Damage Multipliers in Market Relationships

Richard Craswell


It is sometimes said that the optimal sanction is the external harm caused by the offense multiplied by one over the probability of punishment. Prior analyses have identified several factors that could raise or lower this optimal multiplier. This article identifies an additional adjustment when victims are customers of the offender and the sanction is paid to victims in the form of damages. In these market relationships, higher sanctions translate into higher prices for customers. If customers are risk-neutral, this will not matter; but if customers are risk-averse, higher sanctions increase the variance of their returns (even if third-party insurance is available). If customers are risk-averse, the optimal number of violations and the optimal quantity of purchases could also change. The net effect could either raise or lower the optimal multiplier, but simulations suggest reductions on the order of 4-40 percent.