Decoupling as Transactions Tax

Abstract:     
In an influential paper Polinsky and Che (1991) propose that litigation can be made a more cost effective tool for setting primary activity incentives (e.g., for product safety or promissory performance) by reducing plaintiffs' recovery while simultaneously raising defendants' damages. "Decoupling" in this manner reduces the number of filed suits, but increases the deterrent impact of each. Litigation costs fall, but, if damages are raised sufficiently, deterrence is maintained. Yet when the state takes from liable defendants more than it gives to victorious plaintiffs it effectively taxes (probabilistically and collectively) the transaction that led to the present litigation. This tax drives a wedge between the expected social and private benefits of participating in the transaction in the first place. The result is that socially beneficial transactions fail to take place. In this paper we explore the impact of this transactions-discouraging effect on the propriety of decoupling.

Number of Pages in PDF File: 24

Keywords: decoupling, contracts, torts, private versus social surplus

working papers series