How the New Economics Can Improve Employment Discrimination Law, and How Economics Can Survive the Demise of the "Rational Actor"

Beginning of article

ABSTRACT

Much employment discrimination law is premised on a purely money-focused "reasonable" employee, the sort who can be made whole with damages equal to lost wages, and who does not hesitate to challenge workplace discrimination. This type of "rational" actor populated older economic models but has been since modified by behavioral economics and research on happiness. Behavioral and traditional economists alike have analyzed broad employment policies, such as the wisdom of discrimination statutes, but the devil is in the details of employment law. On the critical damages-and-liability issues the Supreme Court and litigators face regularly, the law essentially ignores the lessons of behavioral economics and the affective sciences.

(1) Damages: With emotional distress and punitive damages limited, the basic discrimination damages are the employee's lost income. Courts draw no distinction between a failure to hire a job applicant and a termination of a long-term employee, yet endowment effect and happiness research indicate that terminated long-term employees typically suffer greater psychological loss, justifying greater damages.

(2) Employer Duties: Effective antidiscrimination programs can shield employers from liability, but the cases and scholarship say little about what programs are effective. Research showing that people think and problem solve best in positive emotional states indicates that programs focused on negativity (for example, "discrimination gets us sued") yield fear and backlash but not the productive employee effort, understanding, and empathy that lessen bias.

(3) Employee Duties: Harassment victims often cannot sue unless they first complained to their employer. Courts should recognize the reasonableness of not complaining due to learned helplessness and because the endowment effect and loss aversion explain reluctance to upset even a bad status quo (a job with harassment). The risk of loss (retaliation) outweighs the possible gain (ending harassment).

This Article also analyzes broad implications of behavioral and happiness research for law and economics:

(1) Do behavioral and happiness adjustments to a rational actor model make economics indeterminate? Economics still can yield useful legal analyses, but likely narrower ones (for example, improving individual, micro-level determinations of damages and reasonable behavior) than past economic analyses of macro-level issues, like whether all discrimination law is "efficient."

(2) Psychologically informed economics often prescribes regulation of markets. It asks, "When is such regulation worth the transaction costs and incentive distortions?" More complex rules, like those this Article prescribes, are worth the cost in higher-stakes, less-repeated transactions like employment than in lower-stakes, often-repeated transactions like consumer purchases.

(3) Should courts rely on these new findings or instead disclaim reliance on any social science because new research often displaces prior findings? In employment cases, courts must assess make-whole damages and employee reasonableness, so they cannot avoid some conception of well-being and cognition--and even imperfect new findings beat disproven, too-narrow "rationality" assumptions.

This Article thus offers a half-full/half-empty assessment of the usefulness of economics, and of behavioral and happiness research, to law. It sounds a cautionary note against using social science to assess grand legal policies, but a hopeful note that such research can improve decision making by judges, firms, and individuals.

TABLE OF CONTENTS

INTRODUCTION

I.  "MAKE-WHOLE" RELIEF: COMPENSATING NOT
     JUST MONETARY LOSS, BUT ENDOWMENT LOSS AND
     HAPPINESS LOSS
     A. How Relief Is Limited Primarily to Economic
        Loss in Employment Discrimination Cases
        1. The Limited Prospect of Punitive Damages
        2. The Limited Prospect of Emotional
           Distress Damages
        3. The Lack of Distinction Between Hiring
           Discrimination Damages and Termination
           Discrimination Damages
           a. Back and Front Pay Calculations: Formulaic,
              but with Uncertain Length of Pay Continuation
           b. Factors Determining Duration of Front and
              Back Pay--Which Do Not Distinguish
              Hiring from Termination
     B. Why Relief for Termination Presumptively Should
        Exceed Economic Loss: Endowment Value and
        Happiness Impact
        1. Strong Evidence, but Still-Heated Debate, over
           Existence and Extent of an Endowment Effect
        2. Is There an Endowment Effect for Jobs? The
           Evidence from Experimental Studies
        3. Happiness Economics Evidence: Job Loss
           Yields Substantially More Harm than the
           Income Loss
     C. How Courts Could, Under Current Law, Compensate
        Terminated Employees' Endowment Loss and
        Happiness Loss
        1. Presume Emotional Distress Damages from
           Unlawful Termination, Especially for
           Long-Term Employees--and Make Such
           Damages Available for all Employment Claims
        2. Award More Years of Front Pay for Terminated than
           Nonhired Employees
     D. Objections to Compensating Endowment and
        Happiness Loss, and Responses to Those
        Objections
        1. Which Employees Actually Feel an "Endowment" in
           Their Jobs, or Suffer "Happiness" Loss
           Due to Employment?
        2. Couldn't Nonhired Employees Suffer the Same
           Happiness Loss Due to Unemployment as
           Fired Employees?
        3. Is It Desirable To Compensate Endowment and
           Happiness Loss, Even Assuming Those Losses
           Are Real?
        4. Would Increasing Termination Damages Increase
           Hiring Discrimination?
        5. Would Compensating Endowment Value Favor
           Men over Women, and White-Collar over
           Blue-Collar Workers?

II.  RECOGNIZING THE REALITIES OF EMPLOYER AND
     EMPLOYEE DUTIES: WHEN REASONABLE EMPLOYEES
     MIGHT NOT REPORT DISCRIMINATION; WHEN EMPLOYER
     ANTIBIAS PROGRAMS ARE (NOT) EFFECTIVE
     A. Employee Duty to Report Harassment Internally:
        Too Little Recognition of Reasonable Reluctance To
        Complain
        1. Courts' Strict Rule, Almost Without
           Exceptions, that Employees Must Report
           Harassment Internally
        2. Critiquing the Strict Requirement of Internal
           Reporting: Rational Employee Fear, Heightened by
           Cognitive Biases and Psychological Barriers
        3. The Prescription: Eliminate the Faragher/Ellerth
           Employee Complaint Requirement, or At Least More
           Broadly Recognize Exceptions to the Requirement
        4. Objections to More Judicial Recognition of the
           Reasonableness of Employees Not Reporting
           Harassment and Responses to Those Objections
           a. Failing To Report Harassment Is Based on
              Irrationally Exaggerated Fear
           b. Reporting Harassment Benefits Others and
              Should Be Encouraged
     B. Employers' Antidiscrimination and
        Antiharassment Duties
        1. The Sufficiency of Formalities, and the Lack of
           Close Factual Scrutiny
        2. The Need to Scrutinize the Specifics of Employer
           Policies for Negativity- and Fear-Focused
           Policies, Which are Least Likely to be Productive

III. A BROADER ISSUE: HOW ECONOMICS STILL CAN PROVIDE
     USEFUL ANALYSES IN A POST-BEHAVIORAL,
     POST-HAPPINESS WORLD
     A. Is Economics Now Too Indeterminate To Be of
        Practical Use?
     B. When Are Paternalistic Regulations Worth the
        Transaction Costs and Incentive Distortions?
     C. Should Courts Base Decisions on Recent Social
        Science at All?

CONCLUSION

If it makes you happy, then why the hell are you so sad?

--Sheryl Crow

The most beautiful things in the world are the most useless, peacocks and lilies for instance.

--John Ruskin

INTRODUCTION

Employment discrimination law is stuck in the law-and-economics stone ages--before economists began revising the "rational actor" model with research findings in behavioral economics (1) and on factors affecting subjective well-being ("happiness research"), (2) and before legal scholars started applying those behavioral (3) and happiness (4) findings to law. Worse, in assuming a wholly money-focused "reasonable" employee, many employment doctrines are far narrower than even the earliest, most narrow rationality-based law-and-economics scholarship. (5) Employment discrimination law thus is based upon economic conceptions of decision making and preferences that are so narrow, they at best are out of date, and at worst never really existed.

   [L]abor market specialists and human resources economists are
   coming to realize that traditional economics has been too
   simplistic in its assumptions on human motivation.... [L]abor
   market research must be rewritten.... [N]eoclassical economists
   have maintained that the labor market is no different ... than the
   market in goods.... [Yet] experiments and empirical investigations
   on the effectiveness of incentives indicate ... individuals do not
   exclusively think of themselves. (6)

There has been great debate among economists about whether and to what extent there should be laws against employment discrimination, (7) which, given the employment-at-will doctrine, is both the main field of employment regulation and the source of doctrine for other areas of employment law, like whistleblowing. (8) Yet the devil is in the details of employment discrimination law, and there has been little contemporary economic or social science thinking about those details.

(1) Damages: Whether lawsuits are filed depends heavily on what damages are available, as shown by the dramatic increase in Title VII litigation (9) after Congress increased available damages in 1991. (10) What monetary relief is needed to "make whole" (the Title VII command) (11) a worker who lost a job due to discrimination?

(2) Employer Duties: Even in egregious cases of discrimination or harassment, employers have affirmative defenses, either to punitive damages (12) or to all liability, (13) based on efforts to prevent and redress discrimination. When should employers' antibias efforts be sufficient to shield them from liability for proven discrimination?

(3) Employee Duties: Employers may not be liable for discriminatory or retaliatory harassment, (14) even by supervisors. If an employer has an internal complaint process, an employee must file a prompt internal complaint to a supervisor or with the human resources department before suing. (15) When, if ever, should employees be excused from complaining internally?

The Supreme Court (16) and practicing lawyers (17) regularly grapple with these critical damages-and-liability issues, yet the law essentially ignores the lessons of behavioral economics and cognitive science.

(1) Damages: The basic discrimination damages are the employee's lost income. Courts draw no distinction between a failure to hire an applicant and the termination of a long-term employee, yet damages for the latter should be higher. Behavioral economic findings (on the endowment effect), and happiness research findings (on the effects of unemployment) indicate that a nonhired employee typically suffers less psychological loss than a terminated long-term employee. (18)

(2) Employer Duties: Antidiscrimination/harassment programs vary. Some are effective; others are ineffectual or disingenuous. The cases and scholarship are not well-developed as to what programs suffice. Findings that people think and problem solve best in positive emotional states indicate that programs focused on negativity (for example, do not discriminate because it causes lawsuits and disharmony) risk fear and backlash but are unlikely to yield productive employee effort or the co-worker understanding and empathy that lessen bias. (19)

(3) Employee Duties: Only upon specific evidence of retaliation do courts excuse harassed employees from complaining internally. Yet research findings show why harassed employees may not complain: (a) endowment effects and loss aversion explain reluctance to upset even a bad status quo (a job with harassment), because the risk of loss (retaliation) outweighs the prospect of gain (ending harassment); (b) salience and availability biases heighten that fear; and (c) learned helplessness can make harassment victims unable to complain. (20)

It is particularly surprising that behavioral economics has not been applied to these employment law issues. Behavioral economics has proven popular in the "is there inefficient discrimination?" debate (21) and has helped illuminate similar questions in other areas of law economists more regularly analyze, such as compensation for private property "takings" (22) and the reasonableness of tort victim behavior. (23) This major gap in the scholarship probably traces to a disconnect between those with practical knowledge of Title VII litigation (practicing lawyers and some litigation scholars) and those with knowledge about behavioral economics and happiness research (economists and law professors steeped in economic theory). This Article seeks to bridge this gap, which has left employment doctrine flawed because of its unawareness of recent social science theories and findings.

In sum, this Article suggests that based on behavioral and happiness findings, courts should do the following: (1) reform employment damages rules to provide greater damages for terminated long-term employees, which judges could do under the existing statutory scheme and case law; (2) cast a more critical eye upon employer antidiscrimination programs that foster not positive but negative emotions; and (3) cast a more understanding eye upon whether employees complain internally about harassment, given their understandable but underappreciated reluctance to risk retaliation. This Article then discusses what those specific analyses of employment law say about three broader, more theoretical questions about what behavioral and happiness research have done, for good or for ill, to the project of economic analysis of law.

First, have behavioral and happiness modifications to the old "rational actor" model rendered economics too indeterminate to be useful? This Article's employment law diagnoses are examples of how economics still can provide useful analyses and prescriptions. But they also are examples of how conclusions reachable with behavioral- and happiness-infused economics are likely narrower--for example, improving individual, "micro-lever' determinations like damages and reasonableness of party behavior--than many past economic analyses on "macro" questions, like whether the whole of Title VII is "efficient." (24)

Second, with social science-based economic analysis more often prescribing regulation of free markets (such as employment laws modifying employment at will), when do paternalistic regulations help enough to be worth the transaction costs and incentive distortions? Admittedly, this Article's proposals yield more complex, transaction-costly rules, but regulation is more worth the cost in higher-stakes, less-repeated transactions like employment (or housing, mortgages, and so on) than in lower-stakes, often-repeated transactions like consumer purchases. This Article thus differs from legal scholarship that sees behavioral economics as justifying regulating transactions both minor and major. (25)

Third, with behavioral and happiness research undercutting prior economic models, should courts rely on this newer social science, or instead decline to rely on social science at all, because each research finding displaces prior ones? This Article's replacement of the old with the new is a cautionary tale about relying upon social science, especially current findings that have not stood the test of time. Yet courts have no choice but to decide what damages make an employee whole, and what employee behavior is "reasonable," so they cannot avoid using some conception of employee well-being and cognition. Even imperfect new social science beats relying on disproven, too-narrow "rationality" assumptions. (26)

This Article thus offers a half-full/half-empty assessment of the usefulness of behavioral and happiness research. It sounds a cautionary note that social science cannot often assess broad policies, but that it can improve decision making by judges, administrative bodies, firms, and individuals. A premise of this Article that employment law ignores important research findings--is that social science insights have been too slow to penetrate into noneconomic scholarship and courts' decision making. The lag between academic insight and real-world implementation can be long, at least for applying deep theory to practical matters like damages and litigation defenses. Pessimists may despair that academic knowledge fails to improve the real world, but eventually critiques get loud enough to force courts and policymakers to listen.

I. "MAKE-WHOLE" RELIEF: COMPENSATING NOT JUST MONETARY LOSS, BUT ENDOWMENT LOSS AND HAPPINESS LOSS

A. How Relief Is Limited Primarily to Economic Loss in Employment Discrimination Cases

In employment lawsuits alleging unlawful loss of a job, courts aim to award relief that "make[s] persons whole for injuries suffered" (27)--a concept that, to courts, primarily means awarding plaintiffs economic damages in the amount of the pay they lost (28) plus their attorney's fees. (29) Under Title VII as originally written, this "make-whole" relief was limited to compensating "injuries of an economic character," not emotional or physical injury. (30) Since 1991, plaintiffs in most discrimination cases (race, sex, religion, and national origin discrimination under Title VII, as well as disability discrimination under the Americans with Disabilities Act) also can recover compensatory damages for "emotional pain, suffering, inconvenience, mental anguish, loss of enjoyment of life and other nonpecuniary losses" (31) and punitive damages for violations committed "with malice or with reckless indifference to [plaintiffs] federally protected rights." (32)

Even under employment statutes allowing noneconomic damages, economic damages remain the main form of relief because emotional distress and punitive damages are limited. In Title VII and Americans with Disabilities Act claims, the total of compensatory (emotional distress) and punitive damages faces a statutory cap of $50,000-$300,000 (based on employer size). (33) For other claims, punitive and emotional distress damages are entirely unavailable, including claims brought under the Age Discrimination in Employment Act, (34) the National Labor Relations Act (as to antiunion practices), (35) and many state whistleblower laws. (36)

1. The Limited Prospect of Punitive Damages

Punitive damages are limited in two ways. First, by statute, punitive damages are available for employment discrimination only when the employer acted "with malice or with reckless indifference" to employees' antidiscrimination rights. (37) This means, under Kolstad v. American Dental Ass'n, (38) that punitive damages are unavailable if the employer proves that the discriminatory act of its manager or agent was contrary to the employer's good faith antidiscrimination efforts. (39) Employers thereby can avoid punitive damages for proven discrimination as long as they show the basic range of garden-variety antidiscrimination policies that any reputable company's human resources would administer--mainly a policy against discrimination, an internal complaint procedure, and diversity/discrimination training. (40)

Second, in any case allowing punitive damages (that is, not just employment cases), the Due Process Clause imposes constitutional limits on the size of the awards. Punitive damages cannot be too many times greater than a plaintiffs actual damages, (41) and in employment cases in particular, absent exceptional circumstances, the limit may be four or five times actual damages. (42)

In sum, punitive damages awards, especially large ones, are rare. (43) They are unavailable entirely for many claim types (by statute or common law); even when allowed, they cannot be awarded except upon certain showings (under Kolstad); even when awarded, they are limited in size (under Due Process). Punitive damages thus are not a significant factor in employment claims. (44)

2. The Limited Prospect of Emotional Distress Damages

Emotional distress damages likewise are limited by the case law. Without a professional diagnosis that the illegal behavior caused the plaintiff a specific psychiatric impairment, courts typically limit emotional distress damages to four figures or low five figures. (45) A plaintiff can win more upon showing either a professional diagnosis or personal evidence, typically corroborated by others, of impaired psychological or physical well-being that had a significant quality-of-life impact. (46) Yet most higher awards are based upon actual professional diagnoses (not just laypersons' testimony), plus evidence of severe impact on the plaintiff. (47)

The best evidence that emotional distress awards tend to be low absent professional medical evidence is that plaintiffs often waive such damages to avoid intrusive discovery. A plaintiff may waive any right to claim specific, substantial emotional distress, instead claiming only modest, "garden-variety" emotional distress damages, in order to prevent the defendant from obtaining intrusive discovery such as a psychological exam of the plaintiff or discovery of plaintiffs otherwise private psychological records. (48)

3. The Lack of Distinction Between Hiring Discrimination Damages and Termination Discrimination Damages

a. Back and Front Pay Calculations: Formulaic, but with Uncertain Length of Pay Continuation

Compensating economic loss in an employment claim, especially ongoing future losses, is a formulaic task for the judge in one respect, (49) but an arbitrary task in another respect. The award is formulaic in that the basic annual loss is easily calculable, but arbitrary as to how many years of annual damages to award the plaintiff, an arbitrariness apparent in the following typical fact pattern.

Assume a worker is fired from a $50,000 job in early 2009, then is unemployed for a year, but then lands a $40,000 job in early 2010. Assume that she sues in early 2010 (after satisfying all pre-suit administrative requirements), presses the case through discovery and motion practice for two years, and wins a verdict in early 2012. She typically would win her lost pay, both "back pay" (covering the period from termination to verdict) and "front pay" (from the verdict date into the future). (50) Back pay of one year of her $50,000 lost pay (the year she was unemployed) plus two years of the $10,000 annual pay gap between her current job and the job she lost, and front pay of her $10,000 pay gap per year, all are awarded as a "lump sum" at the time of the verdict. (51)

The formula gets murky because one of the key variables--the number of years of pay continuation--is chosen at worst arbitrarily, and at best by "intelligent guesswork" and calculations that "cannot be totally accurate because they are prospective and necessarily speculative." (52) Courts base their front pay duration "guesswork" on many factors, but as discussed immediately below, (53) those factors do not include whether the plaintiff brought a termination claim (that is, loss of a job she had been holding) or a hiring claim (that is, loss of a job she had applied for, without ever holding the job)--which is a critical distinction, as discussed later. (54)

b. Factors Determining Duration of Front and Back Pay--Which Do Not Distinguish Hiring from Termination

Courts provide lengthy and varied, but ultimately similar, lists of the factors relevant to front pay duration. One court, surveying the case law, compiled the following fairly comprehensive list of factors:

(1) the plaintiffs age;

(2) the length of time the plaintiff was employed by the defendant employer;

(3) the likelihood the employment would have continued absent the discrimination;

(4) the length of time it will take the plaintiff, using reasonable effort, to secure comparable employment;

(5) the plaintiffs work and life expectancy;

(6) the plaintiffs status as an at-will-employee;

(7) the length of time other employees typically held the position lost;

(8) the plaintiffs ability to work;

(9) the plaintiffs ability to work for the defendant-employer;

(10) the employee's efforts to mitigate damages; and

(11) the amount of any liquidated or punitive damage award. (55)

The list of front pay factors does include duration of employment (#2)--but not as a way to estimate the psychological, endowment, or happiness loss that a termination caused. Rather, this and most other front pay factors aim to estimate (1) how many more years the plaintiff would have spent at that job, but for the employer's discrimination (factors 1-3 and 5-9 above), as well as (2) whether, because of other wages or compensation the plaintiff may earn, an award of less than full pay continuation would suffice as full relief (factors 4, 10, and 11).

The one case expressly noting a difference between the impact of not being hired and the impact of being terminated is, oddly, not even a Title VII case. In a Fourteenth Amendment Equal Protection decision about government affirmative action, the Supreme Court in Wygant v. Jackson Board of Education (56) rejected an affirmative action plan that gave members of racial minorities more protection against layoffs than their seniority levels warranted. (57) The Court distinguished affirmative action racial preferences in hiring from such preferences in layoffs, because being terminated has a greater impact than not being hired:

   [H]iring goals ... simply do not impose the same kind of injury
   that layoffs impose. Denial of a future employment opportunity is
   not as intrusive as loss of an existing job.... While hiring goals
   impose a diffuse burden, often foreclosing only one of several
   opportunities, layoffs impose the entire burden of achieving racial
   equality on particular individuals, often resulting in the serious
   disruption of their lives. (58)

While aptly noting a distinction between termination and nonhiring, Wygant has not established any such distinction in the Title VII damages jurisprudence. (59) More broadly, Wygant does not quite note that termination imposes a greater risk of endowment and happiness loss than nonhiring. In focusing on how nonhiring "often foreclos[es] only one of several opportunities," Wygant seems to be saying that nonhiring is less likely to result in economic (income) loss: the nonhired often pursue "several [job] opportunities" simultaneously, so losing just one job possibility is less certain to cause income loss than termination is. (60)

In short, Wygant was insightful as to the hiring/termination distinction, but it did not, as this Article does, note how termination and nonhiring inflict different nonmonetary losses. It also did not advocate any damages distinction between termination and nonhiring. Additionally, its hiring-versus-termination insight has gone unfortunately unnoticed in the ensuing decades of Title VII jurisprudence. Thus, the cases on employment damages draw no distinction between the losses due to an unlawful failure to hire and an unlawful termination, much less between unlawful terminations of short- and long-term employees. (61)

B. Why Relief for Termination Presumptively Should Exceed Economic Loss: Endowment Value and Happiness Impact

For two reasons, it is inadequate for employment damages in termination claims, as distinct from hiring claims, to be based presumptively on economic loss, with little or no additional award. First, due to the endowment effect, someone terminated from an existing job often suffers greater loss than someone merely not hired into a new job. (62) Second, studies show that unemployment causes a long-term loss of happiness, so firing a worker typically causes greater harm than not hiring someone who held another job or already was unemployed through no fault of the discriminatory employer. (63) For both of these reasons, the damages to make whole a terminated employee (especially a long-term employee) are greater than those needed to make whole an individual not hired into a new job. (64)

1. Strong Evidence, but Still-Heated Debate, over Existence and Extent of an Endowment Effect

Whether an "endowment effect" exists in employment depends on whether endowment effects exist at all--a topic of heated scholarly debate. Traditional rational-actor economics "assumes that the value of an entitlement to an individual is independent of ... [whether] she presently owns" that entitlement. (65) Under that view, "[a]n individual may prefer to own either a house in the city or a house in the country, but the location of the house that she presently owns should not affect her preference." (66) Yet a "robust body of social science scholarship" disproves that assumption, Professor Russell Korobkin notes: (67)

   [P]eople tend to value goods more when they own them than
   when they do not. Move a person from a city house to a country
   house and ... he is quite likely to prefer the country house more
   than he did when he resided in the city.... [T]he "status quo
   bias" ... is often used …