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Loss Aversion and the Law

Posted by on Friday, April 27, 2012 in Articles, Volume 65, Volume 65, Number 3, Volumes.

Why is tort law much more developed than unjust enrichment law? Is there a reason for the very different legal treatment of governmental takings and governmental givings? Why are contract remedies structured around the four “interests” and why is the disgorgement interest only marginally protected? What might explain the much greater constitutional protection of civil and political rights, compared to social and economic ones?

This Article suggests that there is a common denominator to these and other puzzles: they are all best answered on the basis of loss aversion. Numerous psychological studies have established that people do not perceive outcomes as final states of wealth or welfare. Rather, they perceive them as gains and losses, and losses ordinarily loom larger than gains. The law protects people from losing much more than it ensures gaining. Loss aversion is thus related to fundamental characteristics of entire legal fields and their relative importance.

In addition to elucidating the correlation between loss aversion and the law, the Article strives to explain this compatibility. One theory is evolutionary. Since people experience losses as more painful than unattained gains, they file lawsuits for recovery of losses much more often than for unattained gains. Consequently, legal doctrines dealing with the former are much more developed. Another theory focuses on the mindset of legal policymakers. Legal thinking largely follows commonsense morality, which conforms to moderate deontology. As such, it inevitably distinguishes between harming people and not aiding them. This theory thus highlights an important correspondence between psychology, morality, and law.

Finally, the Article explores various normative implications of loss aversion. Among other things, it argues that, ceteris paribus, the law should favor not giving over taking. Lawmakers should consider the framing effect of legal norms and the impact of loss aversion on policymaking.