On the Determinants and Importance of Punitive Damage Awards

We examine several theoretical and empirical issues concerning punitive damage awards and their importance to business. First, we argue that previous justifications of punitive damage awards ignore the role of private contracting and reputation in assuring contractual performance. In the absence of externalities, punitive awards are not necessary to assure contractual performance even when firms face less than a 100 percent probability of being sued for contractual breach. Next, we examine empirically the sizes, determinants, and valuation impacts of punitive awards assessed against publicly held companies. We find that settlement amounts are low compared to jury awards, and punitive awards are highly variable and difficult to explain using characteristics of the lawsuit or defendant company. Supreme Court and legislative actions affecting punitive awards generally have not had systematic impacts on firm values. Specific punitive lawsuits, however, decrease the values of defendant companies by amounts that exceed settlement or jury verdict amounts, indicating that punitive lawsuits impose reputational costs on defendants.