Thursday, June 17, 2010

The Perverse Incentives of Tort Reform and Liability Caps -- Good intentions gone awry.

As a practicing attorney, I've seen firsthand the results of negligence on the lives of victims--lives destroyed by the carelessness of others.

When I hear that BP and other large corporations push for liability caps, I practically cringe at the perverse incentives of restricting damage awards.

When a tortfeasor knows they escape paying the full cost of the damages they visit on innocent victims, where's the incentive to maximize safety of their activities?  

To the contrary, liability limits encourages maximization of activities leading to liability.  

For example, if the law suddenly limited the penalty for robbing a bank to an overnight stay in jail, regardless of the amount of money stolen or injuries caused, then more bank robberies would occur.  It's real simple.  

By creating liability caps, we give corporations a license to engage in bad behavior.  We don't allow our children to behave this way, so why do we let companies?  What message does that send about our priorities?

Let's use an analogy:

When disciplining your child, you have a range of options, viz., corporal (spanking), grounding, and privilege withdrawal.

These punishments offer the full range of disciplinary choices. Their impact comes, not from using all of them, but in the uncertainty of which one will be applied.

Now, lets say your spouse hates spanking and he/she successfully dissuades you from spanking--what result?  

The child knows for certain that any misbehavior results in only grounding or loss of privileges.

Similarly, with liability caps large tortfeasors gain the certainty of knowing the maximum cost of misbehavior.  They can calculate the potential cost; they can now maximize their bad actions, knowing they will not pay the full consequences.  

Unfortunately, those costs just don't disappear.  They must go somewhere.  They get pushed onto the innocent who are damaged by these large entities.

Back to our analogy:  Say your child enjoys staying in their room.  

In that case, grounding offers little punitive effect, since grounding equates to an enjoyed activity.  

Your punishment options dwindled to one: Privilege removal.

If a child knows they only risk one punishment for misbehavior, irrespective of how bad that misbehavior may be, and that punishment is privilege loss, then where's the incentive to behave?

Likewise, capping liability awards, by law eliminates any incentive for corporate actors to behave in a socially responsible manner?

In fact, capping liability incentive-izes bad behavior.  These entities rationally increase liability-inducing actions to offset their sum-certain liability?

Liability caps and liability limits do nothing but reduce the free market. Liability serves to place the costs of doing business onto the party actually incurring them. 

We discourage our children from becoming criminals through discipline.  Why would we, as a society, encourage corporations to ignore safety and push the costs of making profits onto the innocent and least capable of bearing those costs?

By limiting liability and by imposing liability caps, that is exactly what we do?