1229304

Stanford Law Review
A Behavioral Approach to Law and Economics

Author(s): Christine Jolls, Cass R. Sunstein and Richard Thaler
Source: Stanford Law Review, Vol. 50, No. 5 (May, 1998), pp. 1471-1550
Published by: Stanford Law Review
Stable URL: http://www.jstor.org/stable/1229304
Accessed: 13-10-2015 10:21 UTC
REFERENCES
Linked references are available on JSTOR for this article:
http://www.jstor.org/stable/1229304?seq=1&cid=pdf-reference#references_tab_contents
You may need to log in to JSTOR to access the linked references.
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at http://www.jstor.org/page/
info/about/policies/terms.jsp
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content
in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship.
For more information about JSTOR, please contact support@jstor.org.
Stanford Law Review is collaborating with JSTOR to digitize, preserve and extend access to Stanford Law Review.
http://www.jstor.org
This content downloaded from 132.198.50.13 on Tue, 13 Oct 2015 10:21:37 UTC
All use subject to JSTOR Terms and Conditions
ARTICLES
A BehavioralApproachto Law and
Economics
ChristineJolls,* Cass R. Sunstein,**
andRichardThaler***
Economicanalysis of law usuallyproceeds underthe assumptionsof neoclassical economics. But empiricalevidencegives muchreason to doubtthese
assumptions;people exhibit boundedrationality,boundedself-interest,and
boundedwillpower. Thisarticle offersa broadvision of how law and economics analysis may be improvedby increasedattentionto insightsabout actual
humanbehavior. It considersspecific topics in the economicanalysis of law
and proposes new models and approachesfor addressingthese topics. The
analysisof the article is organizedinto threecategories: positive,prescriptive,
and normative. Positive analysis of law concernshow agents behave in response to legal rules and how legal rules are shaped. Prescriptiveanalysis
concernswhat rules should be adoptedto advancespecifiedends. Normative
analysisattemptsto assess morebroadlythe ends of the legal system: Should
the systemalwaysrespectpeople's choices? By drawingattentionto cognitive
and motivationalproblemsof bothcitizensandgovernment,behaviorallaw and
economicsoffersanswersdistinctJfomthoseofferedby the standardanalysis.
* AssistantProfessorof Law,HarvardLawSchool.
** KarlN. LlewellynDistinguished
ServiceProfessorof Jurisprudence,
Universityof Chicago.
*** RobertP. Gwinn Professorof Economicsand BehavioralScience, GraduateSchool of
Business,Universityof Chicago.
We acknowledgethe helpfulcommentsof IanAyres,LucianBebchuK,Colin Camerer,David
Chary, RichardCraswell,JonElster,NunoGaroupa,J.B.Heaton,SamuelIssacharoff,Dan Kahan,
Louis Kaplow,Lewis Korhauser,LawrenceLessig, StevenLevitt,A. MitchellPolinsky,EricPosner, RichardPosner,RichardRevesz, StevenShavell,JonathanZittrain,Ari Zweiman,andparticipants at the AmericanLaw and EconomicsAssociationAnnualMeeting,the Boston University
Law School FacultyWorkshop,the ColumbiaUniversityLaw and EconomicsWorkshop,workshops at HarvardLaw Schoolon law andeconomicsandon rationality,the NBER BehavioralLaw
and EconomicsConference,the NYU RationalChoiceColloquium,andthe Universityof Chicago
Law and EconomicsWorkshop.ToddMurthaand Gil Seinfeldprovidedoutstandingresearchassistance. Nicole Armentaprovidedhelpfulmaterialon criminalabstinenceprograms. This work
was finishedwhile Thalerwas a Fellow at the Centerfor AdvancedStudyin the BehavioralSciences;he is gratefulforthe Center'ssupport.
1471
1472
LAWREVIEW
STANFORD
[Vol. 50:1471
INTRODUCTION
...........
.......................................................................
I. FOUNDATIONS:
WHATIS "BEHAVIORAL
LAWAND
................................................................................
ECONOMICS"?
A. Homo Economicusand Real People .......................................

1. Boundedrationality..........................................................
2. Boundedwillpower...........................................................
3. Boundedself-interest........................................................
4. Applications......................................................................
B. TestablePredictions ........................................
........
C. Partial and AmbiguousSuccesses of Conventional
Economics ...............................................................................
D . P arsimony ...............................................................................
II. BEHAVIOROFAGENTS.........
.1.........
...........................
A. The UltimatumGame..............................................................
1. Thegame and its sunk-costvariation.......... .....................
2. Fairness, acrimony,and scruples.....................................
B. BargainingAroundCourtOrders...........................................
1. Coasianprediction............................................................
2. Behavioral analysis ..........................................................
3. Evidence............................................................................
C. Failed Negotiations..............................................................
1. Self-servingconceptionsoffairness .................................
2. Evidence............................................... ...... .........
3. Therole of lawyers ........................................
.....
D. MandatoryContractTerms.....................................................
1. Wageandprice effects......................................................
2. Behavioral analysis ..........................................................
III. THECONTENTOFLAW........................................ ..........................
A. Bans on MarketTransactions................................................
1. Bans on economictransactions........................................
2. Other bans ........................................................................
B. Prior Restraintson Speech......................................................
C. Anecdote-DrivenEnvironmentalLegislation (With
Particular Referenceto Superfund)........................................
1. Estimatingthe likelihoodof uncertainevents...................
2. Superfund..........................................................................
IV. PRESCRIPTIONS
........
....................................................................
1473
1476
1476
1477
1479
1479
1480
1481
1485
1487
1489
1489
1489
1493
1497
1497
1497
1499
1501
1501
1502
1504
1505
1505
1506
1508
1510
1510
1515
1516
1518
1518
1520
1522
A. Negligence Determinationsand OtherDeterminationsof

Fact or Law .............. ............. ..................................................
1523
1. Backgrou nd....................................................................... 1523
May 1998]
BEHAVIORAL
APPROACHTOLAW& ECONOMICS 1473
2. Prescriptions.....................................................................
3. Otherapplications........................................
........
B. InformationDisclosure and GovernmentAdvertising ...........
1. Background......................................................................
2. Antiprescription ................................................
3. Prescriptions.....................................................................
C. Behavior of Criminals.............................................................
1. Background......................................................................
2. Prescriptions.....................................................................
V. NORMATIVE
ANALYSIS:ANTI-ANTIPATERNALISM
......................
A. CitizenError ...........................................................................
B. BehavioralBureaucrats..........................................................
CONCLUSION
........
......................................................
APPENDIX:FRAMEWORK
ANDSUMMARYOFAPPLICATIONS
..............
1527
1532
1533
1533
1534
1536
1538
1538
1539
1541
1541
1543
1545
1548
INTRODUCTION
Objections to the rationalactor model in law and economics are almost

as old as the field itself. Early skeptics about the economic analysis of law
were quick to marshalargumentsfrom psychology and other social sciences
to undermineits claims.1 But in law, challenges to the rational actor assumption by those who sympathize with the basic objectives of economic
analysis have been much less common. The absence of sustainedand comprehensive economic analysis of legal rules from a perspective informedby
insights about actual human behavior makes for a significant contrast with
many other fields of economics, where such "behavioral"analysis has become relatively common.2 This is especially odd since law is a domain
where behavioralanalysis would appearto be particularlypromising in light
of the fact thatnonmarketbehavioris frequentlyinvolved.
Our goal in this articleis to advancean approachto the economic analysis of law that is informedby a more accurateconception of choice, one that
reflects a better understandingof human behavior and its wellsprings. We
build on and attemptto generalize earlier work in law outlining behavioral
findings by taking the two logical next steps: proposing a systematic framework for a behavioralapproachto economic analysis of law, and using behavioral insights to develop specific models and approachesaddressingtop-
1. See, e.g., MarkKelman,ConsumptionTheory,ProductionTheory,and Ideology in the

Coase Theorem,52 S. CAL.L. REV.669 (1979); DuncanKennedy,Cost-BenefitAnalysisof EntitlementProblems:A Critique,33 STAN.L. REV.387 (1981);ArthurAllen Leff, EconomicAnalysis
of Law:SomeRealismAboutNominalism,60 VA.L. REV.451 (1974).
2. See, e.g., volume 112, issue 2 of the QuarterlyJournalof Economics,which contains 11
articlesrelatedto behavioraleconomics.
1474
STANFORD
LAWREVIEW
[Vol. 50:1471
ics of abiding interestin law and economics.3 The analysis of these specific
topics is preliminaryand often in the nature of a proposal for a research
agenda;we touch on a wide range of issues in an effort to show the potential
uses of behavioralinsights. The unifying idea in our analysis is that behavioral economics allows us to model and predictbehaviorrelevantto law with
the tools of traditionaleconomic analysis, but with more accurate assumptions about humanbehavior,and more accuratepredictionsand prescriptions
about law. Certainlya great deal of work would be necessary to justify a
final evaluationof most of the topics pursuedhere; there is fertile groundfor
futureresearch,both theoreticaland empirical,and one of our principalgoals
is to suggest the directionsin which thatresearchmight go.
We suggest that an approachbased on behavioral economics will help
with the three functionsof any proposedapproachto law: positive, prescriptive, and normative.4 The positive task, perhapsmost central to economic
analysis of law and our principalemphasishere, is to explain both the effects
and content of law. How will law affect humanbehavior? What will individuals' likely response to changes in the rules be? Why does law take the
form that it does? A superiorunderstandingof humanbehaviorwill improve
answers to such questions.
The prescriptivetask is to see how law might be used to achieve specified ends, such as deterringsocially undesirablebehavior. Much of conventional economic analysis is concerned with this sort of question. Explicit
considerationof behavioralfactors can improve the prescriptionsoffered by
the analyst. For instance, instead of focusing only on the actual probability
of detecting criminalbehavior in consideringwhether offenders will be deterred, the analyst might also want to consider the perceived probabilityof
detection and how it might differ in systematic and predictableways from
the actualprobability.
The normativetask is to assess more broadly the ends of the legal system. In conventional economic analysis, normative analysis is no different
from prescriptiveanalysis, since the goal of the legal system is to maximize
3. The existing legal literatureincludesseveral articlesthat generallycataloguebehavioral
findingsandsuggestlegal issues to which these findingsmightbe relevant. See WardEdwards&
Detlof von Winterfeldt,CognitiveIllusionsand TheirImplications
for theLaw, 59 S. CAL.L. REV.
225 (1986); MelvinAronEisenberg,TheLimitsof Cognitionand the Limitsof Contract,47 STAN.
L. REV.211 (1995); RobertC. Ellickson,BringingCultureand HumanFrailtyto RationalActors:
A Critiqueof ClassicalLaw and Economics,65 CHI.-KENT
L. REV.23 (1989); Cass R. Sunstein,
BehavioralAnalysisof Law,64 U. CHI.L. REV.1175(1997). Theexistingliteraturealso includesa
numberof articlesthatuse behavioralinsightsto analyzespecifictopicsin the economicanalysisof
law-primarily the Coasetheoremandbehaviorduringbargaining.These articlesarerelevantto a
few of the issues we discussbelow, andwe will drawon themin analyzingthose issues.
4. For a similardistinctionbetweenpositive,prescriptive,andnormativeanalysis,see David
E. Bell, HowardRaiffa& Amos Tversky,Descriptive,Normative,and PrescriptiveInteractionsin
Decision Making,in DECISION
MAKING
9 (David E. Bell, HowardRaiffa & Amos Tverskyeds.,
1988);Sunstein,supranote 3.
May 1998]
BEHAVIORAL
"social welfare," usually measured by people's revealed preferences, and

prescriptive(in our sense of the term) analysis also focuses, for the conventional economist, on how to maximize social welfare. But from the perspective of behavioraleconomics, the ends of the legal system are more complex.
This is so because people's revealed preferencesare a less certaingroundon
which to build; obviously issues of paternalismbecome centralhere.
Each of these three strandsof our project is deeply constructive. Behavioral economics is a form of economics, and our goal is to strengthenthe
predictive and analytic power of law and economics, not to undermineit.
Behavioral economics does not suggest that behavior is randomor impossible to predict;ratherit suggests, with economics, that behavior is systematic
and can be modeled. We attemptto sketch several such models here.
PartI below offers a general frameworkand provides an overview of the
argumentsfor enriching the traditionaleconomic framework. We see this
enrichmentas similar in spirit to the increased emphasis on asymmetricinformationin mainstreameconomic analysis in recent decades. Just as people
often have imperfect information,which has predictable consequences for
behavior, the departuresfrom the standardconception of the economic agent
also alterbehaviorin predictableways.
Parts II and III of the article involve positive analysis. Part II examines
how a behaviorally-informedlaw and economics analysis can help to explain
the behaviorof humanagents insofaras thatbehavioris relevantto law. Our
topics here include bargainingbehaviorand the effects of mandatorycontract
terms. PartIII shifts to an explanationof existing legal rules and institutions.
We suggest thatmany featuresof the legal landscapethat are puzzling from a
traditionallaw and economics perspective follow naturallyfrom behavioral
phenomena.
Part IV of the article examines prescriptiveissues, offering a series of
proposals that might seem surprisingor controversial from a neoclassical
economic perspectivebut that follow naturallyfrom taking into account features of actual choice behavior. Our principal emphasis is on how people
respondto informationand how this point bears on the role of law.
Part V is more speculative and normative. We briefly outline the main
problems-some familiar and others less so-with the idea that the legal
system ought always to respect informedchoice, and also with the idea that
governmentdecisionmakers-who afterall are behavioralactorstoo-can be
relied upon to make better choices than citizens. Because of the complexity
of these issues, we emphasize three broad points: the frameworkthat behavioral economics suggests for thinking about issues of paternalism;the
possibility that some institutions-such as populist government-may be
particularlybad at attemptedcorrectionof citizen error,while others may be
better;and the prospect that some methods of correction(such as those that
1476
LAWREVIEW
STANFORD
[Vol. 50:1471
focus on debiasing ratherthan outrightcoercion) may be acceptable even if

one thinks thatcitizen erroris relativelyunlikely.
I. FOUNDATIONS: WHAT IS "BEHAVIORALLAW AND ECONOMICS"?
In orderto identify, in a general way, the defining featuresof behavioral

law and economics, it is useful first to understandthe defining features of
law and economics. As we understandit, this approachto the law posits that
legal rules are best analyzed and understoodin light of standardeconomic
principles. Gary Becker offers a typical account of those principles: "[A]ll
human behavior can be viewed as involving participantswho [1] maximize
their utility [2] from a stable set of preferencesand [3] accumulatean optimal amount of informationand other inputs in a variety of markets."5 The
task of law and economics is to determinethe implications of such rational
maximizing behavior in and out of markets, and its legal implications for
marketsand other institutions. Although some of Becker's particularapplications of the economic approachmight be thought of as contentious, that
general approachunderliesa wide range of work in the economic analysis of
law.6
What then is the task of behaviorallaw and economics? How does it differ from standardlaw and economics? These are the questions we address
below.
A. Homo Economicusand Real People
The task of behavioral law and economics, simply stated, is to explore
the implications of actual (not hypothesized) human behavior for the law.
How do "realpeople" differ from homo economicus? We will describe the
differences by stressing three important "bounds" on human behavior,
bounds that draw into questionthe centralideas of utility maximization,stable preferences, rational expectations, and optimal processing of information.7 People can be said to display boundedrationality,boundedwillpower,
and boundedself-interest.
All threebounds are well documentedin the literatureof other social sciences, but they are relatively unexplored in economics (although, as we
noted at the outset, this has begun to change). Each of these bounds represents a significant way in which most people departfrom the standardeco5. GARYS. BECKER,THEECONOMIC
APPROACH
TOHUMANBEHAVIOR14 (1976).
6. See, e.g., A. MITCHELL
TO LAW AND ECONOMICS
POLINSKY,AN INTRODUCTION
10 (2d
ed. 1989); RICHARD
A. POSNER,ECONOMIC
ANALYSISOFLAW3-4 (5th ed. 1998).
7. For a further elaboration of this view, see Richard H. Thaler, Doing Economics Without
Homo Economicus, in FOUNDATIONS
OF RESEARCH
IN ECONOMICS:
HOW DO ECONOMISTS
DO
ECONOMICS?
227, 230-35 (Steven G. Medema & Warren J. Samuels eds., 1996).
May 1998]
BEHAVIORAL
nomic model. While there are instances in which more than one bound
comes into play, at this stage we think it is best to conceive of them as separate modeling problems. Nonetheless, each of the three bounds points to
systematic (ratherthan random or arbitrary)departuresfrom conventional
economic models, and thus each of the three bears on generatingsound predictions and prescriptionsfor law. They also provide the foundations for
new and sometimes quite formalmodels of behavior.
1. Boundedrationality.
Bounded rationality,an idea first introducedby HerbertSimon, refers to
the obvious fact that human cognitive abilities are not infinite.8 We have
limited computationalskills and seriously flawed memories. People can respond sensibly to these failings; thus it might be said that people sometimes
respondrationallyto their own cognitive limitations,minimizing the sum of
decision costs and errorcosts. To deal with limited memories we make lists.
To deal with limited brainpower and time we use mental shortcutsand rules
of thumb. But even with these remedies, and in some cases because of these
remedies, humanbehaviordiffers in systematicways from that predictedby
the standardeconomic model of unboundedrationality. Even when the use
of mental shortcutsis rational,it can producepredictablemistakes. The departuresfrom the standardmodel can be divided into two categories: judgment and decisionmaking. Actual judgments show systematic departures
from models of unbiased forecasts, and actual decisions often violate the
axioms of expected utility theory.
A major source of differences between actual judgments and unbiased
forecasts is the use of rules of thumb. As stressedin the pathbreakingwork
of Daniel Kahnemanand Amos Tversky, rules of thumb such as the availability heuristic-in which the frequency of some event is estimated by
judging how easy it is to recall other instances of this type (how "available"
such instances are)-lead us to erroneousconclusions. People tend to conclude, for example, thatthe probabilityof an event (such as a car accident) is
greater if they have recently witnessed an occurrenceof that event than if
they have not.9 What is especially importantin the work of Kahnemanand
Tversky is that it shows that shortcutsand rules of thumb are predictable.
While the heuristicsare useful on average (which explains how they become
adopted), they lead to errors in particularcircumstances. This means that
someone using such a rule of thumbmay be behaving rationallyin the sense
of economizing on thinking time, but such a person will nonetheless make
8. HerbertA. Simon,A BehavioralModelof RationalChoice,69 Q.J.ECON.99 (1955).
9. Amos Tversky& DanielKahneman,JudgmentUnderUncertainty:Heuristicsand Biases,
in JUDGMENT
UNDERUNCERTAINTY
3, 11 (Daniel Kahneman, Paul Slovic & Amos Tversky eds.,
1982).
STANFORD
LAWREVIEW
1478
[Vol. 50:1471
forecaststhat are differentfrom those that emerge from the standardrationalchoice model.10
Just as unbiased forecasting is not a good description of actual human
behavior, expected utility theory is not a good description of actual decisionmaking. While the axioms of expected utility theory characterizerational choice, actual choices diverge in importantways from this model, as
has been known since the early experimentsby Allais and Ellsberg.11There
has been an explosion of research in recent years trying to develop better
formal models of actual decisionmaking. The model offered by Kahneman
and Tversky, called prospect theory, seems to do a good job of explaining
many features of observed behavior, and so we draw on that model (whose
main featureswe summarizein PartIV.B below) here.12
We emphasize that boundedrationalityis entirely consistent with modeling behavior and generatingpredictionsbased on a model, in line with the
methodology of conventionaleconomics. As KennethArrow has explained,
"[T]here is no general principle that prevents the creation of an economic
theory based on otherhypothesesthan that of rationality .... [A]ny coherent
theory of reactions to the stimuli appropriate in an economic
context. . . could in principle lead to a theory of the economy.""3Arrow's
example here is habit formation;that behavior,he says, can be incorporated
into a theory by supposing that people choose goods with an eye towards
minimizing changes in theirconsumption.
Though there is an optimization in this theory, it is different from utility maximization; for example, if prices and income return to their initial levels after
several alterations, the final bundle [of goods] purchased will not be the same as
the initial [bundle]. This theory would strike many lay observers as plausible,
yet it is not rational as economists have used that term.14
10. For furtherdiscussion,see the recentsurveyof resultsin JohnConlisk,WhyBoundedRationality?,34 J. ECON.LITERATURE

669, 671, 682-83 (1996).
11. See Colin Camerer,IndividualDecision Making, in HANDBOOKOF EXPERIMENTAL
ECONOMICS
587, 619-20, 622-24 (JohnH. Kagel& Alvin E. Rotheds., 1995)(describingthe Allais
paradox);DanielEllsberg,Risk,Ambiguity,andtheSavageAxioms,75 Q.J.ECON.643 (1961).
12. Daniel Kahneman& Amos Tversky,Prospect Theory:An Analysisof Decision Under
263 (1979). Fora surveyof empiricaltests of this andothermodels,see
Risk,47 ECONOMETRICA
Camerer,supra note 11, at 626-43. JohnD. Hey & ChrisOrme,InvestigatingGeneralizationsof
1291 (1994), concludethat
ExpectedUtilityTheoryUsingExperimental
Data, 62 ECONOMETRICA
expectedutilitytheoryperformsfairlywell, but theydo not considerprospecttheoryas an alternative. An alternative to prospect theory for modifying expected utility theory is offered by Itzhak
Gilboa& DavidSchmeidler,Case-BasedDecision Theory,110 Q.J.ECON.605 (1995).

13. KennethJ. Arrow,Rationalityof Self and Othersin an EconomicSystem,in RATIONAL
CHOICE:THECONTRAST
BETWEEN
ECONOMICS
ANDPSYCHOLOGY
201, 202 (Robin M. Hogarth &
MelvinW. Redereds., 1987).

14. Id.
May 1998]
BEHAVIORAL
2. Boundedwillpower.
In addition to bounded rationality,people often display bounded willpower. This term refers to the fact that humanbeings often take actions that
they know to be in conflict with theirown long-terminterests. Most smokers
say they would prefernot to smoke, and many pay money to join a program
or obtain a drugthat will help them quit. As with boundedrationality,many
people recognize that they have bounded willpower and take steps to mitigate its effects. They join a pension plan or "ChristmasClub" (a special
savings arrangementunder which funds can be withdrawnonly aroundthe
holidays) to prevent undersaving, and they don't keep tempting desserts
aroundthe house when trying to diet. In some cases they may vote for or
support governmental policies, such as social security, to eliminate any
temptationto succumbto the desire for immediaterewards.15Thus, the demand for and supply of law may reflect people's understandingof their own
(or others') bounded willpower; consider "cooling off' periods for certain
sales and programsthat facilitateor even requiresaving.
3. Boundedself-interest.
Finally, we use the term bounded self-interest to refer to an important
fact about the utility function of most people: They care, or act as if they
care, about others, even strangers,in some circumstances. (Thus, we are not
questioninghere the idea of utility maximization,but ratherthe common assumptionsabout what that entails.) Ournotion is distinct from simple altruism, which conventionaleconomics has emphasizedin areas such as bequest
decisions.16 Self-interestis boundedin a much broaderrange of settings than
conventional economics assumes, and the bound operates in ways different
from what the conventional understandingsuggests. In many market and
bargainingsettings (as opposed to nonmarketsettings such as bequest decisions), people care aboutbeing treatedfairly and want to treatothers fairly if
those others are themselves behaving fairly. As a result of these concerns,
the agents in a behavioraleconomic model are both nicer and (when they are
not treated fairly) more spiteful than the agents postulated by neoclassical
theory. Formal models have been used to show how people deal with both
fairnessand unfairness;we will drawon those models here.
15. See Deborah M. Weiss, Paternalistic Pension Policy: Psychological Evidence and Eco-
nomicTheory,58 U. CHI.L. REV.1275(1991).
16. See B. Douglas Bemheim, How Strong Are Bequest Motives? Evidence Based on Estimates of the Demandfor Life Insurance and Annuities, 99 J. POL.ECON.899, 899-900 (1991).
1480
LAWREVIEW
STANFORD
[Vol. 50:1471
4. Applications.
The goal of this article is to show how the incorporationof these understandings of human behaviorbears on the actual operationand possible improvementof the legal system. The appendixsummarizessome key features
of each of the three bounds on humanbehaviorjust described. It also indicates the law and economics issues we analyze undereach category.
When is each bound likely to come into play? Any general statement
will necessarily be incomplete, but some broad generalizationscan be offered. First, boundedrationalityas it relates to judgmentbehaviorwill come
into play whenever actors in the legal system are called upon to assess the
probability of an uncertainevent. We discuss many examples below, including environmental legislation (Part III.C), negligence determinations
(Part IV.A), and risk assessments (PartsIV.B and V.A.). Second, bounded
rationality as it relates to decisionmaking behavior will come into play
whenever actors are valuing outcomes; a prominent example here is loss
aversion and its corollary,the endowment effect, which we discuss in connection with bargainingbehavior (PartII.B), mandatorycontractterms (Part
II.D), priorrestraintson speech (PartIII.B), and risk assessments(PartIV.B).
Bounded willpower is most relevantwhen decisions have consequences over
time; our example is criminal behavior (Part IV.C), where the benefits are
generally immediate and the costs deferred. Finally, bounded self-interest
(as we use the term) is relevantprimarilyin situationsin which one partyhas
deviated substantiallyfrom the usual or ordinaryconduct underthe circumstances; in such circumstancesthe other party will often be willing to incur
financialcosts to punishthe "unfair"behavior. Ourapplicationshere include
bargainingbehavior (Part II.B) and laws banning market transactions(Part
III.A).
The three bounds we describe do not (at least as we characterizethem
here) constitute a full descriptionof human behavior in all its complexity.
Although we will have more to say about parsimonybelow, we will say for
now that our goal is to sketch out an approachspare enough to generatepredictions across a range of contexts, but not so sparethat its predictionsabout
behaviorare often incorrect(as we will suggest is the case with conventional
law and economics in some contexts). Many interestingfeaturesof behavior
discussed by psychologists but not emphasizedby our frameworkmay also
play a role in explaining specific forms of behaviorrelevantto law.'7 And it
can be illuminatingto attend in some detail to the role of social norms in
17. See, e.g., RussellKorobkin& ChrisGuthrie,PsychologicalBarriersto LitigationSettle-
ment: An Experimental Approach, 93 MICH.L. REV. 107 (1994) (finding effects of"equity seek-
ing" and "reactivedevaluation"on settlementbehavior);MarkKelman,Yuval Rottenstreich&

Amos Tversky,Context-Dependence
in Legal Decision Making,25 J. LEGAL
STUD.287 (1996)
and"contrast"
behavioronjurydecisionmaking).
(describingeffectsof "compromise"
May 1998]
BEHAVIORAL
APPROACHTOLAW&
ECONOMICS 1481
various contexts'8 and to the place of shame, pride, and status,19especially

insofar as an understandingof these variableshelps give content to people's
utility functions in ways that bear on the uses of law. Our principalpurpose
here, however, is to provide predictions,ratherthan to give full descriptions
of individualmotivationsand self-understandings,and we will refer to these
variables only occasionally and in passing. For similar reasons, we do not
emphasize behavioralpatternsthat departfrom standardeconomic assumptions but fail to point in systematic directions;such patternswould not generate distinct predictions(althoughthey would of course matterto a full account of individual behavior). Our focus here is robust, empirically documented phenomena that have reasonably precise implications for legal issues.
B. TestablePredictions
Behavioral and conventional law and economics do not differ solely in
their assumptionsabout humanbehavior. They also differ, in testable ways,
in their predictionsabout how law (as well as other forces) affects behavior.
To make these differences more concrete, consider the three "fundamental
principlesof economics" set forthby RichardPosner in his EconomicAnalysis of Law,20in a discussion that is, on these points, quite conventional.
(Posner's discussion representsan applicationof the basic economic methodology set forth by Becker above.21) To what extent would an account
based on behaviorallaw and economics offer different "fundamentalprinciples"?
The first fundamentalprinciple for the conventional approachis downward-slopingdemand: Total demand for a good falls when its price rises.22
This predictionis, of course, valid. There are few if any documentedcases
of Giffen goods (goods that are consumedmore heavily at high prices, due to
the fact that the price increase makes people unable to afford goods that are
even pricier than the good in question). However, confirmationof the prediction of downward-slopingdemanddoes not suggest that people are optimizing. As Becker has shown, even people choosing at random(ratherthan
in a way designed to serve their preferences)will tend to consume less of a
good when its price goes up as long as they have limited resources.23 This
18. See Symposium, Law, Economics & Norms, 144 U. PA. L. REV. 1643 (1996).
19. See Lawrence Lessig, The Regulation of Social Meaning, 62 U. CHI. L. REV. 943 (1995);
Richard H. McAdams, Relative Preferences, 102 YALEL.J. 1 (1992). McAdams' work draws on
ROBERTH. FRANK,CHOOSING
THERIGHTPOND(1985).
20. POSNER,supra note 6, at 4.
21. See id. at 3.
22. See id.
23. Gary S. Becker, Irrational Behavior and Economic Theory, 70 J. POL. ECON. 1, 4-6
(1962).
1482
W
STANFORD
LAWREVIE
[Vol. 50:1471
behavior has also been demonstratedwith laboratoryrats.24 Thus, evidence

of downward-slopingdemandis not evidence in supportof optimizing models.
The second fundamentalprinciple of conventional law and economics
concerns the natureof costs: "Cost to the economist is 'opportunitycost,"'
and "'[s]unk' (incurred)costs do not affect decisions on prices and quantity."25 Thus, according to traditionalanalysis, decisionmakerswill equate
opportunitycosts (which are costs incurredby foregoing opportunities-say,
the opportunityto sell one's possessions) to out-of-pocket costs (such as
costs incurredin buying possessions); and they will ignore sunk costs (costs
that cannot be recovered, such as the cost of nonrefundabletickets). But
each of these propositions is a frequentsource of predictive failures. The
equality of opportunitycosts and out-of-pocketcosts implies that, in the absence of importantwealth effects, buying prices will be roughly equal to
selling prices. This is frequentlyviolated, as is well known. Many people
holding tickets to a popularsportingevent such as the SuperBowl would be
unwilling to buy tickets at the marketprice (say $1000), yet would also be
unwilling to sell at this price. Indeed, estimates of the ratio of selling prices
to buying prices are often at least two to one, yet the size of the transaction
makes it implausiblein these studies to conclude that wealth effects explain
the difference.26 As describedbelow, these results are just what behavioral
analysis suggests.
The traditionalassumptionabout sunk costs also generates invalid predictions. Here is one: A theaterpatronwho ignores sunk costs would not
take into account the cost of a prepaid season pass in deciding whether to
"rou[se] [him]self ... to go out" on the evening of a particularperformance;27the decision would be made purely on the basis of the benefits and
costs from that moment forward. However, in a study of theater patrons,
some of whom were randomlyassigned to receive discountedprices on prepaid passes, the patronswho received discountswere found to attendsignificantly fewer performancesthan those who did not receive discounts, despite
the fact that (due to random assignment) the benefit-cost ratio that should
have mattered-benefits and costs going forward-was the same on average
24. JOHNH. KAGEL,RAYMONDC. BATTALIO& LEONARDGREEN, ECONOMICCHOICE

THEORY: AN EXPERIMENTALANALYSIS OF ANIMAL BEHAVIOR 8, 17-19, 24-25 (1995).
25. POSNER, supra note 6, at 6, 7.
26. See Daniel Kahneman, Jack L. Knetsch & Richard H. Thaler, Experimental Tests of the
Endowment Effect and the Coase Theorem, 98 J. POL.ECON.1325, 1327 tbl.1 (1990) (summarizing
studies).
27. ROBERTNOZICK,THENATUREOFRATIONALITY
22 (1993).
May 1998]
BEHAVIORAL
in the two groups.28 In short, sunk costs mattered;again, the standardpre-
dictionprovedinvalid.
The thirdfundamental
principleof conventionallaw and economicsis
that"resources
tendto gravitatetowardtheirmostvaluableuses"as markets
driveout any unexploitedprofitopportunities.29
Whencombinedwith the
notionthatopportunity
andout-of-pocket
costsareequated(see fundamental
principletwo), this yields the Coasetheorem-the idea that initialassignmentsof entitlementswill not affectthe ultimateallocationof resourcesso
costsarezero.30Manyeconomistsandeconomicallyorilong as transaction
entedlawyersthinkof the Coasetheoremas a tautology;if therewerereally
no transaction
costs (andno wealtheffects),andif an alternativeallocation
of resourceswouldmakesomeagentsbetteroff andnoneworseoff, thenof
coursethe agentswouldmove to thatallocation. Carefulempiricalstudy,
however,showsthatthe Coasetheoremis not a tautology;indeed,it canlead
to inaccuratepredictions.31
Thatis, even whentransaction
costs andwealth
effectsareknownto be zero,initialentitlementsalterthe finalallocationof
resources.Theseresultsarepredictedby behavioraleconomics,whichemandout-of-pocket
costs.
phasizesthedifferencebetweenopportunity
Considerthe followingset of experimentsconductedto test the Coase
let us offer an interpretation
theorem;32
gearedto the particularcontextof
economicanalysisof law. The subjectswere forty-fourstudentstakingan
advancedundergraduate
coursein law andeconomicsat CornellUniversity.
Half the studentswereendowedwithtokens. Eachstudent(whetheror not
endowedwith a token)was assigneda personaltoken value, the price at
whicha tokencouldbe redeemedforcashat theendof theexperiment;
these
values
induce
and
demandcurvesfor the tokens. Markets
assigned
supply
wereconductedfortokens. Thosewithouttokenscouldbuy one, whilethose
withtokenscouldsell. Thosewithtokensshould(anddo) sell theirtokensif
offeredmorethantheirassignedvalue;thosewithouttokensshould(anddo)
buy tokensif they can get one at a pricebelow theirassignedvalue. These
tokenmarketsare a completevictoryof economictheory. The equilibrium
pricewas alwaysexactlywhatthe theorywouldpredict,andthe tokensdid
in factflow to thosewhovaluedthemmost.
However,life is generallynot abouttokensredeemablefor cash. Thus
anotherexperimentwas conducted,identicalto the firstexceptthatnow half
the studentsweregivenCornellcoffeemugsinsteadof tokens. Herebehavioralanalysisgeneratesa predictiondistinctfromstandardeconomicanaly28. Hal R. Arkes & CatherineBlumer,ThePsychologyof Sunk Cost, 35 ORG. BEHAV.&
HUM.DECISION
PROCESSES
124, 127-28 (1985).
29.
30.
31.
32.
POSNER,
supranote 6, at 11.
R.H. Coase,TheProblemof Social Cost,3 J. L. & ECON.1 (1960).
See Kahnemanet al., supranote 26, at 1329-42.
See id.
1484
STANFORD
LAWREVIEW
[Vol. 50:1471
sis: Because people do not equate opportunityand out-of-pocket costs for

goods whose values are not solely exogenously defined (as they were in the
case of the tokens), those endowed with mugs should be reluctant to part
with them even at prices they would not have consideredpaying to acquirea
mug had they not received one.
Was this prediction correct? Yes. Marketswere conducted and mugs
bought and sold. Unlike the case of the tokens, the assignment of property
rights had a pronouncedeffect on the final allocation of mugs. The students
who were assigned mugs had a strong tendency to keep them. Whereas the
Coase theorem would have predictedthat about half the mugs would trade
(since transactioncosts had been shown to be essentially zero in the token
experiments,and mugs were randomlydistributed),instead only fifteen percent of the mugs traded. And those who were endowed with mugs asked
more than twice as much to give up a mug as those who didn't get a mug
were willing to pay. This result did not change if the marketswere repeated.
This effect is generally referredto as the "endowmenteffect"; it is a manifestation of the broaderphenomenonof "loss aversion"-the idea that losses
are weighted more heavily than gains-which in turn is a central building
block of Kahnemanand Tversky's prospecttheory.
What are we to make of these findings? There are at least three important lessons. First, marketsare indeed robust institutions. Even naive subjects participatingat low stakes produce outcomes indistinguishable from
those predictedby the theory when tradingfor tokens. Second, when agents
must determinetheir own values (as with the mugs), outcomes can diverge
substantiallyfrom those predictedby economic theory. Third, these departures will not be obvious outside an experiment,even when they exist and
have considerableimportance. That is, even in the mugs markets,there was
trading; there was just not as much trading as the theory would predict.
These lessons can be applied to other markets;we offer some examples below.
The foregoing discussion illustratesthe point with which we began this
section: The difference between conventionaland behavioral law and economics is not just a differencein the validity of the assumptionsabouthuman
behavior. While the assumptionsof unboundedrationality,willpower, and
self-interest are unrealistic,the force of behavioral economics comes from
the difference in its predictions(for example, fewer trades for mugs than for
tokens). In this sense, our analysis is consistent with the precept originally
proposedby Milton Friedman: Economics should not be judged on whether
the assumptionsare realistic or valid, but ratheron the quality of its predictions.33 We sharethis view (or at least will accept it for purposesof this arti33. See MILTONFRIEDMAN,The Methodology of Positive Economics, in ESSAYSIN POSITIVE
ECONOMICS
3, 14-16 (1953).
May 1998]

BEHAVIORAL
cle); as we have emphasized,our principalinterestis predictive in character.

A behavioral analysis would be of much less interest if conventional economic models did a satisfactoryjob of predictingthe behaviorof agents insofar as relevantto law. Unfortunately,they often do not.
C. Partial and AmbiguousSuccesses of ConventionalEconomics
What of all the well-known successes of conventional economics? Do
they show that predictionsabout law based on the conventionalassumptions
tend to work? Consider some examples of the successes: (1) the inverse
correlation between price ceilings and queues; (2) the inverse correlation
between rent control and the stock of housing; (3) the positive correlationin
financial marketsbetween risk and expected return;(4) the relation between
futuresprices and spot-marketprices.34 The problem with the first three examples is that, as with tests of downward-slopingdemand curves, they are
quite undemanding;they ask simply whetherthe theory gets the directionof
the effect right-and it does. But this is not a complete vindication of the
theory, for the theory may misstate the magnitude of the effect. Consider
(3), the positive relation between risk and returnin financial markets. As
predicted by this theory, stocks (equities) earn higher returns (on average)
than do riskless assets such as treasurybills. But what can we say about the
magnitude? Is this difference in returnroughly what the theory would predict? This is precisely the question posed by Rajnish Mehra and Edward
Prescott in their well-known paper on the "equitypremiumpuzzle."35 The
equity premiumis the difference in returnsbetween equities and riskless assets. In the United States, the equity premiumhas been roughly six percent
per year over the past seventy years.36 This implies that a dollar invested in
stocks in 1926 would, at the end of 1997, be worth over $1800, while a dollar invested in treasurybills would have accumulatedto less than $15. This
difference is remarkablylarge. Mehra and Prescottthereforeask whether it
can possibly be explained by investor risk aversion. They conclude that it
cannot. That is, no plausible value of risk aversion could explain such a big
difference.37Although the theory gets the sign right in this case, the magnitude of the effect suggests thatthe theoryis wrong. (And note that arbitrage,
which we discuss just below, would not be expected to eliminate the equity
premium;there are often significantcosts of arbitragein equity markets.38)
34. See POSNER,
supranote 6, at 18.
35. RajnishMehra& EdwardC. Prescott,TheEquityPremium:A Puzzle, 15 J. MONETARY
ECON.145 (1985).
36. See IBBOTSON
1997 YEARBOOK.
ASSOCIATES,
STOCKS,BONDS,BILLSANDINFLATION:
37. See JeremyJ. Siegel & RichardH. Thaler,Anomalies:TheEquityPremiumPuzzle, 11 J.

ECON.PERSP.,
Winter1997,at 191, 192, fora discussion.
38. See JeffreyPontiff,CostlyArbitrage:Evidencefrom Closed-EndFunds, 111 Q.J. ECON.
1135 (1996);AndreiShleifer& RobertW. Vishny,TheLimitsofArbitrage,52 J. FIN.35 (1997).
1486
STANFORD
LAWREVIEW
[Vol. 50:1471
Example(4) above,the relationbetweenspot and futuresprices,does

betteron magnitudes.Spotandfuturespricesareverycloselyrelated.However,this case is specialin severalrespects. First,arbitrageis possible. If
spotandfuturespricesget outof line,theninvestorscanmakesureprofitsby
buyingthecontractthatis too cheapandsellingtheone thatis too expensive.
Second,this contextis one in whichmost of the activityis undertaken
by
professionalswho will quicklylose theirmoneyandtheirjobs if they make
frequenterrors.Third,themarketsin whichtheseprofessionalsoperateoffer
forlearning.Underthesecircumstances,
marketstend
frequentopportunities
to work very well,39thoughnot perfectly.40Essentially,these conditions
renderagentswho do not conformto the standardeconomicassumptions
irrelevant(becausetheywill be bankrupt).
suchas futurestrading,marSo, in some (fairlyunusual)circumstances,
ket forcesare strongenoughto makethe three"bounds"irrelevantfor predictivepurposes.Thepointis important;
it suggeststhatwhilehumanbeings
often displayboundedrationality,willpower,and self-interest,marketscan
sometimesleadto behaviorconsistentwithconventionaleconomicassumptions. Thenthe questionbecomeswhen,exactly,do marketforcesmakeit
reasonableto assumethatpeoplebehavein accordancewith those assumptions? Whatcircumstances
applyto mostof the domainsin whichlaw and
economicsis used?
In thisregardit is instructiveto comparethemarketfor futurescontracts
withthe marketfor criminalactivity. Considerthe propositionthata potential criminalwill commitsome crimeif the expectedgains fromthe crime
exceed its expectedcosts.41Supposea criminalmistakenlythinksthatthe
expectedgainsoutweightheexpectedcosts,whenin factthe oppositeis true.
Firstnoticethatno arbitrage
will be possiblein this situation.If someoneis
unfortunate
to
commit
a crimewith a negativeexpectedvalue,then
enough
thereis no way for anyoneelse to profitdirectlyfromhis behavior.Outside
of financialmarkets(andnot alwaysthere),thosewho engagein low-payoff
activitieslose utilitybutdo not createprofitopportunities
for others. Nor do
theytypicallydisappearfromthemarket.(Evenpoorlyrunfirmscansurvive
for manyyears;considerGM.) Beinga badcriminalis rarelyfatal,andexceptpossiblyfororganizedcrime,thereis littleopportunity
for "hostiletakeovers." Finally,the decisionto entera life of crimeis not one thatis made
39. See ThomasRussell & RichardH. Thaler,TheRelevanceof Quasi
Rationalityin Com-
H. THALER,QUASIRATIONAL
petitive Markets, in RICHARD
ECONOMICS
239, 248-49 (1991).
40. For example,in a rationalmarket,the relationbetweenspot and futurescontractsfor foreign exchangearegood forecastsof movementsin exchangerates. In fact, these forecastsare systematicallybiased. See KennethA. Froot& RichardH. Thaler,ForeignExchange,in RICHARD
H.
THALER,THEWINNER'SCURSE:PARADOXES
AND ANOMALIES
OF ECONOMIC
LIFE 182, 185-86
(1992).
41. See, e.g., Steven Shavell, CriminalLaw and the OptimalUse of
NonmonetarySanctions
as a Deterrent,85 COLUM.
L. REV.1232, 1235(1985).
May 1998]
BEHAVIORAL
repeatedly with many opportunitiesto learn. Once a teenager has dropped

out of high school to become a drug dealer, it is difficult to switch to dentistry.
Because law and economics is frequentlyapplied to criminal behavior,
the above argumentis obviously germane. We think that the same analysis
applies to many of the domains in which law and economics has been used.
In fact, economic analysis of law seems to be a branch of economics in
which the limits of arbitrageare particularlypowerful, so special care should
be takennot to push the standardeconomic model too far.
This is by no means to say that conventionallaw and economics has had
no victories. One cannot look at the currentstate of antitrustlaw, or the use
of market-basedregulationin environmentallaw (to name just two of many
examples), without acknowledgingthe importantadvancesproducedthrough
the conventionalapproach. Often this approachpoints in the right direction
and identifies flaws in noneconomicreasoning. Many advances in the positive and prescriptiveunderstandingof law have come from the conventional
assumptions. Attention to incentive effects can often reveal a great deal.
(Thus, those who would argue that rent control helps tenants must contend
with the obvious long-runsupply effects of such laws.)
The project of behaviorallaw and economics, as we see it, is to take the
core insights and successes of economics and build upon them by making
more realistic assumptions about human behavior. We wish to retain the
power of the economist's approachto social science while offering a better
descriptionof the behavior of the agents in society and the economy. Behavioral law and economics, in short, offers the potentialto be law and economics with a higher "R2"-that is, greaterpower to explain the observed
data. We will try to highlight some of that potential (and suggest cases
where it has been realized) in this article.
D. Parsimony
A possible objectionto our approachis that conventionaleconomics has
the advantageof simplicity and parsimony. At least-the objection goes-it
provides a theory. By contrast,a behavioralperspective offers a more complicated and unrulypicture of humanbehavior,and perhapsthat picture will
make predictionmore difficult, precisely because behavior is more complicated and unruly. Everythingcan be explained in an ex post fashion-some
tool will be found that is up to the task-but the elegance, generalizability,
and predictive power of the economic method will be lost. Shouldn't analysts proceed with simple tools? We offer two responses: First, simplicity
and parsimonyare indeed beneficial;it would be highly desirableto come up
with a model of behavior that is both simple and right. But conventional
1488
STANFORD
LAWREVIEW
[Vol. 50:1471
economics is not in this position, for its predictionsare often wrong. We will
encountermany examples in additionto those alreadydiscussed.
Second, to the extent that conventionaleconomics achieves parsimony,it
often does so at the expense of any real predictivepower. Its goal is to provide a unitary theory of behavior, a goal which may be impossible to
achieve. By itself the notion of "rationality"(the centerpiece of traditional
analysis) is not a theory;to generatepredictionsit must be more fully specified, often throughthe use of auxiliaryassumptions.42Indeed, the term "rationality"is highly ambiguousand can be used to mean many things. A person might be deemed rationalif her behavior (1) conforms to the axioms of
expected utility theory; (2) is responsive to incentives, that is, if the actor
changes her behaviorwhen the costs and benefits are altered;(3) is internally
consistent;(4) promotesher own welfare; or (5) is effective in achieving her
goals, whateverthe relationshipbetween those goals and her actual welfare.
We observe departuresfrom most of these definitions;thus, with respect to
(1), scholars have documented departuresfrom expected utility theory for
nearly fifty years, and prospect theory seems to predict behavior better.43
With respect to (4) and (5), people's decisions sometimes do not promote
theirwelfare or help them to achieve theirown goals; and with respect to (3),
behavioralresearch shows that people sometimes behave in an inconsistent
manner by, for example, indicating a preference for X over Y if asked to
make a direct choice, but Y over X if asked to give their willingness to pay
for each option.44Many of our examples will thus show that people are frequentlynot rationalif the term is understoodto mean (1), (3), (4), or (5). As
for (2), without some specificationof what counts as a cost and a benefit, the
idea of responsivenessto incentives is empty. If rationalityis used to mean
simply that people "choose"what they "prefer"in light of the prevailing incentives,45then the notion of rationalityoffers few restrictionson behavior.
The person who drinkscastor oil as often as possible is rationalbecause she
happens to love castor oil. Other self-destructivebehavior (drug addiction,
suicide, etc.) can be explainedon similargrounds. It is not even clear on this
view whether rationalityis intended as a definition of "preference"or as a
prediction.46
42. See Arrow,supranote 13, at 205-06.
43. See notes 11-12 supra and accompanying text.
44. Amos Tversky, Rational Theory and Constructive Choice, in THE RATIONAL
FOUNDATIONS
OF ECONOMIC
BEHAVIOUR185, 189-91 (Kenneth J. Arrow, Enrico Colombatto,
MarkPerlman& ChristianSchmidteds., 1996).
45. See, e.g., TOMASJ. PHILLIPSON

& RICHARDA. POSNER,PRIVATECHOICESANDPUBLIC
HEALTH:THEAIDS EPIDEMIC
INANECONOMIC
4 (1995).
PERSPECTIVE
46. Thus the idea is ambiguousbetween the notion of "revealedpreferences,"in which

choices define preferences,and the notionof a maximizationfunctionthat lies behindand helps
explainchoices. Bothnotionsraisemanydifficultissues. See CassR. Sunstein,Social Normsand
Social Roles, 96 COLUM.L. REV.903, 931-38 (1996).
May 1998]
BEHAVIORAL
If such a notion of rationalityallowed for good predictions,then perhaps

there would be no reason for complaint; the problem, however, is that so
high a degree of flexibility leaves the theorywith few a priorirestrictions. A
theorywith infinite degrees of freedomis no theory at all. For example, consider whetherit is a paradox(as many economists think)that so many people
vote (despite the virtualcertaintythatno one person's vote will alter the outcome). If it is a paradox,so much the worse for the rationalityassumption;if
it is not a paradox,what does the assumptionpredict? Does it merely predict
that people will respond to changes in conditions-for example, fewer people will vote when it is snowing? If so, the predictionis not bad, but surely it
would be possible to say, after an unusuallylarge vote amidst the storm, that
more people voted simply because voting seemed especially valiant in those
circumstances (so much for predictions based on this form of rationality).
Conventionaleconomics sometimes turns to strongerforms of rationalityin
response, and those forms provide strongerpredictions in some cases; but
those predictions are often inaccurate,as described above and as illustrated
by the examples consideredbelow.
We believe that a behavioralapproachimposes discipline on economic
theorizing because assumptionscannot be importedat will. In a behavioral
approach,assumptionsabout behavior should accord with empirically validated descriptionsof actualbehavior. For example, in the case of "fairness,"
specifically defined and empiricallyverified patternsof behavior are used to
generatepredictionsin new contexts. ("Fairness"is not, on this view, simply
a catch-allto explain any observedbehavior.) This is the approachwe advocate for economic analysis of law. This approach,we believe, produces a
betterunderstandingof law and a betterset of predictionsaboutits effects.
We now turn to positive, prescriptive,and normative issues. Our purpose is not to settle all of them, but to show the promise of behavioraleconomics in casting light on a wide range of questions. A great deal of work
would be necessary to justify authoritativejudgments on most of these questions. What follows should be taken partly as a proposal, perhaps in the
spirit of the early economic analysis of law, for a researchagenda to be carried out with a new set of tools.
II. BEHAVIOROFAGENTS
A. The UltimatumGame
1. Thegame and its sunk-costvariation.
We begin with boundedself-interest,the thirdbound describedabove. A
useful first example of this bound is agents' behavior in a very simple bargaining game called the ultimatumgame. In this game, one player, the Pro-
1490
LAWREVIEW
STANFORD
[Vol. 50:1471
poser,is askedto proposean allocationof a sum of moneybetweenherself

andthe otherplayer,the Responder.The Responderthenhas a choice. He
caneitheracceptthe amountofferedto himby the Proposer,leavingthe rest
to the Proposer,or he can rejectthe offer, in which case both playersget
andthe
nothing. Neitherplayerknowsthe identityof his or hercounterpart,
playerswill play againsteachotheronly once, so reputationsandfutureretaliationareeliminatedas factors.
Economictheoryhas a simplepredictionaboutthis game. TheProposer
will offer the smallestunitof currencyavailable,say a penny,andthe Responderwill accept,sincea pennyis betterthannothing.Thisturnsoutto be
a very bad predictionabouthow the game is actuallyplayed. Responders
typicallyrejectoffersof less thantwentypercentof the totalamountavailable;the averageminimumamountthatResponderssay theywouldacceptis
betweentwentyandthirtypercentof thatsum.47Respondersarethuswilling
to punishunfairbehavior,even at a financialcost to themselves. This is a
formof boundedself-interest.And this responseseemsto be expectedand
anticipated
by Proposers;
theytypicallyoffera substantial
portionof the sum
to be divided-ordinarilyfortyto fiftypercent.48
Economistsoften worrythatthe resultsof this type of experimentare
sensitiveto the way in whichthe experimentwas conducted.Whatwould
or the gamewas repeatedsevhappenif the stakeswereraisedsubstantially,
eraltimesto allow learning?In this case, we knowthe answer. To a first
neitherof thesefactorschangesthe resultsin any important
approximation,
way. Raisingthe stakesfrom$10 perpairto $100, or even to morethana
week's income(in a poor country)has little effect;the same is trueof repeatingthe game ten times with differentpartners.49(Of course,at some
pointraisingthe stakeswouldmatter;probablyfew peoplewouldturndown
an offerof five percentof $1,000,000.) We do not see behaviormovingtowardthepredictionof standard
economictheory.
Thus,the factorsthatmanyeconomiststhoughtwould changethe outcome of the gamedidnot. But, as we learnedin a studyconductedfor this
47. See WernerGiith,Rolf Schmittberger
& Bemd Schwarze,An ExperimentalAnalysisof
Ultimatum Bargaining, 3 J. ECON.BEHAV.& ORG. 367, 371-72, 375 tbls.4 & 5 (1982); Daniel
Kahneman,JackL. Knetsch& RichardH. Thaler,Fairnessand the Assumptionsof Economics,59

J. BUS.S285, S291 tbl.2 (1986).
48. See Giithet al., supranote47, at 371-72, 375 tbls.4& 5; Kahnemanet al., supranote 47,
at S291 tbl.2.
49. See Colin Camerer& RichardH. Thaler,Anomalies:Ultimatums,Dictators,and Manners, 9 J. ECON.PERSP.,Spring1995, at 209, 210-11; Vesna Prasnikar& Alvin E. Roth, Considerationsof FairnessandStrategy:Experimental
Datafrom SequentialGames,107 Q.J.ECON.865,
873-75 (1992); RobertSlonim & Alvin E. Roth,Learningin High Stakes UltimatumGames:An
Experiment in the Slovak Republic, 66 ECONOMETRICA

569, 573 (1998). When repetition is com-
binedwith very high stakes,however,offers decreasesomewhat,althoughthey are still far above

whatthe standardanalysiswouldpredict.See Slonim& Roth,supra,at 573, 588 fig.3A.
May 1998]

BEHAVIORAL
article, a factorthat economic theorypredictswill not have an effect, namely

the introductionof a sunk cost, does have an effect. As noted above, economics predicts that decisionmakerswill ignore sunk costs in making their
choices (see fundamentalprinciple two above); but in fact decisionmakers
often do not behave in this way. Do sunk costs alter behavior in the ultimatum game? To find out, we asked classroom volunteers to bring $5-what
would become a sunk cost for them-to class. Studentswere given a form
asking them how they would play both roles in an ultimatumgame in which
the $10 to be divided was contributedhalf by the Proposer and half by the
Responder. They were told that their role would be determinedby chance,
so they had to decide first what offer to make if they were chosen to be a
Proposer and then what minimum offer they would be willing to accept if
they were a Responder.50We also ran a version of the standardultimatum
game (withoutsunk costs by the students)as a control.
Although economic theory says that the sunk-cost variation of the ultimatum game will have no effect on behavior (since the $5 collected from
each student is a sunk cost and should thereforebe ignored by the players),
we predictedthat in this domain sunk costs would matter. In particular,we
anticipatedthat Responderswould feel that they had an "entitlement"to the
$5 they had contributedto the experimentand would thereforebe reluctantto
accept less. This is precisely what we found. In the original version of the
game, when the $10 to be divided was provided to subjects by the experimenter, the average minimum amountdemandedby Responderswas $1.94.
In the sunk-cost version, where the studentseach paid $5 to participate,the
average demand was $3.21 for a group of MIT MBA students, $3.73 for a
group of University of Chicago (UC) MBA students,and $3.35 for a group
of UC Law students. Each of these means is significantly differentfrom the
control value of $1.94 under any conventionalmeasure of statistical significance. Looking past means, 61% of the MIT students demanded at least
$4.00, and 32% demandeda full refund of their $5.00. For UC MBA students, 67% demanded at least $4.00, and 40% demanded $5.00. The UC
Law studentswere slightly less extreme: 47% demandedat least $4.00, and
23% demanded$5.00.
50. Thisexperimentis profitablefor theexperimenter

if any offersarerejectedby Responders
(becausethe experimenterhas collected $10 from each pair of bargainers,which the bargainers
forfeitif the Proposer'soffer is rejected). To solve this "problem,"we conductedanotherexperimentrightafterin whichthe winnerof a gamewas awardedany profitsearnedby the experimenter
in the firstround.
LAWREVIEW
STANFORD
1492
[Vol. 50:1471
GAMERESULTS
ULTIMATUM
Average
Demand
Percent
Percent
Demanding$4.00 Demanding$5.00
32%
61%
MIT MBA
$3.21
UC MBA
$3.73
67%
40%
UC Law
$3.35
47%
23%
Note that our emphasishere, as well as in the ordinaryultimatumgame,

is on the fairness behavior of Responders,not on affirmative concerns for
fairness on the part of Proposers. (As noted above, their behavior appears
fully consistent with financially maximizing responses to Responders' fairness behavior;other experimentalresults supportthis conclusion.51) We do
know, however, that in other contexts people appearto display affirmative
concerns for fairness.52
The fairnessresults obtainedin variousexperimentalsettings, such as the
ultimatumgame, cannot be explained on groundsof reputation. The parties
are interactinganonymously and in a one-shot fashion. Of course, many
real-world situationsmay reflect a combinationof reputationaland fairness
factors. Thus, for example, firms that violate the norms of an industryare
ostracized,presumablyat some cost to the remainingfirms, partlybecause of
a rational fear that the offending party might be untrustworthy,and partly
because of a spiteful tendency to punish unmannerlybehavior, even when
the punishmentis costly to administer(as when Respondersturn down small
offers). Many of RobertEllickson's examples in his pathbreakingbook, Order WithoutLaw, have precisely this flavor.53 Often it is impossible to disentangle the two effects. The value of the experimentalmethod is precisely
that situations can be created in which the reputationalfactor is absent (because the transactionsare anonymousand one-shot), allowing one to test directly for fairness. The ultimatumgame results show that we find it: People
will often behave in accordancewith fairness considerationseven when it is
against their financial self-interestand no one will know. Thus, for instance,
51. See ElizabethHoffman,Kevin McCabe& Veron L. Smith,Social Distance and OtherRegardingBehaviorin DictatorGames,86 AM.ECON.REV.653, 653-54 & fig.1 (1996) (finding
thatProposerstypicallyofferedno morethan10%of the sum to be divided-and over 60%offered
nothing-when (1) the Responderhadno choicebut to acceptthe Proposer'sofferand(2) anonymity was guaranteed).
52. See ErnstFehr,GeorgKirchsteiger& Aro Riedl,Does FairnessPreventMarketClearing: An Experimental
Investigation,108 Q.J.ECON.437 (1993).
LAW(1991).
53. ROBERT
C. ELLICKSON,
ORDER
WITHOUT
May 1998]
BEHAVIORAL
most people leave tips in out-of-townrestaurantsthat they never plan to visit

again.
2. Fairness, acrimony,and scruples.
Theoreticalconsiderations. How can economic analysis be enriched to
incorporatethe behavior observed in the ultimatumgame and its sunk-cost
variant? As we have indicated, the first step is to relax the assumption,
common to most economic theorizing, of "unboundedself-interest." This
assumption implies that Proposers should offer the smallest sum possible,
and Respondersshould accept. An alternativeview is offered in the following account:
IntheruralareasaroundIthacait is commonforfarmers
to putsomefresh
a
on
table
the
road.
There
the
is
a
cash
box
on
table,andcustomers
produce
by
areexpectedto putmoneyintheboxinreturnforthevegetables
theytake. The
boxhasjusta smallslit,so moneycanonlybe putin,nottakenout. Also,the
box is attached
to the table,so no one can(easily)makeoff withthe money.
Wethinkthatthefarmers
whousethissystemhavejustabouttherightmodel
of humannature.Theyfeel thatenoughpeoplewill volunteerto pay forthe
freshcornto makeit worthwhile
to putit outthere.Thefarmers
alsoknowthat
if it were easy to takethe money,someonewoulddo so.54
We emphasize that this is not a story of simple altruism. As noted

above, such altruism is sometimes recognized in conventional economics;
our account, in contrast,is a more complicated story of reciprocal fairness.
A concern for fairness is partof most agents' utility function. The results of
the ultimatumgame, like the behaviorof the Ithacashoppers,cannot readily
be explained on grounds of simple altruism. First of all, the games are
played between anonymous strangers. What reason is there to believe that
these people care about one another? (Most of us give little of our wealth to
anonymousstrangerswhom we have no reason to believe are any worse off
than we are. Similarly,most people drivingby a farm do not pull over and
stuff two dollars throughthe mail slot, even in Ithaca. Fairness behavior is
probably reciprocal.) Second, we observe not only apparently"nice" behavior (generous offers) but also "spiteful"behavior (Responders turning
down small offers at substantialcost to the Proposers). In the ultimatum
game, people appear simultaneouslynicer and more spiteful than conventional assumptionspredict.
It is also no answer to say that the results of the ultimatum game are
readily predictableon the conventionalmodel on the ground that pride and
self-conception are part of players' utility functions. The problem with this
view is not that it is false but that it allows ad hoc, ex post additionsto the
20.
54. RichardH. Thaler& RobynM. Dawes,Cooperation,in THALER,

supra note 40, at 6, 19-
1494
LAWREVIEW
STANFORD
[Vol. 50:1471
utility function, in such a way as to deprive the conventional model of the

ability to make any predictions. The goal of the behavioralapproachis to go
back and forthbetween data and theory to generatepredictionsthat will generalize.
The sort of balanced conception of humannature suggested by the ultimatum game results and the practicesof farmersin Ithacaneed not be informal or ad hoc. It is possible to incorporatematerialand nonmaterialmotives,
such as the desire to be fair (to those who have been fair) and also to be
spiteful (to those who have not been fair), in a rigorousanalysis. An elegant
formal treatment is offered by Matthew Rabin in a model of fairness.55
Rabin's frameworkincorporatesthree stylized facts about behavior. Stated
simply and nonformally:
(A) People are willing to sacrifice their own material well-being to help those
who are being kind.
(B) People are willing to sacrifice their own material well-being to punish
those who are being unkind.
(C) Both motivations (A) and (B) have a greater effect on behavior as the material cost of sacrificing becomes smaller.56
Rabin shows how these assumptionsabout behavior can explain the behavior observedin the ultimatumgame as well as other games of cooperation
such as the Prisoner's Dilemma. Related work, bearing on the appropriate
role of law, has shown the role of such behaviorin helping to producenorms
that solve collective actionproblems.57
Rabin's theory can be viewed as a theory of manners and principles.
Generalizingfrom Rabin's treatment,we might say thatpeople can be understood as having preferencesfor (a) their own materialpayoffs and (b) those
of some others they know well, and in additionthey have preferencesabout
(c) the well-being of some strangerswhose interests are at stake, (d) their
own reputation,and (e) what kind of person they wish to be. A person's
willingness to cooperateor to help others can be seen as a function of these
variables. The last factor is importantand especially easy to overlook; the
desire to think of yourself as an honest, principledperson helps explain why
most of us (though not all) do leave tips in strange restaurantsand would
leave money in the box at the road-side stand. As Rabin says, people are
willing to sacrifice their own materialwell-being to help those who are being
or have been kind. Of course, these desires compete with others in a world
of scarce resources. We don't recommendthat Mercedes dealers adopt the
road-sidestandselling technique.
55. Matthew Rabin, Incorporating Fairness Into Game Theory and Economics, 83 AM.
ECON.REV. 1281 (1993).
56. Id. at 1282.
57. ROBERTAXELROD,THEEVOLUTION
OF COOPERATION
(1984); ROBERTAXELROD,THE
COMPLEXITY
OFCOOPERATION
(1997).
May 1998]
BEHAVIORAL
Thus behavioraleconomicagentshave mannersand scruplesthat can

leadthemto be "nice"in somesettings.But,as we observein the ultimatum
game,peoplecan also be provokedto be spiteful. Sometimesthe fact that
anotherpersonwill lose, in a materialorothersense,is a benefitto the agent;
these are the conditionsfor spite. An agentmay calculatethatthe costs of
benefitinganotherpersonarguestronglyagainsta deal, even if the agent
would benefitmaterially.ThusResponderswho receive (relatively)small
offersarewillingto declinethemin orderto punishthe rudeProposerswho
triedto grabtoo muchfor themselves,even whenthe smalloffer is a substantialamountof money. Noticethatthis spitefulbehavioris also "principled": Peopleare willingto pay to punishsomeonewho has been unfair.
Thisis the samebehaviorthatdrivesboycotts,whereconsumersrefrainfrom
buyingsomethingtheynormallyenjoyin orderto punishan offendingparty.
Conventional
economicshas sometimesrecognizedsuchbehavior,but it has
receivedlittle attentionin law andeconomics,where,unfortunately,
it may
oftenbe quiterelevant.58
Spitefulbehavioris commonunderconditionsof acrimony,such as
even marriedcouduringa fight or argument.Underthese circumstances,
ples will say anddo thingsto hurtthe otherparty;underbadconditions,the
hurting,materialor otherwise,is partof theagent'sgain. A loss to anotheris
a gain to oneself;even the idea of thinkingof oneself as a certainkind of
person(nota doormator a dupe)canleadin thedirectionof inflictinglosses.
as a doormator a dupemayalso
(Concernwithnot establishinga reputation
a
This
is
of
course
the
converse
of circumstances
of cooperative
play role.)
behavior. Unfortunately,
is
acrimony particularly
prevalentin many legal
settings,before,during,and afterlitigation. Muchprotractedlitigationcases thatfail to settleearlyandamicably-may arisepreciselybecausethe
two sides were unableto deal with mattersin a more friendlymanner.
(Divorcesthatend up in courtare,almostby definition,acrimonious.)We
suspect that spiteful behavioris frequentlyobserved in conditions of
concernsareunimportant;
for example,we
acrimonyevenwhenreputational
think that the averagecontestantin a divorcecase that ends up in court
would be likely, in the role of Responderin the ultimatumgame playing
to reject low offers, not wanting the
against his soon-to-be-ex-spouse,
Proposerto benefitgreatly.59
Whatis 'fair"? Absentacrimony,spitefulbehavior-such as rejection
of small offers in the ultimatumgame-is typicallyobservedin situations
58. The conceptsof revengeand retribution,which are relatedto spite, have been discussed
by Posner. See Richard A. Posner, Retribution and Related Concepts of Punishment, 9 J. LEGAL
STUD.71 (1980).
59. Cf. RobertGibbons& Leaf VanBoven,MultipleSelves in the Prisoners'Dilemma(Nov.
16, 1997)(unpublishedmanuscript,on file with the StanfordLawReview)(findingthatsubjectsare
more likely to engage in cooperativebehaviorin games when they have a positive impressionof
theiropponentthanwhentheyhavea negativeimpression).
1496
STANFORD
LAWREVIEW
[Vol. 50:1471
whereone partyhas violateda perceived"normof fairness."Thisraisesan

obviousquestion:Whatis "fair"?In the ultimatumgame,most peopleregardan offerof, say, a pennyto the Responderas "unfair."Thisperception
is an illustrationof a more generalpattern: Peoplejudge outcomesto be
"unfair"if they departsubstantially
fromthe termsof a "referencetransaction"-a transactionthat defines the benchmarkfor the parties' interactions.60 When the interactionsare betweenbargainersdividinga sum of
moneyto whichneitheris moreentitledthanthe other(andthis is common
transaction"
is somethinglike an equalsplit;subknowledge),the "reference
stantialdepartures
are viewed as unfairand,accordingly,punishedby Reoverthedivisionof moneyandbothhave
sponders.If partiesarebargaining
reasonto view one side as moreentitledthanthe other,thenthe "reference
transaction"
is a splitthatfavorsthemore-entitled
party.6'Andif theparties
are a consumerand a firm in the market,the "referencetransaction"
is a
transaction
on theusualtermsfortheitemin question.62We will havemuch
moreto say aboutthis last contextin PartIII below. For now our goal is
simplyto offerourgeneraldefinitionof whatis "fair"andto makeclearthat
we do not view the termas a vague and ill-definedcatch-all. Rather,we
view it as havinga reasonablywell-specifiedmeaningthatcan generateuseful predictionsacrossa rangeof contexts.63
Norms. Thus far the discussionhas emphasizedfairness,and we will
stressthis factorthroughout.But fairness-related
normsare a subsetof a
largecategoryof normsthatgovernbehaviorandthatcanoperateas "taxes"
or "subsidies."An analysislike thatabovecouldbe undertaken
for many
decisionsin whichpeoplecarenot only aboutmaterialself-interestbut also
abouttheirreputations
andtheirself-conception-forexample,throughpurvacation
chasingbooks, suits,
spots, or throughsmoking,recycling,dison thebasisof raceandsex, or throughchoosingfriends,restaucriminating
of the ingredientsof individrants,andautomobiles.A betterunderstanding
ual utility could help a greatdeal with both the positive and prescriptive
moreabout(and
analysisof law. Forexample,it mighthelp us understand
be betterableto predictin relatedcontextsin the future)themassivechanges
60. See Daniel Kahneman,Jack L. Knetsch& RichardThaler,Fairness as a Constrainton
Profit Seeking: Entitlements in the Market, 76 AM. ECON.REV. 728, 729-30 (1986).
61. See ElizabethHoffman& MatthewL. Spitzer,Entitlements,

Rights,and Fairness:An ExSTUD.259, 261
perimentalExaminationof Subjects'Conceptsof DistributiveJustice, 14 J. LEGAL
(1985).
62. See Kahnemanet al., supranote 60, at 729-30.
63. For a recenteffort to incorporatea moregeneralnotionof "fairness"into the economic
analysisof tortlaw, see HenrikLando,AnAttemptto IncorporateFairnessinto an EconomicModel
of TortLaw, 17 INT'LREV.L. & ECON.575 (1997). The relevant"fairness"notionstheremay be
somewhatmore "ad hoc," as Landoultimatelyconcludes,id. at 582, because, in contrastto the
more market-oriented
contexts we consider,there is no clear "referencetransaction"in the tort
context.
May 1998]
BEHAVIORAL
in behaviorthat have followed largely unenforcedbans on smoking in public

places-the phenomenonof"compliance withoutenforcement."64
B. BargainingAroundCourtOrders
1. Coasianprediction.
As noted above, an importantaspect of law and economics is the Coase
theorem,which says that the assignmentof a legal entitlementwill not influence the ultimate allocation of that entitlementwhen transactioncosts and
wealth effects are zero. A straightforwardapplication of this idea is that
when a court enters a judgment, whether in the form of an injunction or a
damage award,the partiesare likely to bargainto a different outcome if that
outcome is preferable to what the court did and the transactioncosts and
wealth effects are small. (Thus, for instance, if the court enters a prohibitively high damage awardbut the activity in question is efficient, the parties
should bargain for a lower damage level, since this would increase the surplus to be sharedbetween them.) To whom an entitlementis allocated after
litigation, and how it is protected(by a propertyrule or a liability rule), are
irrelevantto the ultimateallocationof the entitlementin these circumstances.
2. Behavioral analysis.
Influencedby behavioraleconomics, many legal commentatorshave observed that in light of the endowmenteffect describedin PartI (an aspect of
prospecttheory, and thus an instance of boundedrationality),the assignment
of a legal entitlementmay well affect the outcome of bargaining,even when
transactioncosts (as conventionally defined) and wealth effects are zero.65
This conclusion is suggested by the mugs experimentsdescribedin PartI, as
well as by a substantialbody of other evidence on the endowment effect.66
The mugs results were obtainedin circumstancesthat were the most favorable to the predictions of the conventional theory. Transactioncosts were
zero and the sort of emotionalattachmentsthat can grow over time in the real
world were absent. Mug owners had become mug owners just minutes before the marketswere run. Comparethat with a homeowner who has been
endowed with the right to have her homesteadprotectedfrom noxious fumes
being emittednearby.
64. See Robert A. Kagan & Jerome H. Skolnick, Banning Smoking: Compliance WithoutEnPOLICY:LAW,POLITICS,
ANDCULTURE
69 (Robert L. Rabin & Stephen D.
forcement, in SMOKING
Sugarman eds., 1993).
65. See, e.g., Elizabeth Hoffman & Matthew L. Spitzer, Willingness to Pay vs. Willingness to
Accept: Legal and Economic Implications, 71 WASH.U. L.Q. 59, 99 (1993).
66. See Kahneman et al., supra note 26, at 1327 tbl. 1 (summarizing studies).
1498
LAWREVIEW
STANFORD
[Vol. 50:1471
Althoughthe endowmenteffect suggests generallythat the assignmentof

a legal entitlementmay affect the outcome of bargaining,such an effect is
especially likely when the entitlementis in the form of a court orderobtained
after legal proceedingsbetween opposing parties(our focus here). This is so
for severalreasons.
First, the process of going throughlitigation may strengthenthe endowment effect. Experimentalevidence suggests that there is an especially
strong endowment effect when a party believes that he has earned the entitlement or that he particularlydeserves it.67 Of course someone who has received a courtjudgment in his favor will believe that he has earnedit. Such
a person may also believe strongly that this outcome is fair, based on the
self-serving bias discussed in the following section.
Bounded self-interest, and specifically the acrimony notions developed
above, provide an additionalreason we might expect less bargainingin real
world settings than in law and economics texts. Even if there are financial
gains from making a deal, it is difficult to bargainwithout communication,
and litigants are often not on speakingterms by the end of a protractedtrial.
Even if communicationis possible, bargainsare unlikely to be struckwhen
both sides take pleasure in making the other side worse off; in such circumstances it can be difficult to reach agreementson settlements even if they
would substantiallyimprovethe lot of both parties. For all of these reasons,
behavioralresearch suggests that injunctionsand damage awards may stick
even with low transactioncosts (as conventionallydefined).
Note that anotherway of phrasingthis conclusion is that the concept of
transactioncosts is broaderthanconventionalanalysis assumes. The costs of
a transactioninclude not only the conventionallyrecognized ones (for example, the cost of assembling all of the relevantparties),but also costs such as
the discomfort or displeasureof dealing with an adversary. If "transaction
costs" are defined in this broaderway, then, for the reasons given above,
they will very often be substantialin the case of bargainingaroundcourt orders; hence, deals are unlikely to occur. This observationillustratesan importantgeneral point. Once the behavioralanalysis is understood,it can often be incorporatedinto economic analyses using standardconcepts such as
transactioncosts. This should not be taken to imply, however, that the behavioral analysis is superfluous. Under the usual account, transactioncosts
would have been assumed to be zero as long as the two sides could easily
negotiate.
It is of course true that most cases settle, so that those which do not, and
which thus producecourt orders,may be atypical in some respects. But that
does not mean they are unimportantobjects of study for purposes of positive
67. See GeorgeLoewenstein& SamuelIssacharoff,SourceDependencein the Valuationof
DECISION
MAKING
Objects,7 J. BEHAV.
157, 159-61(1994).
May 1998]
BEHAVIORAL
analysis. Withconventionallaw andeconomics,behavioralanalysisis concernedwiththe fact (andthe consequencesof the fact)thatsome cases proceedto trial.68
Althoughourfocusin this sectionis on positiveanalysis,thereis also a
trickynormativeissue: Whenpeople fail to reachbargainsthatwouldbe
reachedin the absenceof endowmenteffectsandspitefulbehavior,is there
of efficiency?69Onone view, the answeris
anyproblemfromthe standpoint
if
the
do
not
contract
arounda court-ordered
outcomefor these
no;
parties
then
the
outcome
must
be
efficient(even if another,differentoutreasons,
come-favoring the otherside-would also havebeenefficient). An underlying question,however,is whetherspite oughtto count in the efficiency
calculus. Someof themostprominentutilitarian
philosophersbelievethatit
shouldnot.70
3. Evidence.
Conventionaleconomictheoryand behavioralanalysisthus generate

distinctpredictionsaboutwhathappensaftertrials. Thesetheoriescanthereforebe testedwithempiricalevidence.Whathappensonce a courtjudgment
has been entered?How oftendo the partiesbargainto a differentoutcome?
Considerthe set of cases wherethe courthas assignedan entitlementto the
the standardtheorywould
partywho valuesit less. In thesecircumstances,
predictcontractingaroundthe courtorderwhenevertransactioncosts (as
conventionallydefined)and wealtheffects are small. (The possibilityof
asymmetricinformationis discussedbelow in connectionwith the existing
empiricalfindings.) Thebehavioraltheorypredictsthateven in suchcases,
therewill oftenbe no recontracting.Sinceit is unlikelythatcourtordersare,
acrossthe board,uniquelyefficient,it shouldbe possibleto test thesediffering predictions.
Even withoutthis detailedtype of information,datagatheredby Ward
Farnsworth
suggestthatthereis muchless post-trialbargainingthanthe eco68. Conventionallaw and economicsattributesfailuresto settle primarilyto informational
differencesamongparties. Thereis a largebody of literatureon this topic,which is summarizedin
Bruce L. Hay & Kathryn E. Spier, Litigation and Settlement, in THENEWPALGRAVE

DICTIONARY
OFECONOMICS
ANDTHELAW(forthcoming 1998).
69. For a discussionof variousapproachesto this questionin the contextof endowmenteffects, see RussellKorobkin,Note, Policymakingand the Offer/Asking
Price Gap: Towarda Theory
of EfficientEntitlementAllocation,46 STAN.L. REV.663, 675-97 (1994).
70. See John C. Harsanyi, Morality and the Theory of Rational Behaviour, in
UTILITARIANISM
AND BEYOND39, 55-56 (Amartya Sen & Bernard Williams eds., 1982).
A.
MitchellPolinskyand Steven Shavell have acknowledgedthis view in their analysisof punitive

damagesas a responseto the socially illicit gains obtainedby certaindefendants.See A. Mitchell
Polinsky& Steven Shavell,PunitiveDamages:An EconomicAnalysis, 111 HARV.L. REV.869,
908-10 (1998).
1500
LAWREVIEW
STANFORD
[Vol. 50:1471
nomic model would predict.71 Farnsworthinterviewed attorneys from approximatelytwenty nuisance cases in which injunctiverelief was sought and
either grantedor denied after full litigation before a judge. In not a single
case of those Farsworth studieddid parties even attemptto contractaround
the court order, even when transactioncosts were low, and even when an
objective thirdpartymight think that there was considerableroom for mutually advantageousdeals. Conventionalanalysis might attributefailures to
reach an ultimate agreement to asymmetric information;72but under such
analysis it is difficult to explain the complete failure even to negotiate. It is
also interesting to note that the lawyers interviewed said that the parties
would not have reacheda contractualsolution if the opposite result had been
reached. (This last point also means that the no-bargainingresult cannot be
explainedby supposingthatthe courtordersenteredwere uniquely efficient.)
The lawyers' explanationsfor these results are behavioral in character.
Once people have received a courtjudgment,they are unwilling to negotiate
with the opposing party, partly because of an unwillingness by victorious
plaintiffs to confer advantages upon their opponents. Having invested a
great deal of resourcesin pursuingthe case all the way to court and througha
trial, victors perceive themselves as having a special right to the legally endorsed status quo, and they are unlikely to give that right up, especially to
their opponent,for all, or most, of the tea in China. Their investment in the
entitlementgives it a distinctive character. Bargains are unlikely in the extreme; the plaintiff and the defendant tend not even to think about them.
These tendencies are reinforced (according to the lawyers in Famsworth's
study) by the presence of acrimonybetween the parties;thus acrimonycombines with the endowmenteffect to producean absence of negotiation.
Here, as elsewhere in this article, our emphasis is on whether empirical
evidence exists to test the predictions of the conventional and behavioral
economic accounts, and, if more evidence would be helpful, what sort of
study might be most useful. It is frequentlyremarkedthat law and economics is primarilytheoreticalor analytic, and rarelyempirical. Victory is often
declaredbased on a datalessmodel. We think that before victory can be declared for either conventionalor behaviorallaw and economics, the fit of the
theory with the available evidence must be assessed. For behavioralanalysis, it is not enough to build a model consistentwith behavior observed in an
experimentalsetting (such as behavior in the ultimatumgame or the mugs
experiments);the model must be comparedand tested against what we observe in the world. A good aspirationfor both conventional and behavioral
71. WardFarnsworth,Do Partiesto NuisanceLawsuitsBargainAfterJudgment?A Glimpse
Insidethe Cathedral(1998) (unpublishedmanuscript,on file withthe StanfordLawReview).
72. See, e.g., Louis Kaplow & Steven Shavell,PropertyRules VersusLiabilityRules: An
EconomicAnalysis, 109 HARV.L. REV.713, 734 & n.66 (1996) (discussingeconomicmodels in
whichasymmetricinformationleadsto failednegotiations).
May 1998]
APPROACHTOLAW
& ECONOMICS 1501
BEHAVIORAL
approachesis careful empiricalwork thatprovides reasonablydefinitive conclusions aboutpredictivefailuresand successes.

The empiricaldataand futureempiricalresearchdiscussed in this section
concernbehavioraftera courthas entereda judgment. Of course, most cases
settle before trial, and so it is also importantto ask to what degree bargaining
is likely to be successful priorto this point. This is a separatequestion;bargaining may be more likely in that setting because neither side has yet been
endowed through a courtjudgment with a clear entitlement. On the other
hand, self-serving bias and conditions of acrimony (as well as the backgroundforce of the "ordinary"endowmenteffect) may still preclude successful bargaining. The next section examines the effect of self-serving bias on
successful pretrialbargaining(as well as other forms of bargaining)in more
detail.
C. Failed Negotiations
1. Self-servingconceptionsoffairness.
Even among the well-mannered, fair-mindedagents that populate behavioraleconomics, self-interestis very much alive and well. For often there
will be room for disagreementaboutwhat is fair (or, equivalently,what is the
appropriatereferencetransaction)-and thus there will be the opportunityfor
manipulationby self-interestedparties. These partiesmay tend to see things
in the light most favorable to them; while people care about fairness, their
assessments of fairness are distorted by their own self-interest. This is a
form of bounded rationality-specifically, a judgment error;people's perceptions are distortedby self-servingbias.
This form of bias can help to explain the frequency of failed negotiations. It is quite common, in cases involving divorce, child custody, and
even commercial disputes, to see protractedlitigation in circumstances in
which it might be expected that the partieswould be able to reach negotiated
solutions (although it of course remains the case that most suits settle). On
the standardaccount, the existence of such protractedlitigation is somewhat
of a puzzle. With a good sense of the expected value of suit, parties should
settle more than they do. It may be possible to explain some of the observed
behaviorin terms of asymmetricinformationand signaling, which may interfere with settlement prospects.73 However, this account is difficult to test.
By contrast,the effects of self-serving bias in negotiations have been tested
empirically,as describedbelow.
73. See, e.g., POLINSKY,

supranote 6, at 109-11.
LAWREVIEW
STANFORD
1502
[Vol. 50:1471
2. Evidence.
The leadingstudy in this area is one by LindaBabcock,Xianghong

Wang,andGeorgeLoewensteinon the consequencesof self-servingbias for
negotiationimpassein publicschool teachercontractnegotiationsin Pennsylvania.74A commonelementof publicsectorlabornegotiationsis forboth
sides to invokeagreementsin "comparable"
communities,eitheras a measof whatis fair. Do particiure of marketconditionsor as a characterization
in a rationalmanner?
in
a
choose
communities
pants
negotiation
comparable
Babcock,Wang,and Loewensteinhypothesizedthatthey may not; instead,
both sides may adoptself-servingjudgmentsaboutwhich communitiesare
and impassesmay result from such judgments. They de"comparable,"
a
signed surveyof unionandschoolboardpresidentsin all schooldistrictsin
districtsforpurin orderto elicitjudgmentsaboutcomparable
Pennsylvania,
poses of salarynegotiations.Respondentswere askedto "listthe districts
to theirown."75Note thatthereis no strategicinthey felt werecomparable
centivehere to misrepresent
one's view of which districtsare comparable,
eitherto gainan advantagein negotiationsor to currypublicfavorfor one's
negotiatingposition;the only audiencefortheresponsesin the studywas the
study'sauthors.Nonetheless,substantialdifferencesbetweenthe two sides
emerged.The averagesalarylistedby unionpresidentsfor comparabledistricts was $27,633, comparedto an averageof $26,922 for school board
Thisdifferencewas about2.4%of the averageteachersalaryin
presidents.76
a settingin whichthe last offersbeforeteacherstrikesweretypicallyabout
onepercentapart.77
By itself, this differenceis highlysuggestive;if the two sides have differentviews aboutcomparable
districts,bargaining
impassesmaywell occur.
But do these self-servingviews (reportedto the authorsof the studyin response to a surveyquestion)correlatewith actualbehavior? Yes. The
authorsregressedthe percentageof previousnegotiationsthat ended in a
strikeagainstthe differencebetweenthe two sides' lists of comparabledistricts. Theregressionshowedthatthisdifferencehadsubstantial
explanatory
power. In thoseschooldistrictswherethe averagesalaryof the union'slist
is $1000 greaterthan the board'slist, a strikeis forty-ninepercentmore
likely thanwherethe averagesalariesof the two lists arethe same.78Thus
self-servingbiasescanexplainreal-worldbargaining
impasses.
74. Linda Babcock, Xianghong Wang & George Loewenstein, Choosing the Wrong Pond:
Social Comparisonsin NegotiationsthatReflecta Self-ServingBias, 111 Q.J.ECON.1 (1996).

75. Id. at 10.
76. Id. at 11.

77. Id.
78. Id. at 13.
May 1998]

BEHAVIORAL
As already noted, strategicbehavior does not seem to provide a strong

explanationfor the empiricalevidence on school-districtnegotiations. There
was no incentive in the study (as there would often be in negotiations with
the opposing party) for parties to choose comparabledistricts in a strategic
manner.79The behavioralaccount seems to exhibit a higher "R2"-a better
ability to predictthe observeddata-than the standardaccount.
A fertile ground for futurestudy of self-serving bias and its relationship
to bargainingimpasse may be negotiationsbetween baseball players' agents
and team management. It is common practice in these negotiations for both
sides to use the contractsof "comparable"players as reference points, once
again as a measure of marketconditions and as a characterizationof what is
fair. Participants'selection of which players are comparablemay well be
colored by self-serving bias. Explorationof the impact of this behavioral
factor on the success or failure of these negotiations seems far more promising than examining the role of informationalasymmetryin this setting. For
the participantshave equal access to the informationthat defines what is a
comparableplayer. Thus behavioraleconomics appearsmore likely than the
conventionalmodel to predictand accountfor those negotiationsthat fail and
end up in the hands of an arbitrator.
In additionto the existing dataon school districtstrikes,researchershave
conductedexperimentalstudies on the role of self-serving bias in preventing
negotiated agreements.80The studies involved a tort case based on real litigation in Texas. Subjects-college and law students-were randomly assigned to the role of plaintiff or defendant;in this role they were asked to
negotiate a settlement. They received a short summaryof the case and also
twenty-seven pages of materialsfrom the original case. Subjects were told
that the same case materialshad been given to a judge in Texas, who had
reached a judgment between $0 and $100,000. Before beginning to negotiate, subjects were asked to write down their guesses about what the judge
awarded. They were also asked to say what they considered a fair amount
for the plaintiff to receive in a settlement. The authorsfound quite substantial self-serving biases in subjects' assessments of the judge's award. The
subjects acting as the plaintiffs guessed an average $14,527 higher than the
defendants', and the plaintiffs' fair settlement values averaged $17,709
higher thanthose of the defendants.81Nonsettlementwas strongly connected
79. Fora fullerdiscussionthanspaceherepermitsof the possibilityof strategicbehavior,and
experimentalevidencefromotherstudiesthatpointsagainstsuchan explanationfor the results,see
id. at 17-18.
80. Linda Babcock, George Loewenstein,Samuel Issacharoff& Colin Camerer,Biased
Judgmentsof Fairness in Bargaining,85 AM. ECON.REV. 1337 (1995); George Loewenstein,
Samuel Issacharoff,Colin Camerer& LindaBabcock,Self-ServingAssessmentsof Fairness and
PretrialBargaining,22 J. LEGAL
STUD.135 (1993).
81. Loewensteinet al., supranote 80, at 151.
1504
LAWREVIEW
STANFORD
[Vol. 50:1471
to the discrepancyin predictionsabout the judge's likely award.82Note that

the hypothetical,role-playing natureof this study in some ways strengthens
the interpretationof the result. In the short time that it took to read all the
materials, subjects adopted the point of view of their roles and the bias that
comes with it. Of course, the fact that roles were only hypothetical,and the
financial stakes small, means that we cannotbe sure from these studies alone
that parties would display self-serving bias in real-world settings; but the
school districtstudy suggests the importanceof the bias in such settings.
3. Therole of lawyers.
Are real lawyers immune from self-serving biases? There is some evidence that lawyers, as intermediators,are relatively less subject to various
cognitive biases, in ways that can help promotesettlement.83However, there
is suggestive evidence that self-serving bias does affect lawyers and judges
as well as other actors. A study of 205 bankruptcylawyers and 150 bankruptcyjudges found self-serving biases in responses to a wide range of questions involving how long it takes judges to rule on fee applications,the fairness of fees, and lawyers' fee awardsin general.84Thus, for example, thirtytwo percent of lawyers reportthat they never request court-orderedcompensation in excess of normal hourly rates, but judges report that only eleven
percentof lawyers never make such requests.85This evidence does not show
that lawyers do not reduce self-serving bias in actual litigation, but it casts
doubt on the propositionthat this bias is eliminatedby the involvement of
professionals. To the extent that the bias is reduced through lawyers' involvement, it suggests that part of the appropriaterole of lawyers may be to
counter their clients' predictableinclinationto overstatethe fairness of their
own cause. This may be difficult since clients are the ultimatedecisionmakers and lawyers may have an economic interestin not settling. Thus, serious
ethical issues may arise about the lawyer's obligations. To the extent that it
is possible for clients to be "debiased"by their lawyers, behavioralresearch
provides considerable guidance on which debiasing techniques are least
likely to be successful, and which might actuallywork.86
82. Id.
83. See Russell Korobkin& ChrisGuthrie,Psychology,Economics,and Settlement:A New
Lookat the Role of theLawyer,76 TEX.L. REV.77 (1997).
84. TheodoreEisenberg,DifferingPerceptionsof AttorneyFees in BankruptcyCases, 72
WASH.U. L.Q. 979 (1994).
85. Id. at 988 tbl.3.
86. See LindaBabcock,GeorgeLoewenstein& SamuelIssacharoff,DebiasingLitigationIm913 (1997).
passe, 22 J. L. SOC.INQUIRY.
May 1998]

BEHAVIORAL
D. MandatoryContractTerms
1. Wageandprice effects.
One of the most frequentclaims in the economic analysis of law is that
the imposition of mandatoryterms on parties to a contract will make both
parties worse off; it will operateas an effective tax on their transaction. For
example, rules grantingemployees a particularlevel of workplace safety, or
tenantsthe right to a habitableapartment,will make employers and employees, or landlords and tenants, worse off.87 In this section, we suggest that
bounded rationality,in particularthe endowment effect, casts doubt on the
conventional law and economics claim. Our analysis here parallels that offered by Richard Craswell several years ago in the context of mandatory
product warranties;88we build upon Craswell in emphasizing the employment setting and in drawingupon a recent empirical study of the effects of
mandatorycontractterms.
The conventional argumentagainst mandatoryterms such as those just
mentionedhas two steps. First, since the partiesdid not bargainfor the term
in question when left to their own devices, the cost of the term must exceed
its benefit (otherwise they would have agreed to it on their own). Thus, for
example, if a particularemploymentbenefit is worth $100 per year to employees and costs the employeronly $90 to provide, a mandateshould not be
necessary; but if we do not observe the parties agreeing to the benefit on
their own, then the cost must exceed $100. The second step in the conventional argumentis that imposing a mandatoryterm in these circumstances
will operateas a tax on the parties,causing the wage to fall (or, in the case of
a habitable apartment,the price to rise) by somewhere between the benefit
and the cost of the term, and causing the numberof profitabletradesto fall.89
Thus, in the example just given, if the cost of the benefit valued at $100 is
$110, then the employer will reduce the wage rate by somewhere between
$100 (the value of the benefit to employees) and $110 (the cost of the benefit); and the level of employmentwill fall. This analysis assumes an upwardsloping (not vertical) labor supply curve, but, at least for the worker group
87. See POSNER,

supranote 6, at 363, 515-17;RichardA. Epstein,In Defenseof the Contract
at Will,51 U. CHI.L. REV.947, 954-55 (1984); CharlesJ. Meyers,The Covenantof Habitability
and theAmericanLawInstitute,27 STAN.L. REV.879, 890 (1975);EdwardH. Rabin,TheRevolution in ResidentialLandlord-Tenant
Law: Causesand Consequences,69 CORNELL
L. REV.517,
558 (1984).
88. RichardCraswell,Passing on the Costs of Legal Rules: Efficiencyand Distributionin
Buyer-SellerRelationships,43 STAN.L. REV.361, 388-90 (1991).
89. See LawrenceH. Summers,SomeSimpleEconomicsof MandatedBenefits,79 AM.ECON.
REV.,May 1989, Papers& Proceedings,at 177, 180-81& fig.1.
1506
STANFORD
LAWREVIEW
[Vol. 50:1471
discussedbelow in connectionwith the existingempiricalevidence(female

is clearlyreasonable.90
employees),thisassumption
The conventionalaccountthusofferssharppredictionsaboutthe effects
of imposingmandatorycontractterms. Do the databearout these predictions? The leadingstudyin this areais by JonathanGruber;Gruberexamines the effects of imposingmandatorycoverageof childbirthexpensesin
insurancepolicies.91Impositionof themandatory
healthemployer-provided
insuranceterm-which representeda substantialdeparturefrom the usual
contractual
arrangements
priorto themandate-causedthe wagesof affected
workers(mostprominently,
marriedwomenof childbearing
age) to fall by at
least the cost of the mandatedcoverageaccordingto most of the author's
estimates.92The studyalso foundthatthe hoursof employmentof these
workerswere eitherunchangedor slightlyhigherwith the mandateandthat
theirprobabilityof beingemployedwas eitherunchangedor slightlylower.93
In sum,"[t]hefindingsconsistentlysuggestshiftingof the costs of the mandates on the orderof 100 percent,with little effect on net laborinput."94
These findingsare not easy to reconcilewith the conventionalaccount,
whichpredictsa fall in wagesless thanthe cost of the benefit. (If the wage
were going to adjustby the full cost of the benefit,then some substantial
fractionof employersshouldhaveofferedthe benefiteven priorto the mandate.)
2. Behavioralanalysis.
Departuresfrom the assumptionsof expectedutility maximizationby
rationalagentssuggesta differentaccountof the effectsof imunboundedly
posing mandatorycontractterms,one thatis consistentwith the empirical
findingsjust described.As notedabove,the endowmenteffect impliesthat
thatare given to themthan
peopleare oftenless willingto sell entitlements
to buyentitlements
thattheydo not alreadypossess;if givena mug,theywill
not sell it for threedollars,but if not given a mug,theywill not buy one for
thatprice. Thus,the fact thatan employee(say) choosesnot to purchasea
particular
workplacebenefitif he is not grantedan entitlementto it does not
90. See, e.g., PAUL A. SAMUELSON
& WILLIAMD. NORDHAUS,ECONOMICS
681 tbl.28-2
(13th ed. 1989).

91. JonathanGruber,TheIncidenceof MandatedMaternityBenefits,84 AM.ECON.REV.622
(1994).
92. Id. at 623, 630-31, 633, 636. Gruberperformsa numberof differentregressions;one set
did not yield statisticallysignificantresults,id. at 638, while the othersyielded statisticallysignificantresultsalongthe lines describedin the text. The confidenceintervalsfor the majorityof these
resultsalso includevalues indicatingless thanfull shiftingof the cost-but also, of course,values
indicatingmuchmorethanfull shiftingof the cost.
93. Id. at 623, 633, 637.
94. Id. at 623.
May 1998]

BEHAVIORAL
imply that he would want to sell the entitlement(if he could) once it has been
granted. The corollaryof this observationis that imposing a mandatoryterm
may have different effects than the standardanalysis predicts. In supplyand-demandterms, imagine a labor supply curve prior to the imposition of
the mandate, reflecting willingness to work at different wage levels given
provision of the benefit; the consequence of the endowment effect may be
that this curve is shifted to the right once the mandate is imposed, and this
move may more than compensate for the backwardshift in the employer's
labor demandcurve as a result of the mandate. If this occurs, then the wages
of the affected worker will fall by as much as or more than the cost of the
benefit. This is precisely what the Gruberstudy of mandatedchildbirthcoverage finds.95
Three caveats are importanthere. First, while the endowment effect is
consistent with complete or more than complete adjustmentof the wage or
price, it is also possible to have less than complete adjustmentof the wage or
price in the presence of the endowmenteffect. Perhapsworkers are not any
more willing to supply laborin exchange for a given wage plus the benefit in
question once they have an entitlementto the benefit; it may be just that they
would be even less willing to supply laborin the absence of the benefit. It is
also possible that conventionaleconomic analysis, by incorporatinga market
failure such as adverse selection (a possibility generally ignored by the
above-mentionedcritics of mandatorycontractterms), can explain the empirical findings discussed above.96 Our point is just the modest one that the
behavioral account can predict an instance of observed behavior that is inconsistent with the standardlaw and economics account of mandatoryterms.
Futureempirical work could attemptto address the adverse selection possibility by examining the effects of mandatorycontractterms in a setting in
which (in contrastto the health insurance context) adverse selection is unlikely to be a significantforce.
The second qualificationis thatthe endowmenteffect may not operatein
contexts in which the beneficiaries of a mandatoryterm must give up a preexisting level of income, since they may be highly averse to such a loss.97
95. As noted above, RichardCraswelloffers an analogousanalysisin the contextof mandatory productwarrantiesfor consumers. See Craswell,supra note 88, at 388-90. As Craswelldescribes,given the endowmenteffect, the mandatorytermmay causethe pricepaidby consumersto
adjustby morethanthe cost of the term,andthe quantityof the good demandedmay rise. In addition to Craswell'sdiscussionof mandatoryterms,the endowmenteffect has been extensivelydiscussed in the legal literaturein connectionwith waivablecontracttermsand the Coase theorem.
See, e.g., David Chamy,HypotheticalBargains:TheNormativeStructureof ContractInterpretation, 89 MICH.L. REV.1815, 1867-68(1991) (discussingwaivableterms);Kelman,supranote 1, at
678-95 (concerningthe Coasetheorem).
96. See Gruber,supranote 91, at 626 n.9.
97. See Kahneman& Tversky,supranote 12, at 277-79 (arguingthatchangesin welfaremust
be evaluatedin termsof an initialreferencepointandthat"lossesloom largerthangains").
1508
STANFORD
LAWREVIEW
[Vol. 50:1471
This qualificationapplies only to situationsin which there is a financial loss

relative to some preexisting expectation;thus it would not apply to, for example, a consumer's purchaseof a durablegood at a higher price due to the
inclusion of a warranty. The final qualificationhere is that our analysis in
this section is purely positive, concernedwith the effects of imposing a mandatorycontractterm. The endowmenteffect does not necessarily imply that,
from a normative perspective, mandatoryterms are desirable; they may be
efficient, in the sense that they would not be undone (if they could be) once
imposed, but the situationwithout such terms is also efficient, for the same
reasons given by the standardaccount, and there is no obvious means by
which the two situations can be compared. Unlike several of the scenarios
discussed in PartV below, in which we thinkthere is often a relatively strong
argumentfor choosing one normativebenchmarkover another(say because
people are likely to underestimatecertain objective probabilities based on
some form of judgment error),here there does not seem to be a clear basis
for such a decision.
Our emphasis, then, is the positive question of the effects of imposing
mandatorycontract terms. The primarypoint is that there is a substantial
research agenda to test various hypotheses;what we wish to suggest is that
the conventionalview cannotbe accepted a priori and that there is reason to
think thatbehaviorallaw and economics points in helpful directions.
III. THECONTENTOFLAW
One of the goals of law and economics is to explain the content of lawwhat the law allows and what it prohibits. The traditionalapproachprovides
two tools for this analysis. First, laws may be efficient solutions to the
problems of organizing society.98 Such laws can be thought of as solutions
to optimal contractingproblems with all of the affected parties at the table.
Second, laws may come about because of the rent-seeking activities of politically powerful actors; many laws that benefit farmers and concentrated
industries, for example, have been explained along these lines.99 The positive theory of law reflected in the conventionalaccountpredictsthat the legal
rules we observe will be rules that eithermaximize social wealth (if they are
judge-made rules) or redistributewealth to interestgroups able to influence
the legislative process. Law and economics scholars who reject this account
of the content of law have not offered any alternativeaccount to explain and
predictthe rules we observe.
The notion that laws emerge from considerationsof efficiency and conventional rent seeking would probably strike most citizens as odd. Instead,
98. See POSNER,
supranote 6, at 569.
99. See GeorgeJ. Stigler, The Theoryof EconomicRegulation,2 BELLJ. ECON.& MGMT.
SCI.3 (1971).
May 1998]
BEHAVIORAL
we suspect thatmost membersof society-which is to say most of the people

who are entitled to elect legislators-hold the view, undoubtedly naively,
that the purposeof the law is to codify "right"and "wrong." Certainlymany
criminal statuteswould be explainedwithoutreferenceto either of the above
factors. In this section we argue that law and economics explanationsof the
content of law need to be modified by incorporatingthe ideas of bounded
self-interest (in the form of fairness norms) and bounded rationality developed above. As we will try to show, many laws on the books appearto be
difficult to justify on efficiency grounds (for example, those that prohibit
mutually beneficial exchanges without obvious exteralities) and seem to
benefit groups that do not have much lobbying power (such as the poor or
middle class). We argue that the explanationfor the "anomalous"laws is
typically a quite simple one: Most people think the result is fair. We also
suggest that some laws we observe reflect neither efficiency nor conventional rent seeking but, instead, aspects of boundedrationality. Our point is
not the general (and ratherobvious) one that fairness concerns and bounded
rationalitymay shape the content of law; we seek to show specifically how
behavioral analysis has real predictive and explanatorypower. We also do
not claim that fairness concernsand boundedrationalityexplain every aspect
of the content of law-just that they provide a useful supplementto existing
explanations.100
The mechanisms underlying our behavioral economic account of the

content of law are simple and conventional. With the existing analysis, we
assume (for presentpurposes,and insofaras statutoryratherthanjudge-made
law is concerned)that legislators are maximizersinterestedin their own reelection. Legislators interestedin their own reelection will be responsive to
the preferences and judgments of their constituents and those of powerful
interest groups. If constituents believe that a certain practice is unfair or
dangerous,and should be bannedor regulated,self-interestedlegislators will
respond, even if they do not share these views. Likewise, if a mobilized
group holds such views, legislators' response will be affected, in much the
same way as if the group sought legislation to serve a narrowly defined financial self-interest,as posited by the standardaccount.
Mobilized groups may also attemptto manage and exploit the public's
views, including views influenced by bounded self-interest and bounded rationality, to bolster their own efforts;a prime example discussed below is the
"availabilityentrepreneur,"who seeks to publicize an event in orderto make
100. Ouranalysisin this partis similarin spiritto thatofferedby earlierwork such as David
Cohen& JackKnetsch,JudicialChoiceand DisparitiesBetweenMeasuresof EconomicValues,30
OSGOODE
HALLL.J. 737 (1992) (seekingto explainvariouslegal doctrinesbased on the endowment effect), and Sara Sun Beale, What'sLaw Got To Do WithIt?, 1 BUFF.CRIM.L. REV.23
(1997) (seeking to explain criminallaw based on the availabilityheuristicand other aspects of
boundedrationality).
1510
STANFORD
LAWREVIEW
[Vol. 50:1471
it more "available"to the general public, and thus to increase the public's
demand for regulation. We suspect that a full account of the content of law
would have to incorporatelegislators' independentjudgments about fairness
or risk, which play an occasional role; but we do not discuss that point here
because for the examples we consider, public and interest-groupperceptions
seem to provide a good (and the most parsimonious)account of the laws we
observe.
A. Bans on MarketTransactions
This section discusses the demand for the law insofar as that demand is
affected by people's bounded self-interestand in particularby their taste for
fairness as they understandit. We do not mean to defend the laws that we
describe;we suggest more modestly that people's commitmentto fairness is
part of the causal mechanism that establishes those laws. Fairness norms
interactwith other forces to produce some of the seemingly anomalous laws
we observe. "Fairnessentrepreneurs"may play a role, mobilizing public
judgmentsto serve their (selfish or nonselfish) interests.
1. Bans on economic transactions.
A puzzle. A pervasive featureof law is that mutually desired trades are
blocked. Perhapsmost puzzling amidstthis landscape-which includes bans
on baby selling and vote trading,discussed below-are bans on conventional
"economic"transactions,such as usurious lending, price gouging, and ticket
scalping. Usury, or chargingan interestrate above a certainlevel, is prohibited by many states in consumer lending transactions.101Price gouging, or
the chargingof "grosslyexcessive" or "unconscionable"prices, is prohibited
during "states of emergency" (as after a flood or other natural disaster) in
many states that have had recent experience with such events.102 Finally,
ticket scalping, or the resale of tickets at prices well above face prices (in
excess of a modest margin to cover ticket brokers' costs), is prohibitedby
roughly half of all states, including New York (with its heavy theaterpopulation).103What accounts for these laws, which impose constraintson gain101. See UNIF. CONSUMER
CREDITCODE? 2.201 (1974 Act).
102. See ALA. CODE? 8-31-3 (1997); 1997 ARK. ACTS376; CAL. PENALCODE? 396 (West
1998); CONN. GEN. STAT. ? 42-232 (1997); FLA. STAT.ANN. ? 501.160 (West 1998); GA. CODE
ANN. ? 10-1-393.4 (1997); LA. REV. STAT.ANN. ? 29:732 (West 1988); N.Y. GEN. BUS. LAW ?
396-r (McKinney 1997-1998); TEX.BUS. & COM.CODEANN. ? 1746(25) (1998).
103. See ARK. CODEANN. ? 5-63-201 (Michie 1997); CONN. GEN. STAT. ? 53-289 (1997);
FLA. STAT.ANN. ? 817.36 (West 1998); GA. CODEANN. ? 10-1-310 (1997); KY. REV. STAT.ANN.
? 518.070 (Banks-Baldwin 1997); LA. REV. STAT. ANN. ? 4:1 (West 1997 & Supp. 1998); MD.
CODEANN., BUS. REG. ? 4-318 (1992); MASS. GEN. LAWSch. 140 ?? 185A, 185D (West 1994);
MICH. COMP.LAWSANN. ? 750.465 (West 1991); MINN. STAT. ANN. ? 609.805 (West 1987);
MISS. CODEANN. ? 97-23-97 (1994); Mo. ANN. STAT.? 578.395 (West 1995); N.M. STAT.ANN. ?
May 1998]

BEHAVIORAL
for ordinarycommoditiessuchas televisionsets and

producingtransactions
theatertickets?
Not surprisingly,economistsand economicallyorientedlawyersoften
view theselaws as inefficientandanomalous.'04
Thelaws also do not generally seem well explainedin termsof conventionalrent seekingby a politilaws arean excally powerfulfaction. Onemightarguethatticket-scalping
to
this
last
on
the
that
ticket
sellers
ception
point,
ground
(whomaybe politiin
favor
the
of
laws
because
moderatepricesare
callypowerful)mightlobby
necessaryto createdemand,which in turncertifiesqualityand makesthe
productmoredesirable.105
(Thus,for example,the argumentwouldbe that
restaurant
ownersdo not raisepriceswhenwaitsdevelopfor tables,andif a
reservationswereto developwith very high
secondarymarketin restaurant
for
restaurateurs
prices tables,
mightwish to outlawit.) The difficultywith
this formof argumentas appliedhereis thatit cannotexplainthe application
of ticket-scalping
lawsto perenniallypopulareventswhosequalityis known
fromTV andwhose attractiveness
to the publicwouldnot decreasesignifieven
withsomediminutionin demand-a categorythatincludesmany
cantly
professionalsportingevents. Ourpointhereis actuallya moregeneralone:
Althoughit maybe possibleto offerefficiencyor conventionalrent-seeking
there
explanationsfor certainsortsof lawsbanningeconomictransactions,106
does not seemto be a generaltheoryor set of theoriesthatcan explainall or
evenmostof theselawson traditional
grounds.
A behavioralaccount.By contrast,lawsbanningusuriouslending,price
gouging,andticketscalpingwhensuchactivitiesareprevalentarea straightforwardpredictionof the theoryof perceivedfairnessdevelopedin PartII.A
above. (We assumehere that self-interestedlegislatorsare responsiveto
citizens'or otheractors'demandfor the contentof law.) In the case of each
of thesebans,the transaction
in questionis a significantdeparturefromthe
usualtermsof tradein the marketforthe goodin question-thatis, a significantdeparture
fromthe "reference
transaction."Behavioralanalysispredicts
thatif tradesareoccurringfrequentlyin a givenjurisdictionat termsfarfrom
30-46-1 (Michie 1997);N.Y. ARTS& CULT.AFF.LAW? 25.13 (McKinney1984 & Supp. 1998)
(effectiveJune 1, 1998);N.C. GEN.STAT.? 14-344(1997);4 PA. CONS.STAT.ANN.?? 211, 212
ANN.? 16-17-710(LawCo-op. 1985).
(West 1995);R.I.GEN.LAWS? 5-22-26 (1995);S.C. CODE
104. See. e.g., JohnTiemey, Tickets?SupplyMeetsDemandon Sidewalk,N.Y. TIMES,Dec.
26, 1992, at Al (quotingNew York UniversityeconomistWilliam J. Baumol criticizinglaws
againstticketscalping).
105. See GaryS. Becker,A Note on RestaurantPricing and OtherExamplesof Social Influences on Price, 99 J. POL.ECON.1109, 1110(1991) (offeringquality-certification
argument).
106. For an argumentthat usurylaws can be explainedon conventionaleconomic grounds,
see Eric A. Posner,ContractLaw in the WelfareState:A Defense of the UnconscionabilityDoctrine, UsuryLaws, and RelatedLimitationson the Freedomto Contract,24 J. LEGAL
STUD.283
(1995). PeterDiamondhas pointedout to us thatticket-scalpinglaws may be desirableto sports
team ownerswho wish to engage in certaintypes of dynamicpricingstrategiesover the courseof
the season.
1512
STANFORD
LAWREEVIEW
[Vol. 50:1471
those of the reference transaction,there will be strong pressure for a law

banning such trades. Note that the predictionis not that all high prices (ones
that make it difficult or impossible for some people to afford things they
might want) will be banned;what we predictwill be banned are transactions
at terms far from the terms on which those transactionsgenerally occur in
the marketplace.
Considerthis example:
A storehas been sold out of the popularCabbagePatchdolls for a month. A
week beforeChristmasa single doll is discoveredin a storeroom. The managers know thatmanycustomerswould like to buy the doll. They announceover
the store's public addresssystem that the doll will be sold by auctionto the
customerwho offersto pay the most.107
Nearly three-quartersof the respondentsjudged this action to be either

somewhat unfair or very unfair, though, of course, an economic analysis
would judge the auction the most efficient method of assuring that the doll
goes to the person who values it most.108Although the auction is efficient, it
representsa departurefrom the "referencetransaction,"underwhich the doll
is sold at its usual price. (Of course, there would be no need for a law banning such behavior, since it does not appearto be prevalent.) As in the doll
example, if money is loaned to individualsat a rate of interest significantly
greaterthan the rate at which similarly-sizedloans are made to other customers, then the lender's behaviormay be viewed as unfair. Since lumber generally tends to sell for a particularprice, sales at far higherprices in the wake
of (say) a hurricane,which drives demand sky high, are thought unfair.
Tickets to sportingevents or the theateroften sell for aroundthe face price of
the ticket, so large mark-upsover that amountarejudged unfair. Consistent
with this last suggestion, subjects asked whether a team should allocate its
few remainingtickets to a key football game throughan auction thoughtthat
this approachwould be unfair;allocationbased on who waited in line longest
was the preferredsolution.109Of course, waiting in line for tickets is precisely what happens with laws against ticket scalping. Thus, pervasive fairness norms appearto shape attitudes(and hence possibly law) on usury,price
gouging, and ticket scalping.
"Conventionaleconomic analyses assume as a matterof course that excess demand for a good creates an opportunityfor suppliersto raise prices"
and that "[t]he profit-seeking adjustments that clear the market are . . . as
natural as water finding its level-and as ethically neutral,"but "[t]he lay

public does not share this indifference."''0 A system in which, for example,
only fans able to pay $3000 could attendthe SuperBowl would be a system
107. Kahnemanet al., supranote 60, at 735.
108. Id.
109. Kahnemanet al., supranote 47, at S287-88.
110. Kahnemanet al., supranote 60, at 735.
May 1998]
BEHAVIORAL
characterizedby the sort of severe departurefrom the reference transaction

that people view as intolerable. As a letter-writerto the New York Times
colorfully put it in responding to coverage of ticket-scalping laws: "With
legalized scalping, lower- and middle-incomeconsumerswould be relegated
to watching events at home or buying overpricedseats in the nosebleed section"; such a system of "entertainmentDarwinism"would be a "raw deal"
for the averageconsumer.111
We emphasizethat we need not (and do not) find these views of fairness
necessarily rational or compelling. Many of those who think "usurious"
lenders are "unfair"might not have thoughtthroughthe implications of their
views (for example, that paying an outrageousprice for a loan may be better
than paying an infinite price, or that a loan to a riskierborroweris a product
different in kind from a loan to a safer borrower). Still, if such views are
widespread,they may underliecertainpatternsin the content of law, such as
the legal restrictionson usury, price gouging and ticket scalping. Our claim
here is a positive one about the content of the law we observe, not a prescriptiveor normativeone aboutthe shape practicesor rules should take. As
a positive matter, behavioral analysis predicts that if trades are commonly
occurringwith terms far from those of the reference transaction,then legal
rules will often ban tradeson such terms.
We do not claim to have offered a definitive explanationfor the pattern
of usury, price gouging, and ticket scalping laws we observe. Usury seems
to be broadly prohibited,so one is not faced with the question of why we
observe bans in some states but not others. The same cannotbe said of price
gouging and ticket scalping; each is prohibitedonly in certain states. Price
gouging appearsto be prohibitedprimarilyby states that have recently experienced (or whose neighbors have recently experienced) natural disasters;
and ticket scalping laws may be concentratedin states with very popular
theater or sporting events. More in-depth empirical research would be required to determineif these patternsbear out, and whether conventional interest-grouptheories provide an alternativeaccount. Our goal here is simply
to suggest the likelihood, from the perspective of behavioral law and economics, that observed laws reflect, in systematic and predictableways, fairness considerations as well as efficiency and conventional forms of rent
seeking.
Private behavior. It is interestingto note that these transaction-banning
laws often mimic, ratherthan constrain,the behavior of the firms they regulate. Considerfirst usury: It is a well-known puzzle of lending marketsthat
lenders often refuse to loan money to risky borrowerseven at above-market
interestrates;rather,someone either qualifies for a loan at the offered rate or
111. Russ Haven& Amy Chester,Letterto the Editor,Ticket-Scalping
Laws Protectthe AverageFan, N.Y. TIMES,May 9, 1995,at A26.
1514
STANFORD
LAWREVIEW
[Vol. 50:1471
doesnot qualifyfora loanat all.112Thisis trueevenwhena modestincrease

in the interestratewouldnot violateusurylaws.l3 (Adverseselectionconsiderationsmay also explainthis behavior,T14
but they cannoteasily explain
the existence of laws againstsuch behavior.) Price gouging and ticket
scalpingaresimilarin termsof privateactors'behavior.Thus,whenHurricaneAndrewhit Floridaandthe demandfor lumberandotherbuildingsupplies skyrocketed,Home Depot, a majornationalchain, continuedto sell
thesegoodsat its usualprices,despitethe factthatthe stockcouldhavebeen
sold at an enormous(short-term)profit,and despitethe fact that no law
bannedpriceincreases."5Moregenerally,economistshave oftenremarked
on the failureof firmsto increasepricesin responseto temporaryincreases
in demand.116Likewise,an interestingfeatureof ticket-scalping
laws is that
theywill keeppricesdownonlyto the extentthatfirmschooseto sell tickets
at reasonablepricesin the firstplace;but in fact firmsroutinelydo this.117
For example,duringthe 1997 NBA playoffs,the ChicagoBulls sold some
ticketsto the generalpublicat pricesthatweresomewhathigherthanregular
seasongamesbuta fractionof thepricethe ticketscommandedon the (legal
in Illinois)ticketbrokeropenmarket.As the headof a majortheatercompanyexplained,"there'sa strongpublicrelationsargument"
againstraising
pricesfor ticketsfor verypopularshows(andpresumablysportingeventsas
well)-despite excess demandfor seats at the going prices-because the
publicalreadybelieves"thatBroadwayticketpricesaretoo high.""8"Even
thoughwe couldsell ticketsat $100,"anothertheaterownersaid, "we'dbe
cuttingourown throatsbecauseit wouldbe a P.R.disasterfor Broadway.""9
Why would it be a "P.R.disaster"if the marketwould allow them to sell
112. See, e.g., KeithN. Hylton& VincentD. Rougeau,LendingDiscrimination:Economic
Reinvestment
Theory,EconometricEvidence,and the Community
Act, 85 GEO.L.J.237, 258 (1996)
OFTHEFEDERAL
(discussingthe residentialmortgagelending market);BOARDOFGOVERNORS
RESERVESYSTEM,REPORTTO THE CONGRESSON COMMUNITY
DEVELOPMENT
LENDINGBY
DEPOSITORY
INSTITUTIONS
34 (1993) (same).
113. See Hylton& Rougeau,supranote 112,at 258 & n.85.

114. See MichaelKlausner,MarketFailureand Community
Investment:A Market-Oriented
Alternativeto the Community
Reinvestment
Act, 143 U. PA.L. REV.1561, 1566-68 (1995) (citing
JosephP. Stiglitz & AndrewWeiss, CreditRationingin MarketswithImperfectInformation,71
AM.ECON.REV.393 (1981)).
115. See Steve Lohr,Lessonsfrom a Hurricane:It Pays Not to Gouge,N.Y. TIMES,Sept. 22,
1992, at Dl, D5.
116. See DavidD. Haddock& FredS. McChesney,WhyDo Firms ContriveShortages?The
Economicsof IntentionalMispricing,32 ECON.INQUIRY
562, 562-63 (1994) (surveyingthe economicliterature).
117. See StephenK. Happel& MarianneM. Jennings,Assessingthe EconomicRationaleand
Legal Remediesfor TicketScalping, 16 J. LEGIS.1, 8-9 (1989), for fairnessexplanationsof this
behavior.
118. PeterPassell,If ScalpersCan Get So Much, WhyAren't TicketsCostlier?,N.Y. TIMES,
Dec. 23, 1993,at D2 (quotingGeraldSchoenfeld,headof the ShubertOrganization).
119. Tierney,supra note 104, at D24 (quotingRocco Landesman,presidentof Jujamcyn
Theaters).
May 1998]
BEHAVIORAL
theirticketsat $100? We thinkthis wouldbe so becausea $100 ticketprice

for a very popularshow wouldhave been viewedas unfairby manymembersof thepublicgiventhattheusualpricefora ticketwasbelowthis.
Consistentwith the foregoinganalysis,recentevidenceof price stickiness showsthatfirms'behaviorseemsto be affectedgreatlyby theircustomers' perceptionsof unfairpriceincreases.120
Note thatthis is not a standard
fairness
are
the reason that raisingprices
considerations
reputationstory;
harmsthe firm'sreputation.None of this is to say that firmsnever raise
fashion;for instance,whensportsteamssell playpricesin an opportunistic
off ticketsto seasonticketholdersat below-market
prices,it maybe thatthe
ticketholderspaid a premiumfor the playoffticketsex ante (throughthe
purchaseof seasontickets). In eachof the contextswe examine,ourpointis
just the modestone thatfairnessnormsoften seem to constrainfirms'behaviorin muchthe samewaythattheyshapelaws againstbehaviorviolating
those norms. Consistentwith our analysis,it appearsthat firms typically
supportandevenlobbyforlawsagainstticketscalping.121
Why thenarethe laws necessary?Someof the relevantactorswill not
be constrainedby fairnessnormsin the absenceof a law. Noninstitutional
lendersmay be willingto lend at exorbitantrates;suppliersselling lumber
out of the backof pick-uptruckswill oftenchargewhateverthe marketwill
bear(as occurredafterHurricaneAndrew);122
ticketscalpers,who are typihaveno reasonto
cally anonymousactorsengagedin one-timetransactions,
keeppricesdown. It is theseactorswho areregulatedby the law. Themore
firmswill tendto support,or at leastnot oppose,rules
powerfulmainstream
unfair
transactions.
banning
(Note,though,thattheirsupportwouldnot be
predictedby the standard
account.)
2. Other bans.
Lawsbanningeconomictransactions
arejust a speciesof a broaderform
of regulationof transactions.Manydealsareblocked,acrossa widerangeof
contexts. Peoplemaynot buy andsell bodyparts.123
Theycannotsell their
votes.124In some states,commercialsurrogacyis prohibited,125
and baby
120. ALAN BLINDER,ELIER.D. CANETTI,DAVIDE. LEBOW& JEREMYB. RUDD, ASKING
ABOUTPRICES:A NEWAPPROACH
TOUNDERSTANDING
PRICESTICKINESS
9-10, 149-64 (1998).
121. See Steve Kukolla,TicketSelling: One Big UnhappyFamily, INDIANAPOLIS

BUS. J.,
June 20-26, 1994, at 36A; Senate CommitteeOKsBill to LegalizeScalpingof Tickets,ATLANTA
CONST.,Mar.20, 1997, at 2.
122. See Lohr,supranote 115, at D1.
123. See 42 U.S.C. ? 274e (1991).
124. See, e.g., RichardA. Epstein,WhyRestrainAlienation?,85 COLUM.
L. REV.970, 987
(1985).
125. See RadhikaRao, ReconceivingPrivacy:Relationshipsand ReproductiveTechnology,
45 UCLA L. REV. 1077, 1117 n.226 (1998) (citing state statutes).
1516
STANFORD
LAWREVIEW
[Vol. 50:1471
selling is banned in all states.126 People may not contract around bans on
race and sex discrimination,as for example through written agreements.127
Blocked tradescan be found in every Americanjurisdiction.
Bans of this variety raise serious normative questions; those questions
have been well-ventilated. Doubtless reasonable distinctions can be drawn
between bans in differentareas;sometimes exteralities are readily apparent.
We make a simple positive point here: Behavioral analysis suggests that
pervasivejudgments about fairnessmay account for many such bans on voluntarydeals. Whetheror not those judgments make sense, they seem to be
widespread,and they help to explain the persistence of legislation that is often difficult to explain by referenceto an efficiency or rent-seekingaccount.
In banning certain deals, legislatorsmay be respondingto community sentiments about what kinds of things are properly subject to market arrangements. The referencetransactionin these areasis generally "no transaction";
just as the norm or benchmarkis the usual or face price of the ticket, or an
equal division of the amountto be divided in the ultimatumgame, the norm
or benchmarkhere is "no marketexchange." Departuresfrom that norm are
viewed as unfairand are prohibited.
How could this behavioraltheory of law be tested? One idea is to determine,based on historicalevidence, what sorts of transactionswere generally not engaged in (despite their being technologically feasible-for example, baby selling) regardlessof the existence of a law banning them. These
transactionscould be said to have a no-transactionbenchmark. (The importance of looking to a pre-law benchmarkis that the existence of a legal ban
could itself producea no-market-exchangereferencepoint, in which case the
reference point obviously could not account for the existence of the ban.)
Behavioral analysis predicts that such transactionswill be legally censured.
The existing law and economics analysis, by contrast, predicts that such
transactionswill be bannedonly if a ban is either efficient or favorableto a
politically powerful interestgroup.
B. Prior Restraintson Speech
Another instance in which fairness-related norms, and in addition
bounded rationality,may affect law involves one of the enduringpuzzles in
First Amendment law: the special judicial hostility to "priorrestraints"on
126. See MargaretJaneRadin,What,If Anything,Is WrongwithBaby Selling?,26 PAC.L.J.
135, 135 (1995).
127. See Alexanderv. Gardner-Denver
Co., 415 U.S. 36, 51-52 (1974) (dicta). The specific
issue presentedin Alexander-the enforceabilityof agreementsto arbitratediscrimination
claimshas been consideredin morerecentcases. See, e.g., Gilmerv. Interstate/Johnson
Lane Corp.,500
U.S. 20 (1991). However,no courtto ourknowledgehas suggestedthatGilmeror any otherrecent
case permitspeopleto "sell"theirsubstantiverightsnot to be subjectto raceandsex discrimination.
May 1998]
BEHAVIORAL
speech, most notably injunctions.128 A court may well refuse to issue an injunction against speech even if it would allow subsequentpunishmentof that
same speech. The puzzle is that a prior restraintinvolves subsequentpunishment too; what an injunctionmeans is that a violator will be subject to
(subsequent)sanctions. Why is a criminal statuteany less problematicthan
an injunctionwhose violation producescriminalpenalties?
Conventional economic analysis provides no satisfying answer to this
question. True, the injunctionmight be thought to create the prospect of a
greater total punishment for the speech, but no one has suggested that the
First Amendment imposes limits on the severity of punishment for speech
that the government is entitled to criminalize. In any case, many criminal
statutesimpose greaterpunishmentsthanmany injunctions,and the latterare
nonetheless more troublesomethanthe former.
Can behavioral analysis explain the law's special treatmentof prior restraints? As noted in Part I.B above, court-orderedremedies are likely to
create special forms of attachmentfor their beneficiaries; individuals will
typically be reluctantto forego rights grantedby such remedies, due to the
perceived unfairnessof that outcome and the type of attachmentcreated by
the endowmenteffect. This is apt to be as true for prosecutorsas for everyone else. A prosecutorwho has sought an injunction may be particularly
insistent on ensuringthatpunishmentoccurs. A criminalstatute,standingby
itself and unaccompaniedby an injunction,is likely to produce a different
response on the part of the prosecutor. Reasonabledefendantsknow the difference. Hence it is especially importantfor a court to ensure that any injunction imposed on speech is not issued in advance of an accuratejudgment
that the speech involvedis unprotectedby the First Amendment.
As it happens, this account matches the most sophisticateddefenses of
the special barrierto prior restraints.129Those defenses urge that the real
purpose of the prior restraintdoctrine is to ensure that no regulation is imposed without a reliablejudgmentthat the First Amendmentdoes not protect
the speech at risk. The doctrineis difficult to explain on conventional economic principlesbut is a naturalinferencefrombehavioralones.
128. See, e.g., GEOFFREY

R. STONE,LOUISM. SEIDMAN,CASS R. SUNSTEIN& MARKV.
LAW 1183-96 (3d ed. 1996).
TUSHNET,CONSTITUTIONAL
129. See Martin H. Redish, The Proper Role of the Prior Restraint Doctrine in First Amendment Theory, 70 VA. L. REV. 53, 55 (1984).
1518
LAWREVIEW
STANFORD
[Vol. 50:1471
C. Anecdote-DrivenEnvironmentalLegislation (WithParticular Reference

to Superfund)
1. Estimatingthe likelihoodof uncertainevents.
Thus far the discussion has focused on the role of bounded self-interest
(specifically, fairness-relatednorms) and the endowmenteffect in predicting
and explaining the content of law. But judgment errors by boundedly rational individualsalso play a significantrole here. In particular,people seek
law in areas such as environmentalprotectionon the basis of theirjudgments
about the probabilities associated with certain harmful activities. Their
judgments aboutprobabilitieswill often be affected by how "available"other
instances of the harm in question are, that is, on how easily such instances
come to mind. In this section we offer an account of the Superfundstatute,
perhaps the most well-known and popular environmental statute, on this
ground.
Here is a familiarexample of availability: Individualsasked how many
seven-letterwords in a 2,000-word section of a novel end in "ing"give much
larger estimates than individuals asked how many words in such a section
have "n"as the second-to-lastletter,despite the fact that objectively there are
more words which satisfy the lattercriterionthan the former.130Reliance on
how "available"instances of the event in question are is a form of judgment
error, but the error is fully rational-in the sense of reflecting optimizing
behavior-for people with limited information. Still, it can lead to systematic errorsin probabilityassessment. In the context of environmentallegislation, it encourages the well-known "pollutantof the month" syndrome,
where regulation is driven by recent and memorable instances of harm.13
When beliefs and preferencesare producedby a set of probabilityjudgments,
made inaccurateby the availabilityheuristic, legislation will predictablybecome anecdote-driven. Many illustrationscome to mind; consider the outcry
over Agent Orangeand Times Beach,132or the strictregulationof asbestos in
schools after a large amount of media attention.133The same phenomenon
may occur in other areas of regulatorylaw; an example here is the move to-
130. Amos Tversky& Daniel Kahneman,ExtensionalVersusIntuitiveReasoning:The ConREV.293, 295 (1983).

junctionFallacy in ProbabilityJudgment,90 PSYCHOL.
131. See Sunstein,supranote 3, at 1188.
132. See, e.g., KeithSchneider,Fetal HarmIs CitedAs PrimaryHazardIn DioxinExposure,
N.Y. TIMES,
May 11, 1994,at Al, A20.
133. See AsbestosHazardEmergencyAct of 1986, 15 U.S.C. ?? 2641-56 (1994); MargoL.
Fields and Cancer:A LegitimateCauseof Actionor a Resultof
Stoffel, Comment,Electromagnetic
Fear, 21 OHION.U. L. REV.551, 590 (1995) (referringto an ABC news special
Media-Influenced
on how mediareports"heightenedanxietyover... asbestosin schools").
May 1998]
BEHAVIORAL
wardheavyregulationof schoolbus safetyin the wakeof mediacoverageof

schoolbusaccidentsin whichchildrenwerekilled.'34
What determineshow availablea particularenvironmental
hazardis?
Two factorsareparticularly
the
observed
of
important:
frequency thehazard
andits salience. Thus,if a particular
hazardhas materialized
recently,peoto its occurringin the future.And
ple arelikelyto attacha higherprobability
this is particularly
trueif the hazardhas a high degreeof salience-as, for
with
the
instance,
discoveryof asbestosin schools,wheremanychildrenare
present.Apartfromthenatureof theevent,salienceis heavilyinfluencedby
the way the eventis packagedby the media,organizedinterestgroups,and
politicians.
Interestedactorsin theprivateandpublicsectorscan be expectedto exploitthe availabilityheuristicfor theirown purposes.Theseactorsareamateurbehavioralists,operatingstrategicallyto promotetheir selfish or nonselfishgoals. "Availability
will thusfocusattentionon a speentrepreneurs"
cific event in orderto ensurethatthis eventwill be salientand availableto
manymembersof the public.135
Well-organized
groupsin the privatesector
veryfrequentlyuse this strategy,thusshowingthatthey are fine behavioralists. Self-interested
politiciansmay use similarstrategiesto enhancetheir
reelectionprospects. Althoughself-servingbehaviorby such actorsis an
elementof the conventionaleconomicaccount,the role of such factorsas
availabilityis not;thisis whatis addedby behavioralanalysis.
The availabilityheuristiccan lead to under-as well as over-regulation.
thelikelihoodof lowPeoplesometimes(althoughnotalways)underestimate
or
low-salience
events
because
these
threats
probability
simplydo not make
it onto people's "radarscreens";'36
health
and
environmentalrisks
many
(suchas the healththreatsfrompoordietandexercise)may fit this descrip-
tion with some partsof the population. But when a particularthreat,even an

unlikely one, becomes available, as when, for example, asbestos is discovered in schools, then regulationwill be demanded. The behavioral account
thus predicts a patchworkof environmentallaws characterizedby both overand under-regulation,with over-regulationwhen a particularrisk has recently materialized,particularlyif the harmin questionis highly salient.
134. See JERRYL. MASHAW& DAVIDL. HARFST,THESTRUGGLE
FORAUTOSAFETY14146 (1990).
135. See Timur Kuran & Cass R. Sunstein, Availability Cascades and Risk Regulation (Apr.
26, 1998) (unpublished manuscript, on file with the Stanford Law Review).
136. See HowardKunreuther,

TheEconomicsof ProtectionAgainstLow ProbabilityEvents,
in DECISION
MAKING:AN INTERDISCIPLINARY
INQUIRY195, 209 (Gerardo R. Ungson & Daniel N.
Braunstein eds., 1982); Howard Kunreuther,Limited Knowledge and Insurance Protection, 24 PUB.
POL'Y 227, 235-36, 243-44 (1976). For a discussion of overestimation of the likelihood of lowfrequency events, see Colin F. Camerer & Howard Kunreuther,Decision Processes for Low Probability Events: Policy Implications, 8 J. POL.ANAL.& MGMT.565, 566 (1989).
1520
LAWREVIEW
STANFORD
[Vol. 50:1471
2. Superfund.
The basic point that availability may affect the demand for environmental legislation is not new.137We wish to add two featuresto the analysis:
first, an understandingof the mechanismsthroughwhich the availabilityheuristic may operateto produceenvironmentallegislation (and here we emphasize the notion of "availabilityentrepreneurs");
and second, the fact that the
behavioral account predicts the enactment of Superfund,a major piece of
environmental legislation that is not readily explained on conventional
grounds.138
Conventionalapproachespoint to the importantrole of interestgroups in

shaping environmentallaw; these groups can use the law to redistributeresources in their preferreddirections. Some of these groups are sincerely
concernedwith environmentalprotection;others have economic interestsfor
which environmentalissues operateas a smokescreen. Explanationsof this
kind have had some success, but they fail to accountfor Superfund.
Of course it is possible (as it always is) to generate post hoc accounts
that show that some groups benefited from legislation, and to suggest that
such legislation was passed because some groups benefited from it. Superfund is no exception. But an examinationof the history of the statuteshows
that this explanationis extremely weak. Interestgroups played little part in
initiatingits enactment. Insteadthe key actor,as describedmore fully below,
was the EnvironmentalProtectionAgency, and the key mechanism was the
availabilityheuristic.
Superfundwas passed with substantiallegislative and public support;in
light of its crudely draftedcharacterand uncertainempiricalsupport,what is
remarkableis how little oppositionthe statuteprovoked. What is even more
remarkableis that for the last seventeen years, Americans have consistently
ranked"abandonedtoxic waste dumps"among the three most importantenvironmentalproblems, even though experts believe that this is one of the
least pressing environmentalproblems, if indeed it qualifies as a serious
problem at all.139 Experts contend that in terms of risks to human health,
there are at least a dozen problemsthat are more serious; many of them receive less in the way of public (and legislative) support.
Availability provides a convincing explanationof Superfund'sexistence
and its endurance. Its initial developmentoccurredwhen officials within the
137. See W. KIPVISCUSI,RATIONAL
RISKPOLICY96 (1998) (discussing role of availability);
Roger G. Noll & James E. Krier, Some Implications of Cognitive Psychology for Risk Regulation,
19 J. LEGALSTUD. 747, 762 (1990) (same); Cass R. Sunstein, Congress, Constitutional Moments,
and the Cost-Benefit State, 48 STAN.L. REV.247, 265-66 (1996) (same).
138. We draw here from the more detailed discussion in Kuran & Sunstein, supra note 135.
139. See, e.g., STEPHENBREYER,BREAKINGTHE VICIOUSCIRCLE:TOWARDEFFECTIVE
RISKREGULATION
21 (1993).
May 1998]
BEHAVIORAL
EPA, concerned about an apparentgap in federal law and eager to consolidate their authorityover issues of public health, began to draftnew legislation in orderto respondto the existence of abandonedhazardouswaste sites.
But it is doubtfulthatthe EPA could have succeeded if not for the fact that in
August of 1978, national news began to focus on what was soon seen as a
"tickingtime bomb" at Love Canal, New York, consisting of apparentleaks
from the disposal of 21,000 tons of chemical waste into the Canal between
1943 and 1952. In the middle and late 1970s, studies of groundwaterand
cancer incidence appearedto show that the leaks had created serious health
risks, to the point where the New York Health Commissioner declared a
public emergency on August 2, 1978. Within two weeks, President Carter
declared an emergency in the area. A kind of cascade effect occurred,and
hence in the period between August and October, 1978, the national news
was saturatedwith stories of the risks to citizens near Love Canal.
The publicity continued in 1979 and 1980, the crucial years for Superfund's enactment. There can be no doubt that the Love Canal publicity was
pivotal to the law's passage in 1980. In that year, Time magazine made the
topic a cover story, and network documentariesfollowed suit. Polls showed
that eighty percent of Americans favored prompt federal action to identify
and clean up potentially hazardous abandoned waste sites. Congress responded quickly with the new statute. And to this date, Americanpresidents
and serious presidentialcandidatesof both partiesinvoke abandonedhazardous waste dumps as a leading environmentalproblem. By the way, it remains unproventhatLove Canalcreatedsignificanthealthrisks at any stage.
The behavioral account of Superfundis that the availability of "Love
Canal" as a symbol for the problem of abandonedhazardouswaste dumps
greatly intensified public concern, to the point where a legislative response
became nearly inevitable, no matterwhat the actual facts might be.140 And
there can be no doubt that proponents of Superfund self-consciously exploited the Love Canal incident. During crucial periods in the legislative
debate, the prime proponentof the new legislation-the EPA-warned, very
publicly, that hundreds of "Love Canals" could be found throughout the
country. The EPA thus became an "availabilityentrepreneur,"focusing attention on a specific event in orderto ensure that this event would be highly
availableto many membersof the public.
We do not say that conventionalinterest-groupconsiderationsplayed no
role in the specific shape the Superfundstatutetook. The ultimatedesign of
the statute surely owed a great deal to what relevant interest groups were
willing to tolerate;though powerful private groups did not seek the legisla140. Cf. W. Kip Viscusi, Alarmist Decisions with Divergent Risk Information, 107 ECON.J.
1657 (1997) (findingthatin the presenceof divergentinformationaboutrisks,peopleplace inordinateweighton highriskassessments).
1522
LAWREVIEW
STANFORD
[Vol. 50:1471
tion, they did influence its content and structure. But the enactment and
continuedpopularityof Superfundare not predictedby the conventional account alone. The behavioral account, in contrast, suggests that the occurrence of an event such as Love Canal, particularlywhen played up and
dramatizedby the media and other actors, will produce a legislative response. Superfundis one example; regulatoryresponses to Agent Orange
and asbestos in schools are others. Available instances of risk or threatseem
to shape the contentof law.
IV. PRESCRIPTIONS
In this part we shift our focus from the positive to the prescriptive. Instead of seeking to explain what the effects of law will be and why we have
the laws we do, we now explore how the law can best be structuredto
achieve specified ends-deterring socially undesirablebehavior throughthe
tort system, encouraging measures that enhance human health, and so on.
Our claim in each context we consider is that attentionto behavioralinsights
can improvethe law's ability to move society towarddesired outcomes. Our
primaryemphasis is on problems in processing information,problems that
create difficulties both for juries during trials and for those responding to
information required by government or coming from government itself.
Thus boundedrationality,in the form of both judgment errorsand behavior
in accordancewith prospecttheoryratherthanexpected utility theory, are the
central emphases in this part. Section A deals with juries, while section B
deals with government information campaigns and mandatory disclosure.
Section C emphasizes our second bound on human behavior, bounded willpower, and discusses its relevance to prescriptionsdirectedtoward deterring
crime.
This part discusses only a small sample of the many areas in which
sound prescriptiveanalysis may require us to consider possible bounds on
jurors' or other actors' decisionmaking. Other authors have applied these
insights to other topics in the economic analysis of law. Thus, for example,
Daniel Kahnemanand David Schkade,along with one of the present authors
(Sunstein), have challenged the economic prescriptionfor punitive damage
awards recently offered by A. Mitchell Polinsky and Steven Shavell: that
juries should be instructedto focus on the probabilityof nondetectionof the
tortfeasor'sactivities in orderto achieve optimal deterrencethroughpunitive
awards.141From the behavioralpoint of view, this prescriptionfails to appreciate the cognitive and motivationallimitations on jury decisionmaking.
Because of the hindsight bias and overoptimismproblems described below,
juries will have difficulty making probabilityestimates, and in additionthey
141. See Polinsky& Shavell,supranote 70, at 887-91.
May 1998]
BEHAVIORAL
appearto come to the task of awardingpunitivedamageswith strongretributiveinstincts.142

The goal of optimaldeterrencemay be best achieved
administrative
through
agenciesratherthanjuries.'43
Anotherexampleof the applicationof behavioraleconomicsto prescriptive analysisis ThomasJackson'sdiscussionof dischargepolicy in bankeconomicideasof riskallocationwouldoften
ruptcylaw. Althoughstandard
of debts,Jacksondrawson aspectsof whatwe
supportnondischargeability
have termedboundedrationalityand boundedwillpowerto supportthe
"freshstart"policyof dischargeandto sketchthe specificcontoursit should
take.144Ourgoal in thispartis to pointto someadditionaltopicsin the economicanalysisof law in whicha moreaccurateunderstanding
of decisioncan
conventional
law
and
economics
making improveupon
prescriptions.
A. NegligenceDeterminations
andOtherDeterminations
of Fact or Law
1. Background.
juriesarecalleduponto determinetheprobabilityof an event
Frequently
that endedup occurring;a prominentexampleis the negligencestandard,
which(in the formulation
favoredby the economicanalysisof law) requires
jurorsto assess the costs and benefitsof the defendant'scourseof action
froman ex anteperspective,andthusto determinethe probabilitythatharm
wouldendupcomingof thataction. Thesedeterminations
aremadewiththe
"benefit"of hindsight;jurorsknowat the timetheymaketheirdecisionthat
the eventin questiondidin factoccur. Jurors'determinations
arethuslikely
to be afflictedby "hindsight
bias"-the tendencyof decisionmakers
to attach
an excessivelyhighprobability
to aneventsimplybecauseit endedup occurring.145
Hindsightbiashasbeenobservedin a largenumberof studies,including

studiesof "expert"actorssuchas physicians,who, whenaskedto assessthe
probabilitiesof alternativediagnoses,givena set of symptoms,offersignificantlydifferentestimatesdependingon whattheyaretold the actualdiagnosis turnedout to be.146 Hindsightbias also appearsto occurin the specific
142. Cass R. Sunstein,Daniel Kahneman& David Schkade,Assessing PunitiveDamages
(withNotes on Cognitionand Valuationin Law), 107 YALEL.J.2071, 2111-12 (1998).
143. Id. at 2122-25.
144. ThomasH. Jackson,TheFresh-StartPolicy in Bankruptcy
Law,98 HARV.L. REV.1393,
1394-95, 1399-1401(1985).
145. See BaruchFischhoff,HindsightX Foresight: The Effect of OutcomeKnowledgeon
PSYCHOL.HUM. PERCEPTION
Judgment Under Uncertainty, 1 J. EXPERIMENTAL
& PERFORMANCE
288 (1975).
146. Hal R. Arkes,DavidFaust,ThomasJ. Guilmette& KathleenHart,Eliminatingthe HindPSYCHOL.
sight Bias, 73 J. APPLIED
305, 306 tbl.1 (1988).
1524
STANFORD
LAWREVIEW
[Vol. 50:1471
context of negligence determinations.147In the negligence studies, subjects

in the role of jurors-armed with knowledge that harm had in fact occurred-were found to attach significantly higher probabilitiesto harm than
subjects in the role of ex ante decisionmakers-those not informed of the
occurrenceof harm.148This is a straightforwardpredictionof the many prior
studies on hindsightbias.149 Although the negligence studies asked for individual rather than group probabilities (raising the question whether group
interactionon an actualjury could dispel hindsightbias), other studies have
found hindsightbias in groupas well as individualsettings.150
Hindsightbias will lead juries making negligence determinationsto find
defendantsliable more frequentlythan if cost-benefitanalysis were done correctly-that is, on an ex ante basis. Thus, plaintiffs will win cases they deserve to lose. This prediction is consistent with the frequently expressed
(though difficult to verify) view that the tort system imposes too much liability.151
A thresholdissue raised by the hindsight-biasaccount of negligence determinationsis whetherhindsightbias is simply a countervailingweight to a
tendency on the part of defendantsto underestimatethe likelihood of being
sanctioned. A common featureof humanbehavioris overoptimism: People
tend to think thatbad events are far less likely to happento them than to others. Thus, most people think that their probabilityof a bad outcome is far
less than others' probability,althoughof course this cannot be true for more
than half the population.152If defendantsexhibit such overoptimism, then
they will be underdeterredby a correct application of the negligence stan147. See KimA. Kamin& JeffreyJ. Rachlinski,Ex Post ?Ex Ante, 19 LAW& HUM.BEHAV.
89 (1995); SusanJ. LaBine& GaryLaBine,Determinationsof Negligenceand the HindsightBias,
20 LAW& HUM.BEHAV.
501 (1996).
148. Kamin& Rachlinski,supranote 147, at 98; LaBine& LaBine,supranote 147, at 50910.
149. See, e.g., Arkeset al., supranote 146.

150. See DagmarStahlberg,FrankEller,Anne Maass& DieterFrey, WeKnewIt All Along:
PROCESSES
46 (1995); Ed Bukszar
Hindsight Bias in Groups, 63 ORG.BEHAV.& HUM. DECISION
& TerryConnolly,HindsightBias and StrategicChoice:SomeProblemsin Learningfrom Experi-
ence, 31 ACAD.MGMT.J. 628 (1988).

151. See, e.g., JEFFREY
O'CONNELL,ENDINGINSULTTOINJURY:NO-FAULTINSURANCE
FOR
PRODUCTSAND SERVICES42-43 (1975); John G. Fleming, Drug Injury Compensation Plans, 30
AM.J. COMP.L. 297, 311 (1982); StephenD. Sugarman,Doing Awaywith TortLaw, 73 CAL.L.
REV.555, 581-82 (1985).
152. See Neil D. Weinstein, Unrealistic OptimismAbout Future Life Events, 39 J.
PERSONALITY
& SOC. PSYCHOL.806 (1980); Neil D. Weinstein, Unrealistic Optimism About Sus-
ceptibilityto HealthProblems:Conclusionsfrom a Community-Wide

Sample,10 J. BEHAV.MED.
481 (1987) [hereinafterWeinstein,UnrealisticOptimism]. For discussionof the distinctionbetween being below the averageperson'sprobabilityof a negativeevent andbeing below the average probabilityof thatevent (whichcould in fact be truefor the majorityof people), see Christine
Jolls,BehavioralEconomicAnalysisof Redistributive
LegalRules,51 VAND.L. REV.(forthcoming
1998).
May 1998]

BEHAVIORAL
dard;overestimationof the probabilityof harmbased on hindsightbias might

then be a desirablecountervailingfactor. We think that defendantoveroptimism is likely to be a much smaller factor for firms than for individual defendants, since firms that make systematic errors in judgment will be at a
competitive disadvantage. And for individuals,the role of overoptimismis
likely to vary significantlywith context. In a case in which the threatof being found liable is highly salient, individualsmay tend to overestimate the
likelihood of being sanctioned,for reasons discussed in connection with our
account of Superfundabove. Hindsight bias, in contrast, seems to be an
across-the-boardphenomenon;it has been observed in a wide range of contexts across many studies and is likely to be presentwhenever a jury makes a
negligence determination.
It is also possible that the occurrenceof harmitself provides genuine informationabout the probabilityof harm;this fact has led some to consider
the possibility of an "ex post negligence" standard,under which negligence
is assessed based on the informationavailableex post, ratherthan ex ante.153
(However, if prospective defendantscannot easily ascertain(ex ante) the information that will be available ex post, then an ex post approachmay be
inefficient.154) But, even apartfrom situationsin which the fact of harmprovides new informationabout the probabilityof harm,hindsightbias suggests
that decisionmakerswill weigh the fact of harmheavily in assessing its probability.155
The findings on hindsightbias providenew empiricalsupportfor the old
idea that such bias may distortnegligence determinations. Despite the vast
law and economics literaturein the area of torts, no attentionseems to have
been paid to the potentially significant implications of hindsight bias for
achieving optimal deterrence-the goal posited by that literature,and the
goal on which we focus here. (Thus, we accept this goal for purposes of our
prescriptiveanalysis; we do not necessarily endorsethis goal from a normative perspective.) Law and economics scholars generally approveof the use
of the negligence standardfor achieving the goal of optimal deterrence;the
negligence standard,if applied in an error-freefashion, leads to an efficient
level of precaution (although other standardswill as well; note that these
other standardsmay be worse or better along other dimensions, such as encouragingvictim precautionsand inducing optimal activity levels).156These
153. Guido Calabresi & Alvin K. Klevorik, Four Tests for Liability in Torts, 14 J. LEGAL
STUD.585, 590 (1985).
154. See Omri Ben-Shahar, Informed Courts, Uninformed Individuals and the Economics of
Judicial Hindsight, 151 J. INSTITUTIONAL
& THEORETICAL
ECON.613 (1995).
155. For an exampleof a situationin which the fact of harmdoes not providenew information aboutits probability,see Calabresi& Klevorik,supranote 153,at 594-96.
156. See STEVENSHAVELL,ECONOMICANALYSISOF ACCIDENTLAW 8, 11, 14, 23-24
(1987) (analyzingrulesof negligenceandstrictliability).
1526
STANFORD
LAWREVIEW
[Vol. 50:1471
scholarshave also analyzedreasons that legal rules, including the negligence

standard,may be imperfectly applied, but they do not offer any clear prescriptionsfor addressingthis problem, since as they see it, the problem does
not have a clear direction;either underdeterrenceor overdeterrencerelative
to correct applicationof the cost-benefit standardis possible.157In contrast,
we can offer clear prescriptionsbecause the hindsightbias points in only one
direction: overdeterrence(againrelative to what correctcost-benefit analysis
would produce).
In fact the law in areas such as patentlaw alreadytakes clear steps to address the problemscaused by hindsightbias. Thus, as Jeffrey Rachlinskihas
recently pointed out, patent courts are requiredto guard against hindsight
bias in determiningwhether an invention was "nonobvious"at the time of
invention-despite its now (perhaps)seeming obvious-by looking to such
"secondaryconsiderations"as "commercialsuccess, long felt but unsolved
this is in effect a limited form of debiasing
need, [and] failure of others";158
of the decisionmaker. (Thus, the law seems to acknowledgethatjudges, like
juries, may exhibit hindsightbias-although there is evidence that the bias is
less for judges than juries.159) But in the area of tort law the existing responses are partialand incomplete at best.160Hindsightbias seems to be so
deeply ingrained in the tort system that even when it is called to a court's
attention,it may be difficult for the court(never mind a juror)to recognize or
addressit. A colorful example is providedby litigation in which one of the
present authors (Thaler) was an expert witness. The litigation involved
whether investment decisions involving $100 million in assets had been
made in a negligent fashion. Although the court explicitly recognized that
"[c]ase law . . . ties [this determination]to the circumstancesextant at the
time in question, rather than as they may appear in hindsight," the court
characterizedas "very imaginative"defendant's offer of testimony that "a
decision based on informationknown at the time the decision was made can
be evaluatedas good or bad withoutregardto the outcome. In that way the
evaluationis not biased by hindsight."161
Althoughthe judge was very active
throughoutthe trial, he never suggested that the expert testimony offered by
the plaintiff, which focused almost exclusively on the fact that the portfolio
had lost money (ratherthan on the reasonablenessof the investment decisions at the time they were made), was off-target or irrelevant. While the
157. See, e.g., Jason S. Johnston,BayesianFact-Findingand Efficiency:Towardan EconomicTheoryof LiabilityUnderUncertainty,61 S. CAL.L. REV.137, 154-64(1987).
158. JeffreyJ. Rachlinski,A Positive PsychologicalTheoryof Judgingin Hindsight,65 U.
CHI.L. REV.571, 615 (1998) (quotingGrahamv. JohnDeere Co., 383 U.S. 1, 17-18(1966)).
159. See Reid Hastie& W. Kip Viscusi,WhatJuriesCan'tDo Well: The Jury'sPerformance
as a RiskManager(May21, 1998)(unpublishedmanuscript,on file withthe StanfordLawReview).
160. Rachlinskidescribesseveralexistingresponses. See Rachlinski,supranote 158, at 61518.
161. Johnsonv. Johnson,515 A.2d 255, 266-67 & n.17 (N.J.Super.1986).
May 1998]
BEHAVIORAL
court ultimately accepted the "imaginative"argumentof the defendant and

ruled in his favor, its evident surpriseat the natureof the argumentsuggests
the pervasivenessof hindsight-basedthinkingin the tort system.
How might the law respondto hindsightbias in tort cases? An obvious
response is the use of jury instructionsthat informjurors of the bias and tell
them to focus on the ex ante situation. Unfortunately,such debiasing techniques appear either to have no effect on decisions or to reduce hindsight
bias by only a limited degree, leaving a significant gap between ex post and
ex ante decisionmaking.162The findings on the limited effect of debiasing
techniques suggest that attemptsby lawyers to employ such techniques may
also be of limited effectiveness, although there is room here for future research on the role of lawyers. Because of the apparentlimits on debiasing,
we propose two alternativeprescriptions--one simple and clear-cut,but limited to certain sorts of cases, and the other general and giving rise to important avenues for futureresearch.
2. Prescriptions.
First prescription: Manipulate the informationgiven to jurors. One
means of respondingto the problem of hindsightbias in tort cases involves
manipulatingthe set of informationgiven to jurors. Suppose that a foodprocessing company is claimed to have decided in a negligent fashion to use
a particularchemical in its productionprocess; imagine that the chemical
ended up causing cancer in a small number of residents who live near the
company's plant. The company claims that not using the cancer-causing(as
it turned out) chemical would have carried significant risks to residents in
terms of bacterial contamination. We know that if jurors are told that the
chemical was used and ended up causing cancer, they will be likely to overestimate the probabilityof harm from the chemical and, thus, hold the foodprocessing company liable even if liability is not in fact justified under an
unbiasedapplicationof the cost-benefitstandard. (Indeed,in this context the
effects of hindsightbias may be exacerbatedby the fact that the choice made
by the defendantis an act of commission, ratherthan (as would have been
the case had the chemical not been used) an act of omission.163)
Imagine, however, that jurors are not told that the company decided to
use the chemical; ratherthey are told only about the ex ante decision facing
162. See, e.g., Martin F. Davies, Reduction of Hindsight Bias by Restoration of Foresight
Perspective: Effectiveness of Foresight-Encoding and Hindsight-Retrieval Strategies, 40 ORG.
BEHAV.& HUM. DECISIONPROCESSES
40, 61-64 (1987); Baruch Fischhoff, Perceived Informativeness of Facts, 3 J. EXPERIMENTAL
PSYCHOL.349, 354-56 (1977); Kamin & Rachlinski, supra
note 147, at 96-98.
163. See Ilana Ritov & Jonathan Baron, Reluctance to Vaccinate: Omission Bias and AmbiMAKING263 (1990).
guity, 3 J. BEHAV.DECISION
1528
LAWREVIEW
STANFORD
[Vol. 50:1471
the company (whether to use the chemical). They learn about the benefits
and costs of that strategy and must determinewhether either pursuing it or
failing to pursue it would have been negligent. In this scenario the jurors
would be transformedinto ex ante decisionmakers: They wouldn't know
whetherthe "accident"that occurred(promptingthe lawsuit) was harm from
bacterialcontaminationor harmfrom the chemical. Because they would not
know what harmended up materializing,they would not be led by hindsight
bias to overestimatethe probabilityof that harm. Theirprobabilityestimates
for each type of harm-and theirresultingassessmentof whethereither decision by the company would have been negligent-would be untouched by
hindsight bias. In this way it might be possible to eliminate the effect of
hindsightbias on negligence determinations. (If the decision that the defendantactuallymade was one thatthe jury determinedto be negligent, outcome
informationcould be introducedfor purposesof computingdamages.)
It is importantto note the structureof this example: The defendantfaced
a choice of options, each of which could have caused harm. In this sort of
case, jurors assessing the defendant'sconduct would not know (if they were
not told) whether the harm that promptedthe suit was caused by choice of
the first option or choice of the second. It is also importantto note that various proceduralsteps would have to be taken to protectthe secrecy of the defendant's choice if outcome informationwere to be kept from the jury; lawyers' affiliations,for example, could not be revealed, and witnesses could not
be identified as defense-side or plaintiff-side. (One might worry that the
food-processing company's employees would testify in a way that revealed
what choice the companymade. But it would not be in the company's interests to have its employees testify in such a one-sided fashion, since then jurors would suspect which choice was made and would tend to engage in
hindsight-biaseddecisionmakingto the defendant'sdetriment.)
In some cases, it might not be possible to keep the defendant's choice
from the jury; the fact of the suit will make clear what that choice was. For
example, in the well-known case of Petition of Kinsman Transit Co.,164 in
which a bridge operatorfailed to lift the bridge in time to prevent an accident, apparentlybecause he was at a tavern, the fact of a suit may provide
strong indicationthat the bridge was not lifted. In this sort of setting, a possible prescription(offered previously in the literature)involves bifurcationof
trials, so that jurors deciding on liability do not learn any of the details of
what happeneduntil an initial determinationof liability is made.'65 Although
164. 338 F.2d708 (2d Cir. 1964).
165. Hal R. Arkes & Cindy A. Schipani, Medical Malpractice v. the Business Judgment Rule:
Differencesin HindsightBias, 73 OR.L. REV.587, 633-36 (1994); NormanG. Poythress,Richard

Wiener & Joseph E. Schumacher, Refraiing the Medical Malpractice Tort Reform Debate. Social
Science Research Implications for Non-Economic Reforms, 16 LAW& PSYCHOL.REV. 65, 105-11
(1992); David B. Wexler & Robert F. Schopp, How and When to Correctfor Juror Hindsight Bias
May 1998]
BEHAVIORAL
we think this is a sensible prescriptionin such settings, we note that it will

not eliminate the effects of hindsightbias, since (as proponentsof bifurcated
trials recognize) "the jury will undoubtedly know that they are not being
asked simply to engage in an academicexercise,"166
and that (because a trial
is being held) "a bad outcome must have occurred."167In contrast,in cases
in which jurors need not know (because they cannot infer from the fact of a
lawsuit) what choice the defendantmade, it may be possible to eliminate the
hindsight bias completely. And there are many such situations: cases in
which either of two options facing a physician could have caused harm or
death to a patient; cases in which either the use or the failure to use a new
technology could have led to harm;cases in which eitherrevealing or failing
to reveal suicide threatsby a psychiatricpatient could have resulted in suicide.
A furtherfeature of our prescriptionhere is that even if we are wrong
about the effects of hindsightbias, the prescriptionseems unlikely to do significant harm(from the perspectiveof the specified goal of achieving correct
applicationof the ex ante cost-benefit standard). If hindsight bias is unimportant,then whetherjurors are told what outcome occurredshould not matter; either way, they should be able to make a correctex ante determination.
Thus, the prescriptionshould either have no effect on decisionmaking (if
hindsightbias is not a problem)or representan improvementover the current
system (if hindsightbias is a problem).
Secondprescription. Alter the evidentiarystandard. The result of hindsight bias, as describedabove, is thatjurorswill overestimatethe probability
that harm will occur (since harm did, in fact, occur). The determinationof
the probabilityof harm would conventionallybe made under a "preponderance of the evidence" standard:If jurorsthink it more likely than not, based
on the evidence, that the probabilityof harm was above the threshold level
requiredfor liability, they are to find the defendantliable. One might imagine counteractingthe effects of hindsightbias by raising the evidentiarystandard (as an alternative,not in addition,to the previous proposal;the two together would produce overcorrectionand, thus, underdeterrence).Thus, for
example, if the jurors were to find the defendantliable only if the evidence
suggested at least a seventy-five percent likelihood-rather than merely a
fifty-one percent likelihood-that the critical harmprobabilitythresholdwas
met, then they might well reach the correctconclusion about liability: They
would overestimatethe likelihood attachedto the critical threshold, but the
overestimatemight well be below the new requiredlevel.
in MentalHealthMalpracticeLitigation:SomePreliminaryObservations,7 BEHAV.
SCI.& L. 485,
496 (1989).
166. Wexler& Schopp,supranote 165,at 494 (emphasisin original).
167. Arkes& Schipani,supranote 165, at 635.
1530
STANFORD
LAWREVIEW
[Vol. 50:1471
The highest evidentiarythresholdknown to our legal system-the "beyond a reasonable doubt" standard-is used only in criminal cases. However, in civil cases an intermediatestandard(higher than the preponderance
standard,but less demandingthanthe "beyonda reasonabledoubt"standard)
is the "clear and convincing evidence" standard. This standardhas been
and a broadadoptedby many states for punitive-damagedeterminations,168
use
to
all
determinations-or
at
least
those
of
its
in which
negligence
ening
hindsight bias seems most likely to present a significant problem-might
provide a desirable counterweightto the tendency of jurors to overestimate
the probabilitythat harmwill occur. (Of course, furtherstudy would be required before reaching a final conclusion here.) This, of course, would be
likely to be a second-best solution; in some situations defendantsmight be
found not liable when, under a perfectly functioning system with no hindsight bias and no heightened evidentiarystandard,they would be found liable.169This need not be the case, however, and even if it is, we might well
toleratea crude measure that producedsome errorsso long as it represented
an improvementover the currentsystem. Most importantly,there is much
room for research focused on determiningwhether altering the evidentiary
thresholdwould representa desirableresponse on balance-either across the
board or in particularcategories of cases. Our goal is to suggest the value of
research on this issue, ratherthan to urge an immediate change in policy
based on what we now know.
To fix ideas for purposes of exploring these points, imagine first that
hindsightbias producesa similarincrease across cases in a juror's perceived
likelihood that the negligence thresholdis met. (So, for example, suppose
that jurors generally overestimate by fifty percent the likelihood that the
negligence threshold is met, based on the evidence presented.) In this circumstance,the overestimationof the likelihood that the negligence threshold
is met could in theory be precisely offset by a change in the evidentiary
threshold. To see this point, imagine that the likelihood that the negligence
threshold has been met is graphedas a function of the strengthof the evidence. In the absence of hindsight bias, the function will cross the fiftypercent (preponderance)cut-off at a given level of evidentiarystrength,and
all cases in which the evidence is strongerthan that should produce findings
of liability. But with hindsight bias, jurors will overestimatethe likelihood
that the negligence thresholdhas been met, and this will produce an upward
shift in the function we are imagining;as a result, too many cases will cross
the preponderanceline. But if that line itself is shifted up by an appropriate
amount, the hindsight-influencedfunction will cross it at precisely the same
level of evidentiarystrengthas the one at which the original function crossed
168. See Developmentsin theLaw-The CivilJury,110 HARV.L. REV.1408, 1531 (1997).
169. See Rachlinski,supranote 158, at 606-07.
May 1998]
BEHAVIORAL
the preponderancestandard. For instance, if the likelihood that the negligence thresholdhas been met is a linear function of the strengthof the evidence, half of all cases in the system meet the thresholdunderthe preponderance standard,andjurors overestimateby fifty percentthe likelihood that the
threshold is met, then a move to a seventy-five-percentlikelihood requirement would result in the jurors' finding negligence in precisely the half of
cases in which it shouldbe found.
If hindsightbias producesdifferentdegrees of distortionin jurors' probability estimates across differenttypes of cases, then a shift to a higher evidentiary standardmight result in underdeterrenceof some defendants (specifically those whose actions will not be judged in a particularlyhindsightbiased way). But as long as the increase in the evidentiarystandardis modest relative to what hindsight bias in the average case warrants,the change
would produce fewer "underdeterrenceerrors"(findings of no liability for
defendantswho should be found liable) than correctionsof "overdeterrence
errors"(findings of liability for defendantswho should not be found liable).
And the change from a move to the "clear and convincing evidence" standard would be a relatively modest one; a survey of federal district court
judges found that in the judges' view that standardrequires a likelihood of
sixty to seventy percent, comparedto the fifty-one percent threshold under
the preponderancestandard.170(Of course, more interestingwould be data
on howjurors view the two standards.)
One response to this analysis is that the reasonjurors tend to find defendants liable even when liability is not legally warrantedis not that jurors
overestimatethe probabilityof harm,but simply that they want to compensate tort victims. Our first prescriptionaddressesthe latter issue as well as
the former, for if jurors do not know what harm occurred,it is difficult for
them to engage in compensation-baseddecisionmaking. (In the case of the
food-processing company discussed above, the jurors, to ensure compensation for the harm that occurred, would have to say that the company was
negligent whether it used the chemical or refrainedfrom using it-probably
not a likely scenario.) But as far as the second prescriptionis concerned,the
problem of compensation-baseddecisionmakingremains. So if this is what
is going on, jurors may continue to find defendants liable, regardless of a
higher evidentiarythreshold. But there is no reason to think the existence of
a higher thresholdwill make things worse in this situation,and so as long as
there are some cases in which jurors try faithfully to apply the negligence
standard,moving to the higher evidentiarythresholdmay improve decisionmaking. The same response may be offered to the objection thatjurors' behavior is not sensitive to the evidentiarythreshold-a point on which there is
170. UnitedStatesv. Fatico,458 F. Supp.388, 410 (E.D.N.Y.1978).
1532
STANFORD
LAWREVIEW
[Vol. 50:1471
conflicting evidence;71 as long as an increase in the thresholdwill matterin

some cases, the change may be desirable,since there is no reason to think it
will cause harmin cases in which it does not changejurors' behavior.
A final objection might be that altering the evidentiary standardwould
not (it is claimed) survive the Kantian-Rawlsianpublicity condition, which
means, roughly, that principles of justice must be defensible publicly, and
that their basis and content must not be secret.172The question is whether it
is coherent to tell jurors that: Although this case should be decided by the
preponderanceof the evidence, we know that you are likely to think irrationally, so therefore we raise the thresholdto clear and convincing evidence.
We do not believe that there is anythingincoherent,or violative of the publicity condition, in an idea of this sort. In both private and public life, people, acting individually or in groups, take steps to ensure against their own
tendencies to make mistakes. (We discussed in PartI.A the steps that people
frequentlytake to deal with problems of bounded willpower.) Raising the
standardof proof to preventerrorsis consistent with much of the law of evidence, which is also designed to respondto cognitive errors. As just one example, consider the restrictionson admission of evidence of prior crimes.'73
A public defense of such steps is perfectly intelligible.
3. Otherapplications.
The discussion to this point has focused on tort cases decided under the
negligence standard,but similar issues may arise in other areas of law in
which juries (orjudges) must determinewhetheran ex ante standardwas met
while armed with the knowledge that a negative event in fact materialized.
One example is securities fraud litigation, whose perceived excesses
promptedCongress to enact the Private Securities Litigation Reform Act of
1995.174 In a typical securities fraud case, decisionmakersare confronted
with a company whose stock price experienceda dramaticfall, and they are
requiredto assess whethera particularissue or problem facing the company,
whose disclosure promptedthe fall, should have been disclosed at an earlier
stage (typically before it had become an issue or problem). Decisionmakers
in such a case are required to make an after-the-fact determination of
whether a reasonable ex ante decisionmakerwould have thought the prospective issue or problem"material"to the average shareholderbased on the
171. CompareDorothyK. Kagahiro& W. ClarkStanton,Legal vs. QuantifiedDefinitionsof
Standardsof Proof, 9 LAW & HUM.BEHAV.159, 162-65 (1985) (findingno effect of different
evidentiary thresholds), with SANFORDH. KADISH& STEPHENJ. SCHULHOFER,

CRIMINALLAW
ANDITSPROCESSES
40 (6th ed. 1995) (citing studies that find such an effect).
172. JOHNRAWLS,A THEORYOFJUSTICE133 (1971). This issue was raised by Jon Elster in
commentson an earlierdraftof this article.

173. FED.R. EVID.404(b).
174. Pub.L. No. 104-67, 109 Stat.737 (1995) (codifiedin scatteredsectionsof 15 U.S.C.).
May 1998]
BEHAVIORAL
informationavailable at the time.175The problem is that this determination

must be made againstthe backdropof knowledge thatthe issue or problemin
fact materialized,andproduceda large dropin the company's stock price. In
this situation, a decisionmakerwill likely find it difficult to see how a reasonable ex ante decisionmakermight have thought the prospective issue or
problem other than material. Consistentwith this analysis, the main predictor of whethera securities fraudaction is broughtseems to be whetherthere
has been a large change in the company's stock market value, not whether
the company's behaviorwas reasonablefrom an ex ante perspective.176
Another example here involves damage suits for violations of the Fourth
Amendment. A risk in such suits is that if the allegedly illegal search did in
fact produce damagingevidence (say, drugs or other contraband),then decisionmakersare likely to conclude that the law enforcementagency's behavior was reasonable. This will be true even if, from an ex ante perspective
(without knowing the eventual outcome), this behavior would not have been
foundreasonable.
B. InformationDisclosure and GovernmentAdvertising
1. Background.
Suppose it is agreed that individuals lack adequate information on a
given subject-for example, workplace safety, appliance energy efficiency,
or the effects of drug use. In some such instances the governmentmay seek
to foster comparisonshopping and informed decisionmaking(as in the federal truth-in-lendinglaw, which requires lenders to announce interest rates,
measured the same way177);in other instances the governmentmay have a
specific policy goal (reducing drug use, encouraging the use of energyefficient refrigerators). Conventionaleconomics acknowledges the possible
desirabilityof each of these goals (the second in the case of phenomenasuch
as externalities),and it often advocates, as a means of achieving them, providing additional informationto citizens, either through a mandate to the
relevant private actors (for instance, employers), or throughprovision of informationby the governmentitself.178
The prescriptionto "providemore information"is striking in its spareness. Behavioral analysis suggests that this prescriptionis far too spare.
175. See ROBERTCHARLES
LAW? 8.10.4 (1986).
CLARK,CORPORATE
176. See JanetCooperAlexander,Do theMeritsMatter?A Studyof Settlementsin Securities
Class Actions, 43 STAN. L. REV. 497, 511-13 (1991); James Bohn & Stephen Choi, Fraud in the
New-IssuesMarket:EmpiricalEvidenceon SecuritiesClassActions,144 U. PA. L. REV.903, 93540, 979-80 (1996).
177. See EdwardL. Rubin, Legislative Methodology:Some Lessonsfrom the Truth-in-
Lending Act, 80 GEO.L.J. 223, 235-36 (1991).

178. See, e.g., JOSEPHE. STIGLITZ,
ECONOMICS
OFTHEPUBLICSECTOR90-91 (1986).
LAWREVIEW
STANFORD
1534
[Vol. 50:1471
"Providemore information"says nothing about the way in which the information will be provided, and yet we know from much of what has been said
already,as well as from empiricalwork by scholars such as W. Kip Viscusi,
that this will matter a great deal.179Thus, for example, we know that people's perceptions of the probabilityof uncertainevents is influenced by the
salience of the presentationof these events.
That presentationmattershas several implications. One is "antiprescriptive": Prescriptions directed toward fostering comparison shopping-the
first governmentgoal mentioned above-will often be incomplete and may
even be paralyzing,since there is often no "neutral"way to present information. The second implication is that effective prescriptive strategies for
achieving the second goal mentioned above-discouraging particulartypes
of behavior-must take behavioral factors into account. It is not enough
simply to "provideinformation."We discuss several examples of this below.
2. Antiprescription.
Consider the following example of a government attempt to foster informed decisionmaking: In the case of defined contributionplans such as
401(k)s, the LaborDepartment,the relevantgovernmentauthority,has ruled
that employers must give employees investment alternatives,and must provide informationaboutthose alternatives(such as risk and returns);but firms
are not allowed to offer "advice"as to how to invest.180We think that such
spare guidelines place employers in a very difficult position. The reason is
that the way firms decide to describe and display informationon investment
alternativeswill have a powerfulimpacton the choices employees make.
Consider in this connection a recent study of the division of retirement
savings by university staff employees between two different funds, a safe
one (bonds) and a risky one (stocks).81 All the employees were shown actual historical data on the returnsof the two funds, but this informationwas
displayed in two differentways; one groupwas given the distributionof oneyear rates of return, while the other was given a simulated distributionof
thirty-yearrates of return. Those shown the thirty-yearreturns elected to
invest nearly all their savings in stocks, while those shown the one-year returnsinvested a majorityof their funds in bonds. Ourpoint is not that one of
179. See, e.g., W. KipViscusi,IndividualRationality,HazardWarnings,and theFoundations
of TortLaw,48 RUTGERSL. REV.625, 630-36 (1996); W. Kip Viscusi, Wesley A. Magat& Joel
Huber,An Investigationof the Rationalityof ConsumerValuationsof MultipleHealth Risks, 18
RANDJ. ECON.465, 477-78 (1987).
180. See ChristineWilliamson,DefinedContribution;

DOLMovesHelp Sponsors;But New
& INVESTMENTS,
Feb. 5, 1996, at 27.
Proposals Raise Concerns at P&I Conference, PENSIONS
181. Shlomo Benartzi& RichardH. Thaler,Risk Aversionor Myopia?Choicesin Repeated

Gamblesand RetirementInvestments(Nov. 8, 1997) (unpublishedmanuscript,on file with the
StanfordLawReview).
May 1998]
BEHAVIORAL
theseoutcomesis better. Ourpointis simplythatin the realworld,she who

endsup givingadvice.
providesinformation
This is an examplein whichthe prescription
to "providemoreinformation"may be paralyzing;in otherinstancesit may simply be incomplete.
is thatcertainprivateactorsbe required
Thus,supposethatthe prescription
to provide"information";
whatdoes this mean? If it meansthatthose who
expose people to a dangeroussubstanceor productin the workplace(say
aboutthe danger,this
benzene)mustprovidethemwithaccurateinformation
leaves open a tremendousrangeof possibilities. The actorssubjectto the
mandatewill oftenhave an interestin providingthe least scary,most pallid
versionof the information
possible(forexample,"benzenehas been associatedwitha statisticalincreasein risk"),whileregulatorsmightwantthemost
scary, salientmessage available(say, "exposureto benzenewill increase
yourrisk of gettingCANCERandotherFATALdiseases").Of course,the
best messagein this case, if the goal is accurateknowledge,may well be
somewherein between. An importantgoal of the analyst'stask in making
in this areais to say howthe information
shouldbe providedprescriptions
notjustthatit shouldbe provided.
In still othercontexts,suchas ones in whichthepresentation
of information will affectpeople'spreferencesratherthanjust theirperceptionsof risk,
it is not even clearin theorywhatis meantby ensuring"informeddecisionmaking."It is not even clearthattherearesteadyor stablebackground
preferencesthatmightbe "informed."The preferencescan themselvesbe an
artifactof the methodof informing.Forinstance,one of the centralfeatures
of Kahnemanand Tversky'sprospecttheoryis that people evaluateoutcomes based on the changethey representfrom an initialreferencepoint,
ratherthanbasedon the natureof the outcomeitself; also, losses fromthe
initialreferencepointare weightedmuchmoreheavilythangains.182This
aspectof prospecttheory(like its otherfeatures)is basedon evidenceabout
actualchoicebehavior.'83The evaluationof outcomesin termsof gainsand
182. See Kahneman& Tversky,supranote 12, at 277-79.
183. See id. at 273 (outcomesare vieweddifferentlydependingon whetherthey come in the
formof gains or losses froma perceivedstatusquo);id. at 279 (citingEugeneGalanter& Patricia
Pliner, Cross-ModalityMatching of Money Against Other Continua, in SENSATION
AND
MEASUREMENT
65 (HowardR. Moskowitz,BertramScharf & Joseph C. Stevens eds., 1974))
(losses areweightedmoreheavilythangains). Anotherfeatureof how outcomesare viewed, both
empiricallyand underprospecttheory,is thata given changeproducesless reactionthe furthera
decisionmakeris from her referencepoint. Thus, for example,the value differencebetween $10
and$20 is greaterthanthe valuedifferencebetween$1000 and$1010,bothfor gains andfor losses,
assuminga referencepointof $0. See id. at 278. In termsof the shapeof the "valuefunction"for
decisionmakers(a functiongiving the value of each outcome-thisis prospecttheory'scounterpart
to the utilityfunction),this suggestsa functionthatis concavefor gains andconvex for losses; only
with thatshapearebothgains andlosses viewedas less significantthe furtherthe decisionmakeris
fromherreferencepoint. See id. This shapeof the value functionis furthersupportedby evidence
of attitudestowardrisk: People appeargenerally(thoughthere are exceptions)to exhibit risk-
LAWREVIEW
STANFORD
1536
[Vol. 50:1471
losses from an initial reference point, coupled with the special aversion to
losses, means that it mattersa great deal whethersomething is presentedas a
gain or a loss relative to the statusquo; a perceived threatof a loss relative to
the status quo weighs more heavily than a perceived threat of foregoing a
gain. In such cases it is difficult to say which individualis "informed"-the
one who is told of the perceived threatof a loss or the one who is told of the
perceived threatof foregoing a gain. In this and other contexts, preferences
are not preexisting but rather"constructive,context-dependent,"analogous
to the balls or strikes that do not predate the situation of choice and that
"ain'tnothing till" the umpirecalls them.184
3. Prescriptions.
Suppose now that the agreed-upongoal is not to foster "informeddecisionmaking,"but to discourage particulartypes of behavior. Conventional
economics would view this as a desirablegoal at least to the extent that fullyinformedconsumerswould not engage in the behaviorin question, and to an
even greater extent if the behavior in question produces exterality effects.
And to achieve this goal, conventionaleconomics would again prescribe,as
one possible means, "more information." (Other, probably more usual,
means include taxation and regulationdesigned to discourage the unwanted
behavior.) Quite obviously, though, some ways of providinginformationare
more effective than others. There is nothing surprisingabout this statement.
Presumably, when firms pay millions of dollars to advertising agencies to
create splashy new ad campaigns,they think they are getting something for
their money. Likewise, there is of course an enormous marketingliterature
about how best to shape people's behavior in desired directions. These
points apply equally to the government. Below we develop briefly some
specific prescriptionsfor achieving goals that involve changing people's behavior.
First prescription: Exploit loss aversion. As just noted, individualstend
to weight losses far more heavily than gains. As a result, framing consequences in terms of losses ratherthan gains is likely to be far more effective
in changing behavior.185A well-known illustrationof this sort of framing
averse attitudestowardsgains but risk-seekingattitudestowardlosses, and these attitudesimply
concavityof the valuefunctionforgainsandconvexityfor losses. See id. Thispatternof concavity
andconvexityhas receivedconsiderableempiricalsupport. See id. at 268, 278; PeterC. Fishbur
& GaryA. Kochenberger,Two-PieceVonNeumann-Morgenstern
UtilityFunctions,10 DECISION
ScI. 503, 509-10 (1979).
184. Amos Tversky& RichardH. Thaler,PreferenceReversals,in THALER,
supranote 40, at
79, 91.
185. Cf:EdwardJ. McCaffery,DanielJ. Kahneman& MatthewL. Spitzer,Framingthe Jury:
CognitivePerspectiveson Pain and SufferingAwards,81 VA. L. REV.1341 (1995) (findingeffect
of gain versusloss framingon magnitudeof damageawards).
May 1998]
BEHAVIORAL
effect is a study involving breast self-examination;pamphletsdescribingthe

positive effects of breast self-examination(for example, women who undertake such examinationshave a greaterchance of finding a tumor at a treatable stage) are ineffective, but there are significantchanges in behavior from
pamphlets that stress the negative consequences of a refusal to undertake
self-examinations (women who fail to perform such examinations have a
decreased chance of finding a tumor at a treatablestage).186Note that this
example illustrateshow the provision of informationmay be a more natural
tool than taxation or regulation for discouraging some forms of behavior
(such as the failureto performa self-examination).
Second prescription: Exploit salience. Effective prescriptive strategies
need to take account of the fact thatvivid and personalinformationwill often
be more effective than statistical evidence. This sort of informationhas a
high degree of salience, and, as a result of the availability heuristic, people
will tend to respond to it by attaching a higher probability to the event in
question. Thus an antidrugadvertisement,showing a frying egg with the
announcer'svoice claiming, "thisis your brainon drugs,"appearedto have a
significant effect on behavior.'87Availability suggests that the ad produceda
higher perceivedprobabilityof negative effects thana flatterad would have.
Thirdprescription: Avoid the pitfalls of overoptimism. As noted in the
previous section, a common feature of human behavior is overoptimism.'88
This behavior is not specific to the young, althoughit may be diminished as
people move beyond middle to old age, as RichardPosner has suggested.189
What does this featureof behavior imply about governmentprovision of information? Considerthe choice between a safe-drivingcampaignfocused on
drivers' own driving and the ingenuous campaign actually adopted by the
government: "Drivedefensively: Watch out for the other guy."190The government's campaign, perhaps self-consciously, responded to the fact that
most people tend to believe that they are unusually safe drivers. This is a
model of the sort of prescriptiveapproachadvocatedby behavioralanalysis.
186. Beth E. Meyerowitz& Shelly Chaiken,TheEffectof MessageFramingon Breast SelfExamination:Attitudes,Intentions,and Behavior,52 J. PERSONALITY
& SOC.PSYCHOL.
500, 505
(1987).
187. See Douglas Herring,Comment,GettingHighfrom Southof the Border:Illicit Smuggling of Rohynolas an Exampleof the Need to ModifyU.S.Responseto InternationalDrug Smuggling AfterNAFTA,18 LOY.L.A. INT'L& COMP.L.J. 841, 863 (1996) (citing MatheaFalco, Towarda MoreEffectiveDrugPolicy, 1994U CHI.LEGAL
F. 9, 15).
188. See note 152supraandaccompanyingtext.
189. See Weinstein, UnrealisticOptimism,supra note 152 (overoptimismapparentin the
A. POSNER,AGINGANDOLDAGE 104-06 (1995).
general public); RICHARD
190. See Sunstein,supranote 3, at 1177.
STANFORD
LAWREVIEW
1538
[Vol. 50:1471
C. Behavior of Criminals
1. Background.
Our discussion of prescriptiveanalysis has thus far focused on bounded
rationality. But bounded willpower may also play a role. Consider the
question of deterringcriminalbehavior. Economic analysis of this question
typically starts from the premise that potential offenders will be deterred
from criminal acts if the expected costs of those acts exceed their expected
benefits.'91 Potential offenders are imagined to make at least a rough calculation of these costs and benefits in the process of making their decisions.
Bounded rationalitysuggests that people may make systematic (as opposed
to random)errorsin computingthese costs and benefits; for example, as described above, individuals tend to judge the likelihood of uncertain events
(such as getting caught for a crime) by how available such instances are to
the human mind, and this may depend on factors unrelated to the actual
probabilityof the event. This analysis suggests the desirability,from a prescriptive standpoint,of making law enforcementhighly visible, holding constant the actual probabilitythat offenders will be caught; it suggests, for example, the good sense of the familiar method of parking-ticket enforcement-sticking large, brightly-coloredtickets that read "VIOLATION"in
large letters on the drivers' side window, where they are particularlynoticeable to drivers passing by-as opposed to a less costly approach (putting
small, plain tickets underthe windshield wiper on the curb side of the street,
convenient for the parkingofficer to reach). Anotherexample here is "community policing," now widely practicedacross the country;by making more
visible and memorable the presence of police (as, for example, by having
them walk their beats ratherthan ride in patrol cars), authoritiescan, it is
suggested, increase the deterrenceof potential criminalswithout alteringthe
actualprobabilityof apprehension.
But even if one assumes that potentialoffenders can accuratelycompute
the costs and benefits of crime, bounded willpower suggests that they will
often behave in ways at odds with conventional economic analysis, due to
problemsof self-control. A centralfeatureof much criminalbehavioris that
the benefits are immediate, while the costs (if they are incurredat all) are
spread out over time-often a very long time. Economic analysis assumes
that such futurecosts are discountedto presentvalue, and A. Mitchell Polinsky and Steven Shavell have recently suggested that potential criminal offenders may have unusuallyhigh discountrates, so that years in prison far in
191. See Shavell,supranote41, at 1235.
May 1998]
BEHAVIORAL
the future will be discountedvery heavily.192Behavioral economic analysis

carriesthis idea furtherby incorporatingself-controlissues often emphasized
by criminologists.193
2. Prescriptions.
As just noted, the existing economic analysis assumes a constant discount rate (althoughperhapsa high one); this means that the difference between the attractivenessor aversiveness of a reward or punishment today
versus tomorrowis the same as the differencebetween a year from now and
a year and one day from now. In contrastto this theory,there is considerable
evidence that people display sharplydeclining discountrates.194This means
that impatienceis very strong for near rewards(and aversion very strong for
near punishments)but that each of these declines over time-a patternreferredto as "hyperbolicdiscounting."195Such attitudesreflect "dynamicinconsistency"; one's present desires for the futureare at odds with one's future desires for the future.196In an illuminatingoverstatement,Jon Elster has
referredto this as the "absolutepriorityof the present"-akin to the "absolute priority [of the self] over other persons: I am I-while they are all 'out
there.'"197RichardPosner has recently appliedthese ideas to issues of aging
and old age,198and their applicationto criminaloffenders is supportedby the
idea that such offenders often behave "impulsive[ly]"and then have to "exaggerat[e] the benefits of crime" in order to justify their behavior to themselves later.199Such a need for justification would not occur with the ordinary discounting assumed by most conventional economic analysis; decisions would not be regrettedlaterbecause with that form of discountingthere
is no dynamic inconsistencyof preference.200
What does hyperbolic discounting imply for effective deterrence of
criminal behavior? With this sort of bounded willpower on the part of po192. A. MITCHELL
POLINSKY& STEVENSHAVELL,ON THEDISUTILITY
AND DISCOUNTING
OF IMPRISONMENT
AND THETHEORYOF DETERRENCE
12-13 (Harvard Law School, John M Olin
CenterforLaw,Economics,andBusiness,DiscussionPaperNo. 213, 1997).
193. See, e.g., MICHAELR. GOTTFREDSON

& TRAVISHIRSCHI,A GENERALTHEORYOF
CRIME85-120 (1990) (emphasizingrole of lack of self-controlin criminalbehavior);James Q.

Wilson& AllanAbrahamse,Does CrimePay?, 9 JUST.Q. 359, 372-74 (1992) (similar).
194. See GeorgeLoewenstein& RichardH. Thaler,IntertemporalChoice,in THALER,
supra
note40, at 92, 95-96 (discussingstudies).
195. See DavidLaibson,GoldenEggs andHyperbolicDiscounting,112 Q.J.ECON.443, 44546 (1997).
196. See id.
197. JONELSTER,ULYSSESANDTHESIRENS:STUDIESIN RATIONALITY
ANDIRRATIONALITY
71(1979).
198. POSNER,
supranote 189, at 84-94, 281-82.
199. Wilson& Abrahamse,supranote 193,at 374.
200. See Laibson,supranote 195, at 445.
1540
LAWREVIEW
STANFORD
[Vol. 50:1471
tential offenders, the difference between not getting caught and being imprisoned for, say, a year differs dramaticallyfrom the difference between
being imprisonedfor ten years and being imprisonedfor eleven years (even
apart from any fixed costs that may accompany the fact of conviction).
While the standardtheory says thatthese two things differ only insofar as the
costs of imprisonmentin year eleven must be discountedto present value in
order to be comparedwith the loss of wages and personal freedom in year
one, behavioral economic analysis (and basic common sense) tells us that
this is not so. Shortpunishmentswill thus have much more effect than long
punishmentsas a result of the "priorityof the present";adding years onto a
sentence will produce little additionaldeterrence.201This idea is reflected in
policy recommendationssuch as MarkKleiman's "coerced abstinence"proposal, under which drug offenders on probationor parole would be swiftly
and automaticallypunished,but with modest sanctions,for any positive drug
result.202Shortpunishmentsare also desirableunderPolinsky and Shavell's
approach,but for a differentreason.
Our analysis is consistent with empiricalevidence suggesting that criminal behavior is correlatedwith high levels of self-control problems. It appears, for example, that drunk-drivingbehavior is significantly correlated
with not wearing a seat belt-itself a behaviorthat seems to suggest a very
high weight on the present, and thus a lack of self-control in the sense used
here.203Another interestingpiece of empiricalevidence concerns offenders'
views of sentences of different lengths. One study found that they view a
five-year term of imprisonmentas, on average, only twice as bad as a oneyear term; the five-year term had a perceived severity of 200, comparedto
100 for the one-year term.204This alone is also consistent with a high discount rate-a rate of roughly 0.5. But with that discount rate, the difference
between a five- and ten-yearterm should be quite small (approximately6 on
the severity measure); in fact, the difference was 300.205 This difference is
also somewhat higher than hyperbolicdiscountingwould suggest; if the difference between 100 and 200 representsa .25 weight on all years after the
first year (so that the five-year term's severity is 100 + 25 + 25 + 25 + 25 =
200), then the ten-yearterm's severity would be 325-much closer than the
201. Cf RobertD. Cooter,Lapses, Conflict,and Akrasiain Tortsand Crimes:Towardsan
EconomicTheoryof the Will,11 INT'LREV.L. & ECON.149, 154 (1991) (concludingthatshortbut
highlyprobablesentencesare optimalin a model in which potentialoffendersexperience"lapses"
in self-control).
202. MarkA.R. Kleiman,CoercedAbstinence:A NeopaternalistDrug Policy Initiative,in
THENEWPATERNALISM
182, 203, 205-08 (Lawrence M. Mead ed., 1997).
203. See MartinFriedland,MichaelTrebilcock& Kent Roach,RegulatingTrafficSafety,in
SECURING
COMPLIANCE:
SEVENCASESTUDIES165, 192 (1990).
204. WilliamSpelman,TheSeverityof IntermediateSanctions,32 J. RES.CRIME

& DELINQ.
107, 113 (1995).
205. Id.
May 1998]
BEHAVIORAL
APPROACHTOLAW&ECONOMICS 1541
206 predictedby the nonhyperbolicapproach,although still less than the actual severity rating of 500. These data are of course only suggestive; we
have not shown that the boundedwillpower approachleads to improvedpredictions of actual criminal behavior. Empiricalwork on actual behavior of
this sort is notoriously difficult, but scholars such as Steven Levitt have begun to demonstratethe possibilities in this area.206A full analysis of criminal
behavior would also need to incorporateother factors not considered here
(such as the role of community);our goal is only to sketch some of the many
ways in which conventional economic analysis of criminal law can be usefully extended using the tools of behavioraleconomics.
V. NORMATIVE ANALYSIS: ANTI-ANTIPATERNALISM
In its normative orientation,conventional law and economics is often

strongly antipatemalistic. The idea of "consumersovereignty"plays a large
role; citizens, assuming they have reasonableaccess to relevant information,
are thought to be the best judges of what will promote their own welfare.
Yet many of the instances of bounded rationalitydiscussed above call this
idea into question-and also, as we will emphasize below, call into question
the idea that interventionby governmentactors, who themselves may face
the same cognitive or motivationalproblems as everyone else, can improve
matters. In this way bounded rationality pushes toward a sort of antiantipateralism-a skepticism about antipateralism, but not an affirmative
defense of paternalism.207We also note (although we do not explore this
point here) that while boundedrationalitymay increase the need for law (if
government's failings are less serious than citizens'), bounded self-interest
may reduce it, by creatingnorms that solve collective action problems even
without governmentintervention.208
A. CitizenError
Many of the forms of bounded rationality discussed above call into
question the idea of consumer sovereignty. For example, overoptimism
leads most people to believe that their own risk of a negative outcome is far
lower thanthe averageperson's. Similarly,the effect of salience may lead to
substantialunderestimationof certainrisks encounteredin everyday life (for
example, the risks from poor diet), since these harmsmay not be very salient.
206. StevenD. Levitt,UsingElectoralCyclesin Police Hiringto Estimatethe Effectof Police
on Crime,87 AM.ECON.REV.270 (1997); StevenD. Levitt, TheEffectof Prison PopulationSize
on CrimeRates:EvidencefromPrisonOvercrowding
Litigation,111 Q.J.ECON.319 (1996).
207. See Sunstein,supranote3, at 1178.
208. A standardargumentfor law underthe conventionaleconomic approachis that selfinterestedpeople will createcollective irrationality;if people are boundedlyself-interested,however,this problemmay tendto disappear.
1542
STANFORDLAWREVIEW
[Vol. 50:1471
When overoptimism is combined with salience, people may underestimate

risks substantially. We emphasizethat these problems are not ones of insufficient informationper se; they are ones of insufficient ability to process accurately the informationone possesses insofar as that informationbears on
one's own risks. Thus, for example, people may have reasonably adequate
informationabout the risks of smoking,209but this does not at all imply that
they have adequateperceptionsof the risks of smoking that they themselves
face.210 Even if people can obtain accuratestatisticalknowledge, statistical
knowledge may not be enough to inform actualchoices.211It does not follow
from this that informationis useless; it is just that having informationper se
does not automaticallyimply optimalbehavior.
Furtherquestions about the idea of consumer sovereignty arise from the
gap between "decision"and "experience"utility. The utility of actual experience may diverge from the anticipatedutility as revealed by people's decisions.212The identity of decision and experienceutility in conventional economics is often treatedas an axiom, or at least as a propositionthat could not
be falsified. But behavioralresearch shows that people's judgments about
their futureexperience at the time of decision can be mistaken, in the sense
that people are sometimes unable (even apartfrom the sorts of informational
issues recognized by conventionaleconomics) to assess what the experience
will actually be like. Thus, for example, people appearnot to predict accurately the consequences of becoming seriously ill or disabled.213They tend
to underestimatetheir ability to adapt to negative changes, a point that may
bear on law and policy in such areasas global climate change.214
But this suggestion about adaptationraises a complex normative question: Is a person's measure of welfare after (for example) becoming ill the
appropriatemeasure of value? Perhapspeople, throughcoping mechanisms,
are able to adapt to disease better than they anticipatein advance, but does
this mean that disease is a less severe problem than prior attitudes would
209. See W. KIPViSCUSI,SMOKING
4 (1992).
210. See Paul Slovic, Do Adolescent Smokers Know the Risks?, 47 DUKEL.J. (forthcoming
1998).
211. See Sunstein, supra note 3, at 1184.
212. See Daniel Kahneman, New Challenges to the Rationality Assumption, in THE
RATIONAL
FOUNDATIONS
OFECONOMIC
BEHAVIOUR
203 (Kenneth J. Arrow, Enrico Colombatto,
MarkPerlman& ChristianSchmidteds., 1996).

213. See PhilipBrickman,Dan Coates& RonnieJanoff-Bulman,
LotteryWinnersand Accident Victims:Is HappinessRelative?36 J. PERSONALITY
& SOC.PSYCHOL.
917 (1978); George
Loewenstein& David Schkade, Wouldn'tIt Be Nice? PredictingFutureFeelings, in HEDONIC
PSYCHOLOGY: SCIENTIFICAPPROACHES TO ENJOYMENT, SUFFERING, AND WELL-BEING (Ed Die-
ner,NorbertSchwartz& DanielKahnemaneds., forthcoming1998).

214. See George Loewenstein& Shane Frederick,PredictingReactions to Environmental
Change, in ENVIRONMENT, ETHICS, AND BEHAVIOR: THE PSYCHOLOGY OF ENVIRONMENTAL
VALUATION AND DEGRADATION 52, 64-65 (Max H. Bazerman, David M. Messick, Ann E. Ten-
brunsel& KimberlyA. Wade-Benzonieds., 1997).
May 1998]

BEHAVIORAL
have suggested? On conventionalutilitariangrounds,the answer is probably

affirmative;the subjective experienceis what counts. But a well-established
challenge to utilitariananalysis suggests the possibility of a negative answer,
on the groundthat subjectiveexperiencemay not be all that counts.215What
we mean to suggest here is a simple point: People sometimes do mispredict
their utility at the time of decision, and on conventional grounds, this phenomenon raises seriousproblemsfor the idea of consumersovereignty.
B. Behavioral Bureaucrats
Any suggestion that the governmentshould intervenein response to people's mistakes raises the question whether the government will be able to
avoid such errors. The prospectsfor productiveand useful interventionmay
be smallest in the case of populist government;the actions of such a government, based heavily on pressurescoming from citizens, may tend to be subject to the very same biases and errorsthat afflict citizens. (Thus behavioral
analysis complementsexisting accounts of the problemswith populism.) An
example of the effects of populism is the Superfundstatute,discussed in Part
III.C; irregularperceptions of risk by ordinarypeople may tend to produce
irregularitiesin regulation,as the cognitive errorsthat ordinarypeople make
are replicated in statutoryand administrativelaw.216 The effects of social
interactionmay even make governmentaction worse, and more dangerous,
than individual errors. Our earlier discussion suggests a possible mechanism: Availability entrepreneursin the private sector can heighten the demand for regulation, and public sector availability entrepreneurscan take
advantage of, and heighten, this effect, by advocating anecdote-drivenpolicy. Thus public choice accounts of legislation can work productively with
behavioral accounts; there is a good deal of synergy between behavioral
mechanisms and interestgroup leaders, many of whom are amateur(or professional?) behavioraleconomists. The pollutant-of-the-monthsyndrome in
environmentallaw is paralleledby many measures respondingto the crisisof-the-month. These difficulties with populist government also point to
problemswith the referendumprocess.
But populist governmentis not the only worry. Governmentwill often
be subject to cognitive and motivationalproblems even if it is not populist.
(Bureaucratsmay also lack appropriateincentives to make decisions in the
public interest.217)Thus, for example, there is no necessary reason to think
215. See JONELSTER,SOURGRAPES:STUDIESIN THESUBVERSION
OFRATIONALITY
(1983);
AMARTYASEN, COMMODITIES
ANDCAPABILITIES
(1985).
216. See W. KIP VISCUSI,FATALTRADEOFFS:
PUBLICAND PRIVATERESPONSIBILITIES
FOR
RISK 149 (1992); VISCUSI,supra note 137, at 85-88, 94-97; Noll & Krier, supra note 137, at 76072.
217. See Robert C. Clark, Contracts, Elites, and Traditions in the Making of Corporate Law,
89 COLUM.L. REV. 1703, 1719-20 (1989).
1544
W
LAWREVIE
STANFORD
[Vol. 50:1471
thatgovernmentofficialsare,by virtueof theiroffices,ableto avoidoveroptimismor predictexperienceutility. On the otherhand,a degreeof insulation frompopulistpressures,combinedwith knowledgeof behavioraleconomics, might producesome improvement.New institutionsmay play a
role;considerJusticeBreyer'splea for an insulatedbodyof specializedcivil
servants,entrustedwith the job of comparingrisks and ensuringthat resourcesare devotedto the most seriousproblems;218
HowardMargolis'beshouldbe requiredto ensure
haviorally-informed
suggestionthatgovernment
that all initiatives "do no harm";219
even proposals for cost-benefit analysis,
understoodin a behaviorallight as an attemptto overcome biases and confusions in both perceptionand motivation.220We also emphasize that government interventionneed not come in highly coercive forms; perhaps distortions in people's decisionmakingcan be overcome by informationcampaigns
falling well short of coercion. For instance, in the contexts of risks such as
smoking, might debiasing techniques work to link the statistical evidence
with the personalreality?
All of the foregoing ideas raise many complexities; and we have not
even touched upon the complicatedphilosophicalliteratureon the legitimacy
of paternalism. Applicationof these ideas to any specific topic in law would
requirea much fuller developmentof many issues than the space in this article permits. But we need not leave the ideas in purely abstractform; consider the following simple illustration of their application. Imagine that
sunlamps are being sold in an unregulatedmarketand that it is learned that
many consumers fall asleep under the lamps, burning themselves badly.
Consumersmake this mistake in spite of warnings included on the package
and in the instructions,perhapsbecause they fail to anticipatethat lying in a
warmplace with one's eyes closed is likely to induce sleep. Let's call this an
"unintendedrisk,"meaning a risk that consumersfail to appreciate. The existence of this unintended risk leaves open the possibility of welfareenhancingregulation. Suppose, for example, that an automatictimer can be
added to the sunlamp at a cost of twenty-five cents, and that manufacturers
have not included this featurebecause consumersdo not anticipatethat they
will need it. We do not discuss here the issues raisedby the possibility that a
governmentmandateof the timer interfereswith freedom, rightly conceived.
Nor do we address possible distributiveissues (all will pay more for sunlamps, although perhaps only some failed to appreciatethe risks of falling
asleep). All we suggest is that an importantpart of the analysis involves
asking whether the cost of requiringthis safety-promotingfeature (twentyfive cents per customer)is less thanthe cost of the unanticipatedbums.
218. BREYER,
supranote 139,at 55-81.
219. HOWARD
DEALING
WITH
RISK165-89(1996).
MARGOLIS,
220. RISKvs. RISK(JohnD. Graham& JonathanBaertWienereds., 1995). Eachof the solutionsstatedin the text may also be attractiveto conventionaleconomistson a varietyof grounds.
May 1998]

BEHAVIORAL
A centralpoint of this example is that from the perspective of behavioral

law and economics, issues of paternalismare to a significant degree empirical questions, not questions to be answered on an a priori basis. No axiom
demonstratesthatpeople make choices that serve theirbest interests;this is a
question to be answeredbased on evidence. Of course the case for intervention is weakened to the extent that public institutions are likely to make
things worse ratherthan better. What we are suggesting is that facts, and
assessment of costs and benefits, should replace assumptions that beg the
underlyingquestions.
CONCLUSION
Traditionallaw and economics is largely based on the standardassumptions of neoclassical economics. These assumptions are sometimes useful
but often false. People display boundedrationality: They suffer from certain
biases, such as overoptimismand self-serving conceptions of fairness; they
follow heuristics,such as availability,that lead to mistakes; and they behave
in accordancewith prospecttheory ratherthan expected utility theory. People also have bounded willpower; they can be tempted and are sometimes
myopic. They take steps to overcome these limitations. Finally, people are
(fortunately!)boundedlyself-interested. They are concerned about the wellbeing of others, even strangersin some circumstances,and this concern and
their self-conception can lead them in the directionof cooperationat the expense of their materialself-interest(and sometimes spite, also at the expense
of their material self-interest). Most of these bounds can be and have been
made partof formalmodels.
In this article we have sketchedsome of the implicationsof enrichingthe
traditionalanalysis by incorporatinga more realistic conception of human
behavior. We have insisted on the value and importanceof using the three
bounds in the economic analysis of law; more tentatively,we have explored
a series of legal problems in which the bounds may be significant. Obviously there is a great deal of researchto be done, and one of our principal
goals has been to outline areas that could benefit from furtherwork, both
analytic and empirical.
We do not doubt that replacing the simple maximizing model of economics with a more complicated psychological treatment comes at some
cost. Solving optimizationproblemsis usually easier than describing actual
behavior. It has been said (we believe by HerbertSimon) that economics
makes things hardon agents, but easy on economists;behavioraleconomics,
we suggest, does the opposite. We recapitulatehere some of the reasons we
think the enrichedmodel is worth the trouble for those interestedin the economic analysis of law.
1546
LAWREVIEW
STANFORD
[Vol. 50:1471
1. Some of the predictionsof the standardmodel are simplywrong. For

example,people can be both more spitefuland more cooperativethan
traditionalanalysispredicts,and this mattersa greatdeal to law. It is
costsand
also important
to knowthatevenin a worldwithouttransaction
wealtheffects,the assignmentof propertyrightsaltersthe ultimateallocationof thoserights,andthatthis may be particularly
truefor certain
formsof property-rights
court
orders). These feaassignment(suchas
turesof the worldmattergreatlyformakingpredictionsandformulating
policy.
2. In othercases economicsmakesno predictions(or incorrectpredictions
of no effect). Prominentin this categoryarethe effectsof presentation;
since economictheoryassumesthatchoicesareinvariantto the manner
in whicha problemis framed,it falselypredictsthatthe languageof a
mediaaccountor advertisement
has no effect on behavior,holdingthe
information
contentconstant.In contrast,it is well establishedthatpeople reactdifferentlyto potentialoutcomesdependingon whethertheyare
costs (losses),andthatthey
perceivedas foregonegainsor out-of-pocket
arelikelyto think,mistakenly,thatsalienteventsaremorecommonthan
equallyprevalentbutmoresubtleones. Thesepointsbearon the supply
of andthe demandfor law, andon the behaviorof agentsin theirinteractionswiththelegalsystem.
3. Standard
economictheoriesof the contentof law arebasedon an unduly
limitedrangeof potentialexplanations,
namelyoptimal(or second-best)
rules set by judges and rent-seekinglegislationdeterminedby selfinterestedlog-rolling.Behavioraleconomicsoffersothersourcesof potentialexplanation-mostprominently,
perceptionsof fairness.We have
triedto showthatmanylaws whichareseeminglyinefficientanddo not
benefitpowerfulinterestgroupsmay be explainedon groundsof judgmentsaboutrightandwrong.
4. A behavioralapproachto law andeconomicsoffersa host of novel prescriptionsregardinghow to makethe legal systemworkbetter. Some
stemfromthe improvedpredictionsmentionedin point2 above. Cognitive difficultiesandmotivationaldistortionsundermineor alterconventionaleconomicprescriptions
aboutthe jury'srole, most notablyin the
contextof assessingnegligenceandmakingotherdeterminations
of fact
or law. We havetakensomepreliminary
stepsin suggestingwaysto reducethe costsof someof theseproblems.
5. A behavioralapproachto law and economicsproducesnew questions
aboutpossiblemistakesby privateandpublicactors. Onthe one hand,it
raises seriousdoubtsaboutthe reflexiveantipateralismof some economicanalysisof law. On the otherhand,it raisesequivalentquestions
May 1998]

BEHAVIORAL
aboutwhethereven well-motivated
publicofficialswill be able to offer
to
mistakes
andconfusion.
appropriate
responses private
We hope thatthis articlewill encourageothersto continuethe inquiry
andresearch,boththeoreticalandempirical,thatwill be neededto flesh out
the behavioralapproachforwhichwe havearguedhere. This approachwill
use traditional
economictools,enhancedby a betterunderstanding
of human
behavior.Thirtyyearsfromnow,we hopethattherewill be no suchthingas
behavioraleconomics. Insteadwe hope thateconomistsand economically
orientedlawyerswill simplyincorporate
the useful findingsof othersocial
sciences,and in so doing,transformeconomicsinto behavioraleconomics,
andeconomicanalysisof law intoone of its mostimportant
branches.
1548
LAWREVIEW
STANFORD
[Vol.50:1471
APPENDIX:FRAMEWORK
AND SUMMARYOFAPPLICATIONS
This appendix summarizesour frameworkfor behavioral law and economics. It also lists the law and economics issues we analyze within each
category of the framework. The specific behavioral mechanisms we draw
upon, which are summarizedhere, do not constitutean exhaustive list of the
mechanismsthatmight be relevantto law and economics; they simply reflect
the mechanismswe have used here. For each mechanism, we provide a reference to the literature,as an overview of or entry to the existing research;
we refer the interestedreader to the text of our article for additionalreferences on each topic.
A. Boundedrationality
Judgmenterrors
1. self-serving bias
reference: Linda Babcock & George Loewenstein, Explaining
Bargaining Impasse: The Role of Self-Serving Biases, 11 J.
ECON.PERSP.,Winter1997, at 109.
our applications: bargainingaroundcourt orders; failed negotiations.
2. availabilityheuristic
reference: Amos Tversky & Daniel Kahneman,Judgment Under Uncertainty:Heuristics and Biases, in JUDGMENT
UNDER
UNCERTAINTY
3 (Daniel Kahneman,Paul Slovic & Amos Tversky eds., 1982).
our applications: environmentallegislation, governmentadvertising, anti-antipatemalism.
3. hindsightbias
reference: BaruchFischhoff, Hindsight ?Foresight: The Effect
of Outcome Knowledge on Judgment Under Uncertainty, 1 J.
EXPERIMENTAL
PSYCHOL.HUM. PERCEPTION
& PERFORMANCE
288 (1975).
May 1998]
BEHAVIORAL
our applications: negligence determinations;other determinations of fact or law.
4. omission bias
reference: Ilana Ritov & JonathanBaron, Reluctance to Vaccinate. Omission Bias and Ambiguity, 3 J. BEHAV.DECISION
MAKING
263 (1990).
our applications: negligence determinations;other determinations of fact or law.
5. overoptimism
reference: Neil D. Weinstein, Unrealistic OptimismAbout Future Life Events, 39 J. PERSONALITY& SOC. PSCYHOL.806
(1980).
our applications: governmentadvertising,anti-antipateralism.
6. inabilityto predict experienceutility
reference: Daniel Kahneman,New Challenges to the Rationality
FOUNDATIONS
OF ECONOMIC
Assumption, in THE RATIONAL
BEHAVIOUR
203 (Kenneth J. Arrow, Enrico Colombatto, Mark
Perlman& ChristianSchmidteds., 1996).
our applications: anti-antipateralism.
Decisionmakingbehavior
1. loss aversion
reference: Daniel Kahneman& Amos Tversky, Prospect Theory: An Analysis of Decision Under Risk, 47 ECONOMETRICA
263 (1979).
our applications: governmentadvertising.
1550
STANFORD
LAWREVIEW
[Vol. 50:1471
2. endowmenteffect (a corollary of loss aversion)

reference: Daniel Kahneman,Jack L. Knetsch & Richard H.
Thaler, Experimental Tests of the Endowment Effect and the
Coase Theorem,98 J. POL.ECON.1325, 1327 (1990).
our applications: bargaining around court orders, mandatory
contractterms,priorrestraintson speech.
B. Bounded willpower
1. "hyperbolic"discounting
reference: David Laibson, Golden Eggs and Hyperbolic Discounting, 112 Q.J. ECON.443 (1997).
our applications: criminalbehavior.
C. Boundedself-interest
1. fairness behaviorand spitefulness
reference: Colin Camerer& RichardH. Thaler,Anomalies: Ultimatums,Dictators, and Manners, 9 J. ECON.PERSP.,Spring
1995, at 209.
our applications: bargainingaroundcourt orders;bans on market transactions;priorrestraintson speech.

1229304

Загружено:

Сведения о документе

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

1229304

Загружено:

Авторское право:

Доступные форматы

Stanford Law Review

A Behavioral Approach to Law and Economics

A. Homo Economicusand Real People .......................................

A. Negligence Determinationsand OtherDeterminationsof

Objections to the rationalactor model in law and economics are almost

1. See, e.g., MarkKelman,ConsumptionTheory,ProductionTheory,and Ideology in the

"social welfare," usually measured by people's revealed preferences, and

focus on debiasing ratherthan outrightcoercion) may be acceptable even if

In orderto identify, in a general way, the defining featuresof behavioral

10. For furtherdiscussion,see the recentsurveyof resultsin JohnConlisk,WhyBoundedRationality?,34 J. ECON.LITERATURE

Gilboa& DavidSchmeidler,Case-BasedDecision Theory,110 Q.J.ECON.605 (1995).

MelvinW. Redereds., 1987).

nomicTheory,58 U. CHI.L. REV.1275(1991).

ing" and "reactivedevaluation"on settlementbehavior);MarkKelman,Yuval Rottenstreich&

various contexts'8 and to the place of shame, pride, and status,19especially

behavior has also been demonstratedwith laboratoryrats.24 Thus, evidence

24. JOHNH. KAGEL,RAYMONDC. BATTALIO& LEONARDGREEN, ECONOMICCHOICE

in the two groups.28 In short, sunk costs mattered;again, the standardpre-

sis: Because people do not equate opportunityand out-of-pocket costs for

APPROACHTOLAW& ECONOMICS 1485

cle); as we have emphasized,our principalinterestis predictive in character.

37. See JeremyJ. Siegel & RichardH. Thaler,Anomalies:TheEquityPremiumPuzzle, 11 J.

Example(4) above,the relationbetweenspot and futuresprices,does

repeatedly with many opportunitiesto learn. Once a teenager has dropped

MarkPerlman& ChristianSchmidteds., 1996).

45. See, e.g., TOMASJ. PHILLIPSON

46. Thus the idea is ambiguousbetween the notion of "revealedpreferences,"in which

Social Roles, 96 COLUM.L. REV.903, 931-38 (1996).

If such a notion of rationalityallowed for good predictions,then perhaps

poser,is askedto proposean allocationof a sum of moneybetweenherself

Kahneman,JackL. Knetsch& RichardH. Thaler,Fairnessand the Assumptionsof Economics,59

Experiment in the Slovak Republic, 66 ECONOMETRICA

binedwith very high stakes,however,offers decreasesomewhat,althoughthey are still far above

APPROACHTOLAW& ECONOMICS 1491

article, a factorthat economic theorypredictswill not have an effect, namely

50. Thisexperimentis profitablefor theexperimenter

Note that our emphasishere, as well as in the ordinaryultimatumgame,

most people leave tips in out-of-townrestaurantsthat they never plan to visit

We emphasize that this is not a story of simple altruism. As noted

54. RichardH. Thaler& RobynM. Dawes,Cooperation,in THALER,

utility function, in such a way as to deprive the conventional model of the

Thus behavioraleconomicagentshave mannersand scruplesthat can

whereone partyhas violateda perceived"normof fairness."Thisraisesan

61. See ElizabethHoffman& MatthewL. Spitzer,Entitlements,

in behaviorthat have followed largely unenforcedbans on smoking in public

Althoughthe endowmenteffect suggests generallythat the assignmentof

Conventionaleconomictheoryand behavioralanalysisthus generate

Bruce L. Hay & Kathryn E. Spier, Litigation and Settlement, in THENEWPALGRAVE

MitchellPolinskyand Steven Shavell have acknowledgedthis view in their analysisof punitive

approachesis careful empiricalwork thatprovides reasonablydefinitive conclusions aboutpredictivefailuresand successes.

73. See, e.g., POLINSKY,

The leadingstudy in this area is one by LindaBabcock,Xianghong

Social Comparisonsin NegotiationsthatReflecta Self-ServingBias, 111 Q.J.ECON.1 (1996).

76. Id. at 11.

APPROACHTOLAW& ECONOMICS 1503

As already noted, strategicbehavior does not seem to provide a strong

to the discrepancyin predictionsabout the judge's likely award.82Note that

APPROACHTOLAW& ECONOMICS 1505

87. See POSNER,

discussedbelow in connectionwith the existingempiricalevidence(female

(13th ed. 1989).

APPROACHTOLAW& ECONOMICS 1507

This qualificationapplies only to situationsin which there is a financial loss

we suspect thatmost membersof society-which is to say most of the people