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effects of moral norms on contracting. First, I offer evidence from psychology that many people believe breach of contract is a moral harm irrespective of actual losses suffered by the promisee. Second, I review empirical studies on the notion of the “reference profit,” which suggest that people are more sympathetic when a party to a contract breaches in an attempt to preserve the expected profit than when the breach is motivated by an opportunity to exploit the market for an increased profit. Finally, I argue that moral norms often act as default rules in legal decision making about contracts when a contingency is unspecified in the contract.

Th is review includes studies that directly examine legal decision-making processes as well as others that seem to have a natural application to the legal context. This research offers some evidence that parties may not behave in line with economic expectations. Parties’ moral intuitions may affect their willingness to breach when it is otherwise efficient to do so, their ability to reach settlement once a contract has been breached, their predictions about legal rules of contract, and their post hoc assessment of appropriate damages.

I. Breach as Moral Harm

Research on attitudes toward promise and contract indicates that there is a special psychological harm in breaching a contract, a harm that is conceptually separate from the financial or actual losses of the promisee. When people perceive a moral wrong, they are apt to focus on the punishment that the breacher “deserves” rather than the rules that would create the most efficient incentives. The rule of expectation damages sets optimal economic incentives for the making and breaking of contracts. However, we know that people are often insensitive to these kinds of incentives, especially when the incentive structure fails to punish adequately for moral harms. Jonathan Baron and Ilana Ritov have studied intuitions about penalties and compensation in tort law.2 Th ough subjects were highly sensitive to moral distinctions, they ignored the information about deterrence altogether, uniformly imposing punishments based on the moral rule that the punishment should be proportionate to the outrageousness of the act, whether the punishment would be useful, pointless, or even harmful. In the criminal context, John Darley and Paul Robinson3 have repeatedly shown that subjects are more sensitive to morally salient information than they are to factors associated with deterrence

2Jonathan Baron & Ilana Ritov. Intuitions about Penalties and Compensation in the Context of Tort Law. 7 J. Risk Uncertainty 17–33 (1993).

3Paul Robinson & John Darley. The Utility of Desert. 91 Northwestern Univ. Law Rev. 453–99 (1997).

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rationales, and that people punish in line with retributive theories of justice. However, when parties interact under an assumption of mutual trust, they may be particularly disappointed by a breach, insofar as the breach feels like a betrayal.

Recently, Cass Sunstein has described a phenomenon he calls the “betrayal heuristic.”4 People seem to respond more negatively, and more punitively, to harms caused by a trusted agent than identical harms not caused by a trusted agent. In an empirical study on betrayal, Koehler and Gershoff asked two groups of subjects to assign punishments for five different crimes; in both cases, subjects were shown information about the professions of the respective perpetrators.5 In one condition, the perpetrators were randomly assigned to the crimes; in the other, each crime was committed by someone who would normally be entrusted to prevent just such an occurrence (e.g., a bank robbery committed by a security guard). Subjects were more punitive when the perpetrator was an otherwise trusted agent. There might be good reasons for this. As Sunstein points out, a betrayal causes not only the harm of the crime itself, but also a disruption to the victim’s propensity to be trusting in the future. However, Koehler and Gershoff also demonstrated betrayal aversion in cases in which it was arguably non-normative. In their studies, subjects preferred inferior products – products that were actually less safe – to superior products that had a small risk of betrayal (e.g., a car with no airbag and a higher risk of death in a collision vs. a car with a lower overall risk of death but with an air bag that causes death or injury in a small number of cases).

Th is evidence suggests that people might also be more averse to losses coming from someone who has promised to confer a benefit (e.g., a promisor) than from someone with a neutral status (say, a negligent tortfeasor). Jonathan Baron and I tested the intuitive difference between identical harms resulting from breach of contract versus negligence.6 Using web-based questionnaires, we showed subjects a set of vignettes describing either a breach of contract or a negligent tort, and asked them to indicate the appropriate damages award.

In the contract version of each case, subjects read about an efficient breach, in which the promisor breaks the contract in order to accept a more lucrative contract elsewhere. In the control condition, the same contract is rendered impossible to complete when a third party negligently causes a harm that in

4 Cass Sunstein. Moral Heuristics. 28 Behav. Brain Sci. 531–73 (2005).

5Jonathan Koehler & Andrew Gershoff. Betrayal Aversion: When Agents of Protection Become Agents of Harm. 90 Org. Behav. & Hum. Dec. Processes 244–61 (2002).

6Tess Wilkinson-Ryan & Jonathan Baron. Moral Judgment and Moral Heuristics in Breach of Contract. 6 J. Empir. Legal Stud. 405–23 (2009).

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turn prevents performance. In this case, we were asking subjects not about the damages that would be paid by the promisor, who is presumably excused from the contract, but rather the liability damages paid by the third party. In each condition, the financial harm is identical, and the harm is confined to the harm of not being able to realize the benefit of the contract. An example of a scenario is as follows:

Th e Millers are getting ready to sell their condo. Their real estate agent tells them that their condo will be worth $10,000 more if they get the floors refinished (and you should assume that the agent is correct). They meet with Todd, from Todd’s Hardwood Floors, agree on a price of $6,000 to refinish the floors, and they all sign the contract. Todd is going to refinish the floors right before the condo goes on the market in early October.

Three of these scenarios were presented in one of two conditions, the promise condition and the no-promise condition.

Promise Condition About three days before he is slated to work on the Millers’ floors, Todd gets an offer to refinish all of the floors in another apartment building. If he accepts this offer, he will make much more money, but he will not be able to refinish the Millers’ floors. Todd decides to take the new job and break his contract with the Millers.

No-Promise Condition About three days before Todd is slated to start working on the Millers’ floors, the owners of the next apartment down, the Bakers, are trying to move a gas line in their own condo, even though it is quite dangerous. They do not take proper precautions and the line breaks, gas leaks, and the Millers’ apartment is too toxic for Todd to do his work. The Millers have already moved into their new home, so they are not personally affected by the fumes. However, the fumes are quite toxic in the Millers’ condo for more than a week, so Todd is unable to refinish the floors before the condominium goes on the market. (Note that Todd does not need to be compensated, because he gets a similar, highly paying job for the same week once he is released from his contract with the Millers.)

In order to assess subjects’ judgments about harm in contract and tort, I took the mean of the difference of each subject’s promise and no-promise damages responses. Subjects imposed much higher damages overall in the promise cases than in the no-promise cases.

Our between-subjects tests of guilt and morality indicate that subjects thought a person who caused harm by breaking a contractual promise was more immoral and should feel more guilt than a person who caused harm

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Table 19.1. Ratio of subjects’ chosen damages to expectation damages

through negligence. On a 7-point scale where 7 is extremely immoral and 1 is not immoral at all, the average rating for a negligent wrongdoer was 3.3, and the average rating for a breacher who caused an identical loss was 5.1, a statistically significant difference. Similarly, on a 7-point scale, subjects on average felt that a negligent wrongdoer’s guilt should rate a 3.3, and a breacher’s guilt should rate a 5.

Subjects were also inclined to report that the promisors should honor the contract rather than pay damages and breach (even though it was clear in every case that the promisor would be better off by breaching). Responses were fairly consistent across cases, with an average of 75.8 percent of subjects responding that the promisor should honor the contract in a given case. Subjects also indicated that they thought the law should force the promisor, in many cases, to honor the contract and perform. Subjects answered a series of questions about appropriate damages (and the mean damages awards were usually above expectation value), and were then asked whether the law should require performance. The average percentage across scenarios of respondents who thought the law should require specific performance was 66.7 percent.

One reasonable objection to this interpretation of these results is that the promise/no-promise manipulation is confounded with the level of intentionality on the part of the agents: The promisor knowingly breaches, but the tortfeasor just takes an imprudent risk. In order to rule out this explanation, I conducted a follow-up study in which I kept the parties’ intentions constant across conditions.7 In the Promise condition, subjects read either that the promisor was going to take another job and had to break his deal, or that the promisor was taking another out-of-town job that would entail a 10-percent risk that he would not get back in time for the target contract. In the No-Promise condition, subjects read either that the tortfeasor knew for certain that the given action was certain to harm the neighbors or meant a

7Tess Wilkinson-Ryan. What Is a Promise Worth? Reputation and Moral Intuition in Efficient Breach (2009, on fi le with author).

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10-percent risk of harming the neighbors (again, the harm was the neighbors’ inability to get the contracted-for work done on their house). Comparing the risky breach situation to the risky tort situation, I found that subjects thought that the risky breach should be punished more severely than the risky tort. The same pattern emerged in the comparison between the certain breach and the certain tort.

Th e most important implication of this study for law is that intuition treats a contract like an obligation in tort. When subjects read that a promisor breached his contract in order to make more money, subjects wanted to treat him like an intentional tortfeasor, including levying punitive damages.

II. Breach and the Reference Profit

Breach of contract is efficient when performance is more costly than breach – whether the cost is in terms of an actual loss to the promisor or opportunity costs. However, most people treat losses much more seriously, and sympathetically, than forgone gains. This is one of the central predictions of loss aversion, that losses loom larger than gains. T he role of loss aversion in contractual exchanges has been refined even further in research by Daniel Kahneman, Jack Knetsch, and Richard Thaler.8 Th ey argue that an important determinant of perceptions of fairness in contract-like transactions is the “reference transaction.” Most people believe that a firm is entitled to the reference profit – the profit that the firm expected in the original or baseline situation. When a firm’s reference profit is threatened, it can change the terms of the exchange at the expense of the transactor. However, a firm may not increase its profits by decreasing the transactor’s reference profit. Two classic examples of this effect are demonstrated by comparing responses to a pair of questions. In the first example, experimenters asked some subjects whether it is fair for a landlord to raise the rent to cover cost increases, knowing that the increased rent would force the tenant to move; 75 percent of survey respondents said that was acceptable. A second question asked if it is acceptable for a landlord to raise the rent when he learns that his tenant has taken a nearby job and is therefore unlikely to move; in this case, 91 percent of respondents thought that raise was unfair. Another example was about an employment relationship. One condition asked subjects whether it is acceptable for a company that

8Daniel Kahneman, Jack L. Knetsch, & Richard Thaler. Fairness as a Constraint on Prof it Seeking: Entitlements in the Market. 76 Amer Econ. Rev. 728–41 (1986).