Loss Aversion and Law's Formation

Abstract:     
Why is tort law much more developed than unjust enrichment law? Is there a reason for the very different legal treatment of governmental takings and governmental givings? Why are contract remedies structured around the four ‘interests’ and why is the disgorgement interest only marginally protected? What might explain the fact that affirmative action plans invariably apply to hiring and not to firing?

This Article suggests that there is a common denominator to these and other puzzles: they are all best answered on the basis of loss aversion. Psychological studies have established that people do not perceive outcomes as final states of wealth or welfare, but rather as gains and losses. Gains and losses are defined relative to some reference point, and losses ordinarily loom larger than gains. Loss aversion thus explains fundamental characteristics of entire legal fields and even their relative importance.

The article also hypothesizes about the causes of the compatibility between loss aversion and the law. One, evolutionary theory focuses on plaintiff’s behavior. Another theory focuses on the mindset of legal rule-makers and points to an important correspondence between psychology, morality, and law.

Finally, the article explores various normative implications of loss aversion. Among other things, it argues that, ceteris paribus, the law should favor not-giving over taking. Lawmakers should take into account the effect of legal norms on the way people frame gains and losses, as well as the effect of loss aversion on legal policymakers themselves.

Number of Pages in PDF File: 60

Keywords: Prospect Theory, Loss Aversion, Reference Points, Behavioral Law And Economics, Contract Remedies, Disgorgement, Tort Law, Unjust Enrichment, Restitution, Takings, Affirmative Action, Burden of Proof, Efficiency of the Common Law, Moral Psychology, Commonsense Morality, Deontology

JEL Classification: A12, D61, D81, K00, K11, K12, K13

working papers series