Bar-Gill & Ben-Shahar 2009)

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Example: Overbooked Flights
 A common sentiment reported is that

“overbooking is a conscious fraud, in that the

seller has sold a contract knowing that it might
not honor that contract.”
 Puzzling. Why are people so resentful about

this seemingly efficient practice?

 One passenger is quoted as saying: “If flights

are being overbooked, then what does that say

about how the airline runs their business?”

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 Why does fault, willfulness, matter?
 Some breaches are stand-alone events; others are part
of a pattern.
 Some promisors are “bad types” in the sense that they

chose low ex ante investment/effort,

 The low effort creates a pattern of sub-par

performances.
 Not all breaches and sub-par performances are observed

 Breach is a “signal” that the promisor is a “bad type” 

we infer that there is a pattern of undetected violations.

 If some of the breaches by the bad type are not detected

 punish more severely the one that is detected

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Information-Based Explanation
 This is a theory about patterns of breach of “bad”
actors.
 There is nothing especially blameworthy about the
breach itself. The extra punishment is for the
undetected breaches – the missing pieces of the
picture/pattern.
 The fault is located at the ex ante stage: low investment
 stand-alone breach v. breach that is part of a pattern.

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Puntive Damages for Willful Breach –
 “Willfulness” and fault are not the reason or the

test
 There is no “MENS REA”

 Willfulness is a “label”, the CONCLUSION, of the

analysis that focuses on the underlying decision to

impose a pattern of sub-performance behaviors

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 Emotional Harm
• A type of punitive damages rule
• Common law courts award compensation for
“emotional distress” when
– Bad Faith breach
– Contracts that have a “personal” element
– Torts specifically designed to protect against non-
pecuniary wrongs: libel, intentional infliction of
emotional distress, invasion of privacy.

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 Emotional Harm
Examples:
• Volkswagen emissions deception
• Selling food labeled “vegetarian” or “kosher”
or “fair trade” despite knowing that it is made
with meat products, or non-kosher, or with
unfair labor practice

How to compensate for the emotional distress

to consumers?
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 Emotional Harm
The problems:
• How to measure in $$$ the emotional
damage?
• How to verify that an individual plaintiff truly
suffered the distress?

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 Emotional Harm
Ben-Shahar & Porat (work-in-progress, 2017):
• “Restoration Damages” = money paid by
wrongdoer
• To restore the underlying interest that was
injured
– VW: Purchase emissions permits and not use them, in
the amount of pollution that deception caused
– Vegetarian food: Payment to animal welfare
organization
– Kosher food: donation to religious institution
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 Emotional Harm
Ben-Shahar & Porat (work-in-progress, 2017):
• “Restoration Damages” = money paid by
wrongdoer
• To restore the underlying interest that was
injured
• Payment does not go to victim directly

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 Emotional Harm
Screening: how to verify which plaintiff suffered
emotional harm?
• “No Arbitrage”: plaintiff cannot sell a release
• Sorting mechanism: Offer a plaintiff either
1) Full restoration damages paid to repair the
damage
2) Small sum of money damages paid to plaintiff
• Emotionally-harmed victims will choose (1)
• Fakers will choose (2)
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 Emotional Harm
Ben-Shahar & Porat (work-in-progress, 2017):
• “Restoration Damages” solve the problem of
– Measuring emotional harm
– Awarding recovery only to those truly harmed
• “Restoration Damages” provide stronger
deterrence against injuries that have a
predictable emotional component

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 Emotional Harm
Ben-Shahar & Porat (work-in-progress, 2017):

(Paper will be posted on SSRN later in the summer)

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 Personalizing Negligence Law
• Tort law uses “one size fits all” standards of
care
– “Reasonable Person”
• Should Standards of care be tailored to the
characteristics of the specific actor?
– “Reasonable YOU”

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 Two “Big Data” Questions

1) Personalization (Granularity): Towards

algorithmic legal rules
– personalized default rules, disclosures

2) Machine learning: Replacing human actors

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. . . On replacing human actors:

Strong hostility to algorithmic judges

But: is the opposition a“status quo” bias?

100 years ago: “The horse is here to stay but

automobiles are only a novelty, a fad”
- Daimler: “Not enough chauffeurs”
Existing Law: Uniform standards
– based on averages
– Some limited tailoring (Elevated capacity)
– Size of the comparative pool may vary: “All actors,”
“All Doctors,” “All Specialists”

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Ben-Shahar & Porat, Personalized Negligence Law
(NYU Law Review, 2017)

Personalized Negligence standards are superior!

- Better prevention of accidents
- Better fit with ideals of justice

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 Two Dimensions of Personalization
1. “Skill”: according to acquired proficiency
– “skilled” v “unskilled” (technical training, equipment)
– Example: surgeon at S/K v. county hospital
2. “Risk”: according to inherent dangerousness
– “safe” v. “dangerous” (instinct, mental/physical power)
– Example: age of surgeon; eyesight of driver

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 Two Dimensions of Granuality
1. “Skill”: according to acquired proficiency
– “skilled” v “unskilled” (technical training, equipment)
– Example: surgeon at S/K v. county hospital
2. “Risk”: according to inherent dangerousness
– “safe” v. “dangerous” (instinct, mental/physical power)
– Example: age of surgeon; eyesight of driver

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People may be more harmful if
–Unskilled (e.g., slower to react)
–Dangerous (e.g., overworked)

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 Claim #1: Efficient Care
Personalized standards are more efficient
• Unskilled actors  take less care than the Skilled
• Dangerous actors  take more care than Safe actors

(The two effects may be pulling in different directions)

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 Claim #2: Victim Contributory Care
Criticism: Injurers’ behavior is MORE differentiated,
and therefore victims face more volatile environment
and would not be able anticipate their burden of care

Wrong!

Risk imposed by injurers is LESS differentiated

– under risk-based personalization

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 Claim #3: Incentive to Improve
Intuitive objection to personalization: undermining
the incentive to reduce one’s harmfulness
• Distortion occurs only if standards depend on
acquired skill: improved skill leads to higher cost
of compliance
• Distortion does NOT occur if standards depend
on inherent riskiness; reduced riskiness leads to
lower cost of compliance (caveat)

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 Incentive #4: Levels of Activity
Criticism: Reduced standards of care to harmful injurers
leads to too much activity
– Holmes, Posner: This is the #1 reason against
personalized standards of care
• This is correct only with respect to skill-based standards
• Risk-based standards: more inherently dangerous
injurers have to take HIGHER care  reduced level of
activity

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 Summary
Standard based on inherent “riskiness”:
- Improve care by injurers
- Reduce expected risk borne by victims
- Create incentives to reduce riskiness, ex ante
- Have desirable indirect effect on levels of
activity

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Are personalized standards “fair”?
Corrective justice:
- Should the duty owed to the victim depend on
the personal characteristics of the injurer?
- Leading philosophers: NO (cost is irrelevant)
- Ben-Shahar & Porat: YES

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Are personalized standards “fair”?
Distributive justice:
- Is it distributively fair to treat different injurers
who acted the same differently?
- When people have different skills, it is fair to
demand different behavior
- A progressive policy

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 Implementation
• Big Data in courts?
– Applied in insurance, medicine, education,
employment, manufacturing/design, advertising –
Why not courts?
• Do actors have the information to anticipate the
personalized standards?
– Easier to anticipate personalized standards
– Gradual personalization (“three-step”)
– Presumptions

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 Personalized Negligence Law
Ben-Shahar & Porat (NYU Law Review, 2017):

(Posted on SSRN)

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 Sanctions versus Rewards
A basic choice in private law:
• Sanctions for wrongdoing
• Reward for not wrongdoing

Example: environmental enforcement

• How to get nations, corporations, to comply
with GHG emissions standards?

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 Sanctions versus Rewards
The problem with sanctions:
• Wrongdoers may not have money to pay

The problem with rewards:

• Enforcers may not have enough money to pay

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 Rewards v. Sanctions
• Sanctions
– Superior if the threat of sanctions credible
– When no credible threat, may be very costly or ineffective
• Rewards
– No deadweight loss, just a monetary transfer
– Cost of rewards
– Why rare?
• Combining rewards and sanctions: “Reversible
Rewards” (Ben-Shahar &Bradford, ALER 2010)
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 “Reversible Rewards”
• Establishing an enforcement fund
• Dual use of the money in the fund:
– Offered as a reward to the Violator for complying;
or:
– Offered as a reward to the Enforcer for
sanctioning

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 “Reversible Rewards”
Examples:
• International law: fund used to reward
compliance, or punish for non compliance
• Property disputes: offer reward to end
nuisance, or use the money to finance lawsuit
• Elections: offer support for candidate A, and
threaten to divert the support candidate B
• Antitrust: Cartel investigations - offer reward
to company A for compliance, and threaten to
offer it to company B
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 Summary

• Punitive Damages for undetected violations

• Compensation for emotional distress
• Personalized Law
• Rewards for Compliance

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 Summary

• Punitive Damages for undetected violations

• Compensation for emotional distress
• Personalized Law
• Rewards for Compliance

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