Imagine you are at the airport gate waiting for a flight home on Christmas Eve, and an announcement is made: your flight has been overbooked. Even though the airline offers significant compensation, and even though you know this is a standard practice from which you benefit in the form of lower ticket prices, you are (probably) quite angry. Or imagine that you have ordered a custom bicycle from a high-end shop. Later you go to pick it up only to find out that the shop has sold it to someone else who made a better offer. Even though the shop refunds your money and offers you a valuable coupon, you remain angry and might resolve not to do business with the shop anymore.
Both examples are cases of "efficient breach," which law and economics scholars have powerfully argued should not be punished above and beyond standard compensatory remedies for contract breach. According to the standard account, these kinds of actions are in fact social-welfare maximizing (so long as the "victim" is compensated), so that even if we are (possibly irrationally) aggravated by them individually, we should permit and even celebrate them as a society, and at a minimum refrain from punishing them. At least doctrinally, this describes the law (at least in the US) - it does not entitle you to any extra compensation for these "willful" breaches of contract.
But this is not always true in practice - courts in the US often award punitive damages or similar remedies for breaches of contract characterized as willful. In other countries, particularly those with civil law systems, the law may explicitly provide for different penalties for willful and non-willful breach. Why doesn't practice match up with theory and doctrine? More deeply, why are even economists and others who pride themselves on rational thinking still aggravated by these kinds of behavior when they experience them?
Professor Omri Ben-Shahar has attempted to answer these questions in his paper (with Professor Oren Bar-Gill of NYU) "An Information Theory of Willful Breach," which he presented at this week's Works in Progress (WiP) talk at the Law School.
To greatly simply Prof. Ben-Shahar's analysis, he argues that those behaviors that we characterize as willful breach are penalized not because of something "bad" about them per se (the intuition that the economic analysis of efficient breach explicitly rejects), but because they signal other underlying behaviors that are both worth punishing and difficult or impossible to attack directly.
To illustrate this, Prof. Ben-Shahar returned to the airline overbooking example mentioned above. He suggested that we are angry about, and might punish, the overbooking practice not because it is "unfair" or otherwise blameworthy, but because it is indicative of an underlying, systematic failure to make good investments in and choices about consumer interests. In other words, his explanation goes, overbooking reflects (or at least might reflect) a general airline practice of "screwing" consumers that is both hard to catch and largely happens outside of the contractual context, where it can't be punished even if it can be detected.
Prof. Ben-Shahar noted some similarities between this approach and the "character theory of punishment" in the criminal law context, in which more severe punishment of behavior for which the defendant is convicted is justified on the grounds that it is evidence of deeper problems - though he noted that the problems addressed by willful breach penalties are bad ex-ante investments and choices, rather than character flaws of some kind.
Later in the talk Prof. Ben-Shahar added an important piece to this analysis - that it depends on some form of market failure. If prices include accurate judgments about the level of ex-ante investments (or, to put it more directly, if customers have an accurate sense in advance of which companies are going to screw them), then no ex-post punitive damages for willful breach are needed.
While this account seems like a theoretically sound explanation of observed behavior, commenters at the WiP offered some criticism. One commenter urged Prof. Ben-Shahar to be careful to distinguish between implying that willful breach itself is bad (that is, social-welfare reducing) rather than that it signals some underlying bad conduct. The commenter further noted that Prof. Ben-Shahar, a law-and-economics scholar by vocation, is in fact making arguments very similar to those offered in more general philosophical critiques of the rationality of utilitarianism. While I don't have the background to evaluate this particular criticism, it does fit in with my general sense that there are deeper issues implicated by Prof. Ben Shahar's arguments.
More practically, it would be useful to identify what "bad" (or, as Prof. Ben-Shahar later characterized them, "rent-seeking") behaviors may be associated with willful breach. Even after identifying these possibilities, the empirical question of whether they are in fact associated remains open (though it would surely be better addressed in subsequent work).
A broader critique, and in my opinion a more dangerous one for Prof. Ben-Shahar's arguments, is simply the possibility that we as individuals and a society are making a mistake when we attempt to assign additional punishment to willful breach. The alternative story goes something like this: it is part of human nature to attempt to punish some kinds of behavior, even if it appears irrational to do so. Behavioral economists have identified one example of this in studying the "ultimatum game," in which participants were found to consistently reject deals they perceived as unfair even if they "left money on the table" by doing so. This can be explained, possibly, as a culturally or evolutionarily determined behavior that seeks to enforce behavioral norms - if one gets a reputation for rejecting bad deals, the account goes, people will offer you better deals in the long run. The instinct then misfires by creating the behavior observed in the game, even though there is no repeat play.
A similar facet of human nature may explain our individual anger at efficient breach - even though we might realize its general benefits, this deep instinct still drives our emotional response. But the reputational benefits of penalizing behavior perceived as "bad" don't exist when the practice is generalized to a legal rule - as others have shown, when efficient breach is penalized generally, the result is simply a reduction in social welfare. The instinct to punish has value for individuals, but not as a principle on which to base rules for the group. Prof. Ben-Shahar suggests that there is more going on here in that other, underlying behaviors are being detected and punished, but isn't it just as likely that we are applying intuitions that are appropriate to individual conduct to group rules, where they don't make sense anymore? Other human instincts, such as revenge, clearly don't work as rules for a society, so why should this one - or why should we conclude that it is anything other than a reflection of individual, emotional responses?
Similarly, human intuition rather than rational analysis seems to drive the definition of willful breach itself. Some commenters and Prof. Ben-Shahar himself pointed out that in terms of our emotional reactions and often in law, we treat the breacher who profits from breach (like the bike shop owner who sells to a higher bidder) differently from the one who makes savings due to breach (like a shop owner who breaches because materials have become much more expensive). Economics teaches us that the two are not really distinguishable. Why should it be the case that in one scenario, breach indicates underlying behavior worth punishing, while in the other it does not? Isn't it more likely that this variation in treatment comes from some human instinct gone haywire? One commenter called it a "misfiring intuition" and analogized it to the action/inaction distinction, which seems to be deeply rooted in our minds, but is difficult or impossible to explain rationally.
Prof. Ben-Shahar's best response to these criticisms is that he is trying to give as much credit as he can to observed behavior and identify its root cause, rather than simply dismiss it. While the instinct to explain rather than reject observed behavior is undoubtedly a good one, at some point explanations can either become so tenuous or so complicated that Occam's Razor pushes us towards the possibility that observed behavior is simply systematically irrational, though one must always be careful to avoid telling a "just so" story that lacks real explanatory or predictive power. I'm not sure that our treatment of willful breach is best explained this way, but it is a powerful criticism that Prof. Ben-Shahar will have to confront as the paper develops. I, for one, look forward to seeing that debate play out.