Liquidated Damages and Freakonomics by Tom Moore

Posted on July 2, 2014


Editor’s Note: I wanted to share Tom Moore’s latest post from the Procurement Insights EU Edition because it raises an important question regarding contracts . . . do penalties have the opposite effect on supplier performance?

Procurement Insights EU Edition

Many of the more old-school contract managers I’ve worked with over the years have always loved liquidated damages (LDs). For many people, there is something satisfying about punishing those suppliers who fail to deliver the requirements of the contract, and LDs are a seemingly perfect vehicle for this. However, as economists know, incentives can be tricky things, people do not always react in the way the incentive is intended. The team over at Freakonomics give an interesting example of this in their article on kindergarten late fines. In essence an experiment was conducted on a sample of kindergartens in Israel to address the problem of parents picking up their children late. To try and reduce the number of late pick-ups a small fine was introduced in some of the kindergartens for parents who were late in collecting their children. Then the unexpected happened:

‘In day cares where the fine was…

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