Inadequate compensation and multiple equilibria

This paper studies alternative care situations in which the injurer is liable for harm but the victim is only partially compensated for her losses, for example, because the accident will result in serious bodily injury or death. In these situations, liability gives rise to multiple equilibria, some of them inefficient. We analyze possible solutions to the multiple equilibria problem including precaution costs liability and regulation. Notably, we show that in a dynamic setting punitive damages do not eliminate the inefficient equilibrium, but make its attainment less likely; we thus provide a novel justification for punitive damages which is consistent with legal doctrine and practice. Our analysis illustrates the importance of compensating victims, when feasible, rather than merely burdening injurers, for efficiency purposes. This suggests that common theoretical conclusions on accuracy in assessing damages and on decoupling damages and compensation, which leave victims only partially compensated, may not apply.