A Regulatory Compliance Model for Punitive Damages

This paper proposes a regulatory compliance model of punitive damages, to provide an economic framework for assisting the trier of fact in determining the appropriate level of punitive damages. Existing models and case law for punitive damages generally posit punitive damages as a multiple of the compensatory award. Using a regulatory compliance model, this paper shows that existing models for computing punitive damages have no economic basis because the wrongdoer’s gain is neither the same as nor a constant ratio of compensatory damages (i.e., harm) in the general case. The results show that because higher compensatory damages result in a smaller gain, punitive awards should be smaller as the compensatory award becomes larger. A key distinction between this and existing models is that optimal deterrence for the potential wrongdoer and socially optimal deterrence are not necessarily the same. Optimal deterrence in the proposed model flows from perfect adherence to regulation. To the degree that regulations result in socially suboptimal deterrence, the solution to this imbalance is regulatory change, not punitive damages, because punitive damages for a wrongdoer, who ex ante complied with regulation, are not consistent with conduct warranting punitive damages. If the regulatory level is perfectly aligned with the social optimum, there is no difference between socially optimal deterrence and optimal deterrence in the proposed model. Further, tying the punitive damages award to wealth has no economic basis when the motive is profit. Similarly, damage caps or limits on punitive awards, if binding, will result in underdeterrence, but this assumes that punitive damages are correctly based on a multiple of the gain, not compensatory damages.