Punitive Damages: Their Determinants, Effects on Firm Value, and the Impact of Supreme Court and Congressional Attempts to Limit Awards

Abstract

All three of these punitive awards were upheld by the U.S. Supreme Court, but in recent decisions the Court has begun to reign in such awards.The Court ruled that the punitive damage award in BMW v. Gore, for example, was so excessive that it violated the Due Process Clause of the U.S. Constitution.The U.S. Congress also recently has considered legislation that would place limits on punitive damages.In 1995, for example, the House of Representatives passed two bills that would cap punitive awards and impose costs on parties who refused settlements and subsequently received judgments for smaller amounts.These efforts are based on a view that large punitive awards are costly to defendant companies.Little is known, however, about the importance of punitive awards for firm value, and hence, the value of judicial or legislative limits on such awards.Anecdotes about a few exceptionally large awards do not necessarily imply that firms in general expect large losses when cases are filed against them.Nor do they indicate that punitive damages impose large losses on the market as a whole.One objective of this paper is to measure the valuation impacts of punitive awards, the lawsuits that bring them about, and judicial and legislative attempts to place limits on them.We also examine the predictability of punitive damage awards.Sunstein et.al (1997) present a theory implying that potential punitive awards should be both unbounded and unpredictable.The evidence about the predictability of punitive awards, however, is mixed.Consistent with their prediction, Sunstein et.al. provide experimental evidence supporting the notion that dollar awards made by juries are inherently difficult to predict.Similar results using experimental markets are reported by Kahneman, et.al. (1997).Using data from actual practice, however, Eisenberg, et.al. (1997) conclude that punitive damages are at least as predictable as compensatory damages.They find that nearly 50 percent of the cross-sectional variation in punitive damages can be explained with a simple linear model using compensatory damages and broad descriptions of the type of case (e.g., medical malpractice or fraud).However, serious concern has been raised about the Eisenberg study, as it excludes cases that have been settled and explains only the variation in punitive damages cases where punitive damages have been awarded (Polinsky, 1997).We address this issue by examining