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Reference Guide on Estimation of Economic Damages M A R K A . A L L E N , R O B E RT E . H A L L , A N D VICTORIA A. LAZEAR Mark Allen, J.D., is Senior Consultant at Cornerstone Research, Menlo Park, California. Robert Hall, Ph.D., is Robert and Carole McNeil Hoover Senior Fellow and Professor of Economics, Stanford University, Stanford, California. Victoria Lazear, M.S., is Vice President at Cornerstone Research, Menlo Park, California. C onTenTs I. Introduction, 429 II. Damages Experts’ Qualifications, 431 III. The Standard General Approach to Quantification of Damages, 432 A. Isolating the Effect of the Harmful Act, 432 B. The Damages Quantum Prescribed by Law, 433 C. Is There Disagreement About What Legitimate Conduct of the Defendant Should Be Hypothesized in Projecting the Plaintiff’s Earnings but for the Harmful Event? 439 D. Does the Damages Analysis Consider All the Differences in the Plaintiff’s Situation in the But-For Scenario, or Does It Assume That Many Aspects Would Be the Same as in Actuality? 440 IV. Valuation and Damages, 443 V. Quantifying Damages Using a Market Approach Based on Prices or Values, 444 A. Is One of the Parties Using an Appraisal Approach to the Measurement of Damages? 445 B. Are the Parties Disputing an Adjustment of an Appraisal for Partial Loss? 445 C. Is One of the Parties Using the Assets and Liabilities Approach? 446 D. Are the Parties Disputing an Adjustment for Market Frictions? 446 E. Is One of the Parties Relying on Hypothetical Property in Its Damages Analysis? 447 F. What Complications Arise When Anticipation of Damages Affects Market Values? 448 425

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Reference Manual on Scientific Evidence VI. Quantifying Damages as the Sum of Discounted Lost Cash Flows, 448 A. Is There Disagreement About But-For Revenues in the Past? 449 B. Is There Disagreement About the Costs That the Plaintiff Would Have Incurred but for the Harmful Event? 449 C. Is There Disagreement About the Plaintiff’s Actual Revenue After the Harmful Event? 450 D. What Is the Role of Inflation? 451 1. Do the parties use constant dollars for future losses, or are such losses stated in future dollars whose values will be diminished by inflation? 451 2. Are the parties using a discount rate properly matched to the projection? 452 3. Is one of the parties assuming that discounting and earnings growth offset each other? 453 E. Are Losses Measured Before or After the Plaintiff’s Income Taxes? 454 F. Is There a Dispute About the Costs of Stock Options? 456 G. Is There a Dispute About Prejudgment Interest? 457 H. Is There Disagreement About the Interest Rate Used to Discount Future Lost Value? 459 I. Is One of the Parties Using a Capitalization Factor? 459 VII. Limitations on Damages, 461 A. Is the Defendant Arguing That Plaintiff’s Damages Estimate Is Too Uncertain and Speculative? 461 B. Are the Parties Disputing the Remoteness of Damages? 463 C. Are the Parties Disputing the Plaintiff’s Efforts to Mitigate Its Losses? 464 D. Are the Parties Disputing Damages That May Exceed the Cost of Avoidance? 466 E. Are the Parties Disputing a Liquidated Damages Clause? 467 VIII. Other Issues Arising in General in Damages Measurement, 468 A. Damages for a Startup Business, 458 1. Is the defendant challenging the fact of economic loss? 468 2. Is the defendant challenging the use of the expected value approach? 468 3. Are the parties disputing the relevance and validity of the data on the value of a startup? 469 B. Issues Specific to Damages from Loss of Personal Income, 470 1. Calculating losses over a person’s lifetime, 470 2. Calculation of fringe benefits, 471 3. Wrongful death, 473 4. Shortened life expectancy, 474 5. Damages other than lost income, 474 C. Damages with Multiple Challenged Acts: Disaggregation, 475 426

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Reference Guide on Estimation of Economic Damages D. Is There a Dispute About Whether the Plaintiff Is Entitled to All the Damages? 477 E. Are the Defendants Disputing the Apportionment of Damages Among Themselves? 479 1. Are the defendants disputing apportionment among themselves despite full information about their roles in the harmful event? 479 2. Are the defendants disputing the apportionment because the wrongdoer is unknown? 480 F. Is There Disagreement About the Role of Subsequent Unexpected Events? 480 IX. Data Used to Measure Damages, 482 A. Types of Data, 482 1. Electronic data, 482 2. Paper data, 482 3. Sampling data, 482 4. Survey data, 483 B. Are the Parties Disputing the Validity of the Data? 483 1. Criteria for determining validity of data, 484 2. Quantitative methods for validation, 485 C. Are the Parties Disputing the Handling of Missing Data? 485 X. Standards for Disclosing Data to Opposing Parties, 486 A. Use of Formats, 487 B. Data Dictionaries, 487 C. Resolution of Problems, 488 D. Special Masters and Neutral Experts, 489 XI. Damages in Class Actions, 489 A. Class Certification, 489 B. Classwide Damages, 489 C. Damages of Individual Class Members, 490 D. Have the Defendant and the Class’s Counsel Proposed a Fair Settlement? 490 XII. Illustrations of General Principles, 491 A. Claim for Lost Personal Income, 491 1. Is there a dispute about projected earnings but for the harmful event? 492 2. Are the parties disputing the valuation of benefits? 492 3. Is there disagreement about how earnings should be discounted to present value? 495 4. Is there disagreement about subsequent unexpected events? 495 5. Is there disagreement about retirement and mortality? 495 6. Is there a dispute about mitigation? 496 7. Is there disagreement about how the plaintiff’s career path should be projected? 496 427

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Reference Manual on Scientific Evidence B. Lost Profits for a Business, 497 1. Is there a dispute about projected revenues? 498 2. Are the parties disputing the calculation of marginal costs? 499 3. Is there a dispute about mitigation? 499 4. Is there disagreement about how profits should be discounted to present value? 500 5. Is there disagreement about subsequent unexpected events? 500 Glossary of Terms, 501 428

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Reference Guide on Estimation of Economic Damages I. Introduction This reference guide identifies areas of dispute that arise when economic losses are at issue in a legal proceeding. Our focus is on explaining the issues in these disputes rather than taking positions on their proper resolutions. We discuss the application of economic analysis within established legal frameworks for dam- ages. We cover topics in economics that arise in measuring damages and provide citations to cases to illustrate the principles and techniques discussed in the text. We begin by discussing the qualifications required of experts who quantify damages. We then set forth the standard general approach to damages quantifica- tion, with particular focus on defining the harmful event and the alternative, often called the but-for scenario. In principle, the difference between the plaintiff’s economic value in the but-for scenario and in actuality measures the loss caused by the harmful act of the defendant. We then consider damages estimation for two cases: (1) a discrete loss of market value and (2) the loss of a flow of income over time, where damages are the discounted value of the lost cash flow. Other topics include the role of inflation, issues relating to income taxes and stock options, adjustments for the time value of money, legal limitations on damages, damages for a new business, disaggregation of damages when there are multiple challenged acts, the role of random events occurring between the harmful act and trial, data for damages measurement, standards for disclosing data to opposing parties, special masters and neutral experts, liquidated damages, damages in class actions, and lost earnings.1 Our discussion follows the structure of the standard damages study, as shown in Figure 1. Damages quantification operates on the premise that the defendant is liable for damages from the defendant’s harmful act. The plaintiff is entitled to recover monetary damages for losses occurring before and possibly after the time of the trial. The top line of Figure 1 measures the losses before trial; the bottom line measures the losses after trial.2 The goal of damages measurement is to find the plaintiff’s loss of economic value from the defendant’s harmful act. The loss of value may have a one-time character, such as the diminished market value of a business or property, or it may take the form of a reduced stream of profit or earnings. The losses are net of any costs avoided because of the harmful act. The essential elements of a study of losses are the quantification of the reduc- tion in economic value, the calculation of interest on past losses, and the appli- 1. For a discussion of specific issues relating to estimating damages in antitrust, intellectual property, and securities litigation, see Mark A. Allen et al., Estimation of Economic Damages in Antitrust, Intellectual Property, and Securities Litigation (June 2011), available at http://www.stanford.edu/~rehall/ DamagesEstimation.pdf. 2. Our scope here is limited to losses of actual dollar income. However, economists sometimes have a role in the measurement of nondollar damages, including pain and suffering and the hedonic value of life. See generally W. Kip Viscusi, Reforming Products Liability (1991). 429

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Reference Manual on Scientific Evidence Figure 1. Standard format for a damages study. Earnings before trial, Actual Damages Prejudgment – + = had the earnings before interest harmful event before trial trial not occurred + Projected earnings after Projected Damages – – = trial, had the earnings Discounting after trial harmful event after trial not occurred Total Damages Figure 8-1.eps cation of financial discounting to future losses. The losses are the difference between the value the plaintiff would have received if the harmful event had not occurred and the value the plaintiff has or will receive, given the harmful event. The plaintiff may be entitled to interest for losses occurring before trial. Losses occurring after trial are usually discounted to the time of trial. The plaintiff may be due interest on the judgment from the time of trial to the time the defendant actually pays. The majority of damages studies fit this format; thus, we have used such a format as the basic model for this reference guide. We use numerous brief examples to explain the disputes that can arise. These examples are not full case descriptions; they are deliberately stylized. They attempt to capture the types of disagreements about damages that arise in practical experience, although they are purely hypothetical. In many examples, the dispute involves factual as well as legal issues. We do not try to resolve the disputes in these examples and hope that the examples will help clarify the legal and factual disputes that need to be resolved before or at trial. We introduce many areas of potential dispute with a question, because asking the parties these questions can identify and clarify the majority of disputes over economic damages. The reader with limited experience in the economic analysis of damages may find it most helpful to begin with Sections II and III and then read Section XII.A, which provides a straightforward application of the principles. Sections IV, V, and VI may be particularly helpful for readers knowledgeable in accounting and valuation. The other sections discuss specific issues relating to damages, and some readers may find it useful to review only those specific to their needs. Section XII.B 430

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Reference Guide on Estimation of Economic Damages discusses an application of some of these more specific issues in the context of a damages analysis for a business. II. Damages Experts’ Qualifications Experts who quantify damages come from a variety of backgrounds. The expert should be trained and experienced in quantitative analysis. For economists, the common qualification is the Ph.D. Damages experts with business or accounting backgrounds often have M.B.A. degrees or other advanced degrees, or C.P.A. credentials. Both the method used and the substance of the damages claim dictate the specific areas of specialization the expert needs. In some cases, participation in original research and authorship of professional publications may add to the qualifications of an expert. However, relevant research and publications are not likely to be on the topic of damages measurement per se but rather on topics and methods encountered in damages analysis. For example, a damages expert may need to restate prices and quantities for a but-for market with more sellers than are present in the actual market. For an expert undertaking this task, direct par- ticipation in research on the relation between market structure and performance would be helpful. Many damages studies use statistical regression analysis.3 Specific training is required to apply regression analysis. Damages studies sometimes use field sur- veys.4 In this case, the damages expert should be trained in survey methods or should work in collaboration with a qualified survey statistician. Because damages estimation often makes use of accounting records, most damages experts need to be able to interpret materials prepared by professional accountants. Some damages issues may require assistance from a professional accountant. Experts also benefit from professional training and experience in areas relevant to the substance of the damages claim. For example, in antitrust, a background in industrial organization may be helpful; in securities damages, a background in finance may assist the expert; and in the case of lost earnings, an expert may benefit from training in labor economics. An analysis by even the most qualified expert may face a challenge under the criteria associated with the Daubert and Kumho cases.5 These criteria are intended to exclude testimony based on untested and unreliable theories. Relatively few economists serving as damages experts succumb to Daubert challenges, because 3. For a discussion of regression analysis, see generally Daniel L. Rubinfeld, Reference Guide on Multiple Regression, in this manual. 4. For a discussion of survey methods, see generally Shari Seidman Diamond, Reference Guide on Survey Research, in this manual. 5. Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579 (1993); Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999). For a discussion of emerging standards of scientific evidence, see Margaret A. Berger, The Admissibility of Expert Testimony, Section IV, in this manual. 431

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Reference Manual on Scientific Evidence most damages analyses operate in the familiar territory of measuring economic values using a combination of professional judgment and standard tools. But the circumstances of each damages analysis are unique, and a party may raise a Daubert challenge based on the proposition that the tools have never before been applied to these circumstances. Even if a Daubert challenge fails, it can be an effective way for the opposing party to probe the damages analysis prior to trial. III. The Standard General Approach to Quantification of Damages In this section, we review the elements of the standard loss measurement in the format of Figure 1. For each element, there are several areas of potential dispute. The sequence of issues discussed here should identify most of the areas of disagree- ment between the damages analyses of opposing parties. A. Isolating the Effect of the Harmful Act The first step in a damages study is the translation of the legal theory of the harm- ful event into an analysis of the economic impact of that event. In most cases, the analysis considers the difference between the plaintiff’s economic position if the harmful event had not occurred and the plaintiff’s actual economic position. In almost all cases, the damages expert proceeds on the hypothesis that the defendant committed the harmful act and that the act was unlawful. Accordingly, throughout this discussion, we assume that the plaintiff is entitled to compensation for losses sustained from a harmful act of the defendant. The characterization of the harmful event begins with a clear statement of what occurred. The character- ization also will include a description of the defendant’s proper actions in place of its unlawful actions and a statement about the economic situation absent the wrongdoing, with the defendant’s proper actions replacing the unlawful ones (the but-for scenario). Damages measurement then determines the plaintiff’s hypotheti- cal value in the but-for scenario. Economic damages are the difference between that value and the actual value that the plaintiff achieved. Because the but-for scenario differs from what actually happened only with respect to the harmful act, damages measured in this way isolate the loss of value caused by the harmful act and exclude any change in the plaintiff’s value aris- ing from other sources. Thus, a proper construction of the but-for scenario and measurement of the hypothetical but-for plaintiff’s value by definition includes in damages only the loss caused by the harmful act. The damages expert using the but-for approach does not usually testify separately about the causal relation between damages and the harmful act, although variations may occur where there are issues about the directness of the causal link. 432

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Reference Guide on Estimation of Economic Damages B. The Damages Quantum Prescribed by Law In most cases, the law prescribes a damages measure that falls into one of the following five categories: • Expectation: Plaintiff restored to the same financial position as if the defen- dant had performed as promised. • Reliance: Plaintiff restored to the same position as if the relationship with the defendant or the defendant’s misrepresentation (and resulting harm) had not existed in the first place. • Restitution: Plaintiff compensated by the amount of the defendant’s gain from the unlawful conduct, also called compensation for unjust enrich- ment, disgorgement of ill-gotten gains, or compensation for unbargained- for benefits.6 • Statutory: Plaintiff’s compensation is a set amount per occurrence of wrongdoing. This occurs in cases involving violations of state labor codes and in copyright infringement. • Punitive: Compensation rewards the plaintiff for detecting and prosecuting wrongdoing to deter similar future wrongdoing. Expectation damages7 often apply to breach of contract claims, where the wrongdoing is the failure to perform as promised, and the but-for scenario hypothesizes the absence of that wrongdoing, that is, proper performance by the defendant. Expectation damages are an amount sufficient to give the plaintiff the same economic value the plaintiff would have received if the defendant had ful- filled the promise or bargain.8 6. Courts and commentators often subsume unjust enrichment in defining restitution. Profes- sor Farnsworth, for example, states: “[T]he object of restitution is not the enforcement of a promise, but rather the prevention of unjust enrichment. . . . The party in breach is required to disgorge what he has received in money or services. . . .” See, e.g., E. Allen Farnsworth, Contracts § 12.1, at 814 (1982). However, others have argued that restitution and unjust enrichment are different concepts. See, e.g., James J. Edelman, Unjust Enrichment, Restitution, and Wrongs, 79 Tex. L. Rev. 1869 (2001); Peter Birks, Unjust Enrichment and Wrongful Enrichment, 79 Tex. L. Rev. 1767 (2001); and Emily Sherwin, Restitution and Equity: An Analysis of the Principle of Unjust Enrichment, 79 Tex. L. Rev. 2083 (2001). Judge Posner discusses restitution (defined as returning the breaching party’s profits from the breach) in relation to contract damages and unjust enrichment (defined as compensation for unbargained-for benefits) in connection with implied contracts. See Richard A. Posner, Economic Analysis of Law 130, 151 (1998). See also Restatement (Third) of Restitution and Unjust Enrichment (2011). 7. See John R. Trentacosta, Damages in Breach of Contract Cases, 76 Mich. Bus. J. 1068, 1068 (1997) (describing expectation damages as damages that place the injured party in the same position as if the breaching party completely performed the contract); Bausch & Lomb, Inc. v. Bressler, 977 F.2d 720, 728–29 (2d Cir. 1992) (defining expectation damages as damages that put the injured party in the same economic position the party would have enjoyed if the contract had been performed). 8. See Restatement (Second) of Contracts § 344 cmt. a (1981). Expectation has been called “a queer kind of ‘compensation,’’’ because it gives the promisee something it never had, i.e., the benefit 433

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Reference Manual on Scientific Evidence Reliance damages generally apply to torts and to some contract breaches. Such damages restore the plaintiff to the same financial position it would have enjoyed absent the defendant’s conduct as well as, in the case of torts, com- pensation for nonpecuniary losses such as pain and suffering.9 Reliance most often includes out-of-pocket costs, but may also include compensation for lost opportunities, when appropriate. In such cases, reliance damages may approach expectation damages. For a tort, reliance damages place the plaintiff in a position economically equivalent to the position absent the harmful act.10 For a breach of contract, measuring damages as the amount of compensation needed to place the plaintiff in the same position as if the contract had not been made in the first place will result in refunding the part of the plaintiff’s reliance investment that cannot be recovered in other ways.11 Thus, reliance damages may be appropriate when the plaintiff made an investment relying on the defendant’s performance. of its bargain. L.L. Fuller & William R. Perdue, Jr., The Reliance Interest in Contract Damages: 1, 46 Yale L.J. 52, 53 (1936). The policy underlying expectation damages is that they promote and facilitate reliance on business agreements. Id. at 61–62. 9. Generally, the objective of reliance damages is to put the promisee or nonbreaching party back to the position in which it would have been had the promise not been made. See E. Allan Farnsworth, Legal Remedies for Breach of Contract, 70 Colum. L. Rev. 1145, 1148 (1979). See also Restatement (Second) of Contracts § 344(b). Reliance damages include expenditures made in preparation for per- formance and performance itself. Restatement (Second) of Contracts § 349. 10. See, e.g., East River Steamship Corp. v. Transamerica Delaval Inc., 476 U.S. 858, 873 n.9 (1986) (“tort damages generally compensate the plaintiff for loss and return him to the position he occupied before the injury”). The compensatory goal of tort damages is to make the plaintiff whole as nearly as possible through an award of money damages. See Randall R. Bovbjerg et al., Valuing Life and Limb in Tort: Scheduling “Pain and Suffering,” 83 Nw. U. L. Rev. 908, 910 (1989); John C.P. Goldberg, Two Conceptions of Tort Damages: Fair v. Full Compensation, 5 DePaul L. Rev. 435 (2006). Often, the damages expert is not asked to provide guidance relating to estimating damages for nonpecuniary losses such as pain and suffering. However, hedonic analysis may sometimes be used. 11. Economists and legal scholars have debated contract damages and the concepts of expectation and reliance for decades. Fuller and Perdue’s definition of reliance included the plaintiff’s foregone lost opportunities in addition to his expenditures. But courts that award reliance damages typically award only out-of-pocket expenditures. See, e.g., Michael B. Kelly, The Phantom Reliance Interest in Contract Damages, 1992 Wis. L. Rev. 1755, 1771 (1992). Farnsworth has suggested that this is most likely explained by difficulties in damages proof rather than any rule excluding lost opportunities from reliance damages—that is, that the reason for barring the expectation measure (most often lack of proof of damages with reasonable certainty) will apply equally to bar lost opportunities. E Allan Farnsworth, Precontractual Liability and Preliminary Agreements: Fair Dealing and Failed Negotiations, 87 Colum. L. Rev. 217, 225 (1987). Reliance damages including lost opportunities may be awarded in cases where the expectation is unavailable because the agreement is illusory or too indefinite to be enforceable. See, e.g., Grouse v. Group Health Plan, Inc., 306 N.W.2d 114 (Minn. 1981), where the plaintiff employee resigned one job and turned down the offer of another in reliance on defendant’s promise of employment, but the promised employment would have been at will. The court stated that the proper measure of damages was not what the plaintiff would have earned in his employment with the defendant, but what he lost in quitting his job and turning down an additional offer of employment. Id. at 116. Finally, we note that in a competitive market, reliance damages including lost opportunities 434

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Reference Guide on Estimation of Economic Damages Example: Agent contracts with Owner for Agent to sell Owner’s farm. The ask- ing price is $1,000,000, and the agreed fee is 6%. Agent incurs costs of $1,000 in listing the property. A potential buyer offers the asking price, but Owner withdraws the listing. Agent calculates damages as $60,000, the agreed fee for selling the property. Owner calculates damages as $1,000, the amount that Agent spent to advertise the property. Comment: Under the expectation remedy, Agent is entitled to $60,000, the fee for selling the property. However, the Agent has only partly performed under the contract, and thus it may be appropriate to limit damages to $1,000. Some states limit recovery in this situation by law to the $1,000, the reliance measure of damages, unless the property is actually sold.12 Restitution damages13 are often the same, from the perspective of quantifi- cation, as reliance damages. If the only loss to the plaintiff from the defendant’s harmful act arises from an expenditure that the plaintiff made that cannot oth- erwise be recovered, the plaintiff receives compensation equal to the amount of that expenditure.14 Interesting and often difficult issues arise in cases that involve elements of both contract and tort. Consider a contract for a product that turns out to be defective. Generally, under what has become known as the economic loss rule, if the defective product only causes economic or commercial loss, the dispute is a private matter between the parties, and the contract will likely control their dis- pute. But if the product causes personal injury or property damage (other than to the product itself), then tort law and tort damages will likely control.15 are generally equivalent to expectation damages. See, e.g., Robert Cooter & Melvin Aron Eisenberg, Damages for Breach of Contract, 73 Cal. L. Rev. 1432, 1445 (1985). 12. Compare Hollinger v. McMichael, 177 Mont. 144, 580 P.2d 927, 929 (1978) (broker earned his commission when he “procured a purchaser able, ready and willing to purchase the seller’s prop- erty”) with Ellsworth Dobbs, Inc. v. Johnson, 50 N.J. 528, 236 A.2d 843, 855 (1967) (broker earns commission only when the transaction is completed by closing the title in accordance with the provi- sions of the contract). See generally Steven K. Mulliken, When Does the Seller Owe the Broker a Commis- sion? A Discussion of the Law and What It Teaches About Listing Agreements, 132 Mil. L. Rev. 265 (1991). 13. The objective of restitution damages is to put the promisor or breaching party back in the position in which it would have been had the promise not been made. Note the traditional legal distinction between restitution and reliance damages: Reliance damages seek to put the promisee or nonbreaching party back in the position in which it would have been if the promise had not been made. See E. Allan Farnsworth, Legal Remedies for Breach of Contract, 70 Colum. L. Rev. 1145, 1148 (1979). Both measures seek to restore the status quo ante. See also Restatement (Third) of Restitution and Unjust Enrichment (2011). 14. See Restatement (Second) of Contracts § 344(c). 15. Judge Posner has advocated using the term “commercial” rather than “economic” loss because, since personal injuries and property losses destroy values that can be monetized, they are economic losses also. See Miller v. United States Steel Corp., 902 F.2d 573, 574 (7th Cir. 1990). See generally Dan B. Dobbs, An Introduction to Non-Statutory Economic Loss Claims, 48 Ariz. L. Rev. 713 435

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Reference Manual on Scientific Evidence are so severe that his lifespan has been shortened by 3.5 years. Although he was a construction worker at the time of the accident, he had been going to school to become a CPA. The plaintiff’s damages study presumes that he will not be able to work at all in the future. The defendant argues that the plaintiff should have continued his education after the accident and worked as a CPA. The defendant also disputes the reliability of the reduced life expectancy calculation. The judge has ruled that a jury should decide if there is a sufficient basis to conclude that the calculation of lost personal earnings should reflect the plaintiff’s reduced life expectancy. 1. Is there a dispute about projected earnings but for the harmful event? A plaintiff who seeks compensation for lost earnings will normally estimate dam- ages based on wages or salary; other cash compensation, such as commissions, overtime, and bonuses; and the value of fringe benefits. Employees in similar jobs whose earnings were not interrupted form a natural benchmark for earning growth between the harmful event and trial. The plaintiff may make the case that a promotion or job change would have occurred during that period. Disputes involving the more variable elements of cash compensation are likely to arise. The plaintiff may measure bonuses and overtime during a period when these parts of compensation were unusually high, while the defendant may choose a longer period, during which the average is lower. In our example, the construction worker claims that he would have made $75,000 working for one more year in construction while completing his degree. After that, he would have worked as a CPA earning $100,000 a year until retire- ment at age 70 based on the average salary for all CPAs. As a result of his injury, he only receives $22,000 a year from disability payments. Table 4 shows these projections. The defendant’s damages study presumes that the plaintiff could have con- tinued his education after the injury and begun working as a CPA a year later. However, he argues the plaintiff would have earned only $75,000 as a CPA because of the plaintiff’s lackluster record as an undergraduate and his career as a construction worker, where his work resulted in a depreciation of the skills that a CPA needs. This salary is based on the median salary for all CPAs. Table 5 shows the defendant’s projections. 2. Are the parties disputing the valuation of benefits? Lost benefits are an important part of lost personal earnings damages. As discussed in Section VIII.B, strict adherence to the format of Figure 1 can help resolve these disputes. In the example, plaintiff includes only disability payments because of the injury. Absent his injury, he would have received higher benefits than the dis- ability payments after retirement at age 70. The defendant projects higher social 492

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Table 4. Plaintiff’s Estimate of Lost Personal Income Actual But-for But-for But-for But-for Social Total Probability Probability Social Total Probability Probability But-for Total Discount Discounted Actual Sec Actual of of Expected But-for Sec But-for of of Expected Lost Discount Rate Lost Age Earnings Benefits Income Surviving Working Income Earnings Benefits Income Surviving Working Income Income Rate Index Income 56-57 0 22,008 22,008 1.00 0.00 22,008 75,000 75,000 1.00 0.90 67,500 45,492 0.01 1.00 45,492 57-58 0 22,008 21,727 0.99 0.00 21,727 87,083 87,083 0.99 1.00 86,341 64,615 0.01 0.99 63,975 58-59 0 22,008 21,428 0.97 0.00 21,428 100,000 100,000 0.98 1.00 98,238 76,810 0.01 0.98 75,297 59-60 0 22,008 21,107 0.96 0.00 21,107 100,000 100,000 0.97 1.00 97,258 76,151 0.01 0.97 73,911 60-61 0 22,008 20,761 0.94 0.00 20,761 100,000 100,000 0.96 1.00 96,195 75,434 0.01 0.96 72,491 61-62 0 22,008 20,387 0.93 0.00 20,387 100,000 100,000 0.95 1.00 95,039 74,653 0.01 0.95 71,029 62-63 0 22,008 19,984 0.91 0.00 19,984 100,000 100,000 0.94 1.00 93,788 73,804 0.01 0.94 69,527 63-64 0 22,008 19,556 0.89 0.00 19,556 100,000 100,000 0.92 1.00 92,448 72,892 0.01 0.93 67,988 64-65 0 22,008 19,104 0.87 0.00 19,104 100,000 100,000 0.91 1.00 91,024 71,920 0.01 0.92 66,417 65-66 0 22,008 18,629 0.85 0.00 18,629 100,000 100,000 0.90 1.00 89,514 70,885 0.01 0.91 64,813 66-67 0 22,008 18,130 0.82 0.00 18,130 100,000 100,000 0.88 1.00 87,916 69,786 0.01 0.91 63,177 67-68 0 22,008 17,605 0.80 0.00 17,605 100,000 100,000 0.86 1.00 86,220 68,615 0.01 0.90 61,501 68-69 0 22,008 17,052 0.77 0.00 17,052 100,000 100,000 0.84 1.00 84,414 67,362 0.01 0.89 59,780 69-70 0 22,008 16,467 0.75 0.00 16,467 100,000 100,000 0.82 1.00 82,483 66,016 0.01 0.88 58,006 70-71 0 22,008 15,849 0.72 0.00 15,849 31,152 31,152 0.80 0.00 25,053 9,203 0.01 0.87 8,007 71-72 0 22,008 15,197 0.69 0.00 15,197 31,152 31,152 0.78 0.00 24,365 9,168 0.01 0.86 7,897 72-73 0 22,008 14,506 0.66 0.00 14,506 31,152 31,152 0.76 0.00 23,626 9,121 0.01 0.85 7,778 73-74 0 22,008 13,775 0.63 0.00 13,775 31,152 31,152 0.73 0.00 22,832 9,058 0.01 0.84 7,648 74-75 0 22,008 13,005 0.59 0.00 13,005 31,152 31,152 0.71 0.00 21,982 8,977 0.01 0.84 7,505 75-76 0 22,008 12,200 0.55 0.00 12,200 31,152 31,152 0.68 0.00 21,074 8,875 0.01 0.83 7,346 493 76-77 0 22,008 11,364 0.52 0.00 11,364 31,152 31,152 0.65 0.00 20,113 8,748 0.01 0.82 7,170 77-78 0 22,008 10,505 0.48 0.00 10,505 31,152 31,152 0.61 0.00 19,098 8,594 0.01 0.81 6,973 78-79 0 22,008 9,628 0.44 0.00 9,628 31,152 31,152 0.58 0.00 18,035 8,408 0.01 0.80 6,755 79-80 0 22,008 8,740 0.40 0.00 8,740 31,152 31,152 0.54 0.00 16,927 8,187 0.01 0.80 6,512 80-81 0 22,008 7,852 0.36 0.00 7,852 31,152 31,152 0.51 0.00 15,780 7,928 0.01 0.79 6,244 81-82 0 22,008 6,973 0.32 0.00 6,973 31,152 31,152 0.47 0.00 14,602 7,629 0.01 0.78 5,949 82-83 0 22,008 6,112 0.28 0.00 6,112 31,152 31,152 0.43 0.00 13,401 7,289 0.01 0.77 5,627 83-84 0 22,008 5,283 0.24 0.00 5,283 31,152 31,152 0.39 0.00 12,188 6,906 0.01 0.76 5,279 84-85 0 22,008 4,494 0.20 0.00 4,494 31,152 31,152 0.35 0.00 10,976 6,481 0.01 0.76 4,905 85-86 0 22,008 3,758 0.17 0.00 3,758 31,152 31,152 0.31 0.00 9,777 6,019 0.01 0.75 4,510 86-87 0 22,008 3,082 0.14 0.00 3,082 31,152 31,152 0.28 0.00 8,605 5,523 0.01 0.74 4,097 87-88 0 22,008 2,475 0.11 0.00 2,475 31,152 31,152 0.24 0.00 7,474 5,000 0.01 0.73 3,673 88-89 0 22,008 1,941 0.09 0.00 1,941 31,152 31,152 0.21 0.00 6,400 4,459 0.01 0.73 3,243 89-90 0 22,008 1,484 0.07 0.00 1,484 31,152 31,152 0.17 0.00 5,394 3,911 0.01 0.72 2,816 90-91 0 22,008 1,102 0.05 0.00 1,102 31,152 31,152 0.14 0.00 4,469 3,367 0.01 0.71 2,401 91-92 0 22,008 793 0.04 0.00 793 31,152 31,152 0.12 0.00 3,634 2,841 0.01 0.71 2,005 92-93 0 22,008 551 0.03 0.00 551 31,152 31,152 0.09 0.00 2,895 2,344 0.01 0.70 1,638 93-94 0 22,008 369 0.02 0.00 369 31,152 31,152 0.07 0.00 2,256 1,887 0.01 0.69 1,306 94-95 0 22,008 236 0.01 0.00 236 31,152 31,152 0.06 0.00 1,716 1,480 0.01 0.69 1,014 95-96 0 22,008 145 0.01 0.00 145 31,152 31,152 0.04 0.00 1,272 1,127 0.01 0.68 765 96-97 0 22,008 84 0.00 0.00 84 31,152 31,152 0.03 0.00 916 832 0.01 0.67 559 97-98 0 22,008 46 0.00 0.00 46 31,152 31,152 0.02 0.00 640 594 0.01 0.67 395 98-99 0 22,008 24 0.00 0.00 24 31,152 31,152 0.01 0.00 433 410 0.01 0.66 270 99-100 0 22,008 11 0.00 0.00 11 31,152 31,152 0.01 0.00 283 272 0.01 0.65 177 100 and over 0 22,008 0 0.00 0.00 0 31,152 31,152 0.00 0.00 0 0 0.01 0.65 0 Total Lost Personal Income 1,043,866

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Table 5. Defendant’s Estimate of Lost Personal Income Actual But-for But-for But-for But-for Social Total Probability Probability Social Total Probability Probability But-for Total Discount Discounted Actual Sec Actual of of Expected But-for Sec But-for of of Expected Lost Discount Rate Lost Age Earnings Benefits Income Surviving Working Income Earnings Benefits Income Surviving Working Income Income Rate Index Income 56-57 0 0 0 1.00 0.00 0 75,000 75,000 1.00 0.80 60,000 60,000 0.05 1.00 60,000 57-58 75,000 0 74,361 0.99 1.00 74,361 75,000 75,000 0.99 1.00 74,361 0 0.05 0.95 0 58-59 75,000 0 73,678 0.98 1.00 73,678 75,000 75,000 0.98 1.00 73,678 0 0.05 0.91 0 59-60 75,000 0 72,944 0.97 1.00 72,944 75,000 75,000 0.97 1.00 72,944 0 0.05 0.86 0 60-61 75,000 0 72,146 0.96 1.00 72,146 75,000 75,000 0.96 1.00 72,146 0 0.05 0.82 0 61-62 75,000 0 71,280 0.95 1.00 71,280 75,000 75,000 0.95 1.00 71,280 0 0.05 0.78 0 62-63 75,000 0 70,341 0.94 1.00 70,341 75,000 75,000 0.94 1.00 70,341 0 0.05 0.75 0 63-64 75,000 0 69,336 0.92 1.00 69,336 75,000 75,000 0.92 1.00 69,336 0 0.05 0.71 0 64-65 75,000 0 68,268 0.91 1.00 68,268 75,000 75,000 0.91 1.00 68,268 0 0.05 0.68 0 65-66 75,000 0 67,135 0.90 1.00 67,135 75,000 75,000 0.90 1.00 67,135 0 0.05 0.64 0 66-67 75,000 0 65,937 0.88 1.00 65,937 75,000 75,000 0.88 1.00 65,937 0 0.05 0.61 0 67-68 75,000 0 64,665 0.86 1.00 64,665 75,000 75,000 0.86 1.00 64,665 0 0.05 0.58 0 68-69 75,000 0 63,310 0.84 1.00 63,310 75,000 75,000 0.84 1.00 63,310 0 0.05 0.56 0 69-70 75,000 0 61,863 0.82 1.00 61,863 75,000 75,000 0.82 1.00 61,863 0 0.05 0.53 0 70-71 0 30,864 24,821 0.80 0.00 24,821 31,152 31,152 0.80 0.00 25,053 232 0.05 0.51 117 71-72 0 30,864 24,140 0.78 0.00 24,140 31,152 31,152 0.78 0.00 24,365 225 0.05 0.48 108 72-73 0 30,864 23,408 0.76 0.00 23,408 31,152 31,152 0.76 0.00 23,626 218 0.05 0.46 100 73-74 0 30,864 22,621 0.73 0.00 22,621 31,152 31,152 0.73 0.00 22,832 211 0.05 0.44 92 74-75 0 30,864 21,779 0.71 0.00 21,779 31,152 31,152 0.71 0.00 21,982 203 0.05 0.42 84 75-76 0 30,864 20,879 0.68 0.00 20,879 31,152 31,152 0.68 0.00 21,074 195 0.05 0.40 77 494 76-77 0 30,864 19,927 0.65 0.00 19,927 31,152 31,152 0.65 0.00 20,113 186 0.05 0.38 70 77-78 0 30,864 18,922 0.61 0.00 18,922 31,152 31,152 0.61 0.00 19,098 177 0.05 0.36 63 78-79 0 30,864 17,868 0.58 0.00 17,868 31,152 31,152 0.58 0.00 18,035 167 0.05 0.34 57 79-80 0 30,864 16,771 0.54 0.00 16,771 31,152 31,152 0.54 0.00 16,927 156 0.05 0.33 51 80-81 0 30,864 15,634 0.51 0.00 15,634 31,152 31,152 0.51 0.00 15,780 146 0.05 0.31 45 81-82 0 30,864 14,467 0.47 0.00 14,467 31,152 31,152 0.47 0.00 14,602 135 0.05 0.30 40 82-83 0 30,864 13,277 0.43 0.00 13,277 31,152 31,152 0.43 0.00 13,401 124 0.05 0.28 35 83-84 0 30,864 12,076 0.39 0.00 12,076 31,152 31,152 0.39 0.00 12,188 113 0.05 0.27 30 84-85 0 30,864 10,874 0.35 0.00 10,874 31,152 31,152 0.35 0.00 10,976 101 0.05 0.26 26 85-86 0 30,864 9,686 0.31 0.00 9,686 31,152 31,152 0.31 0.00 9,777 90 0.05 0.24 22 86-87 0 30,864 8,525 0.28 0.00 8,525 31,152 31,152 0.28 0.00 8,605 80 0.05 0.23 18 87-88 0 30,864 7,405 0.24 0.00 7,405 31,152 31,152 0.24 0.00 7,474 69 0.05 0.22 15 88-89 0 30,864 6,341 0.21 0.00 6,341 31,152 31,152 0.21 0.00 6,400 59 0.05 0.21 12 89-90 0 30,864 5,344 0.17 0.00 5,344 31,152 31,152 0.17 0.00 5,394 50 0.05 0.20 10 90-91 0 30,864 4,428 0.14 0.00 4,428 31,152 31,152 0.14 0.00 4,469 41 0.05 0.19 8 91-92 0 30,864 3,600 0.12 0.00 3,600 31,152 31,152 0.12 0.00 3,634 34 0.05 0.18 6 92-93 0 30,864 2,868 0.09 0.00 2,868 31,152 31,152 0.09 0.00 2,895 27 0.05 0.17 5 93-94 0 30,864 2,235 0.07 0.00 2,235 31,152 31,152 0.07 0.00 2,256 21 0.05 0.16 3 94-95 0 30,864 1,700 0.06 0.00 1,700 31,152 31,152 0.06 0.00 1,716 16 0.05 0.16 2 95-96 0 30,864 1,260 0.04 0.00 1,260 31,152 31,152 0.04 0.00 1,272 12 0.05 0.15 2 96-97 0 30,864 908 0.03 0.00 908 31,152 31,152 0.03 0.00 916 8 0.05 0.14 1 97-98 0 30,864 634 0.02 0.00 634 31,152 31,152 0.02 0.00 640 6 0.05 0.14 1 98-99 0 30,864 429 0.01 0.00 429 31,152 31,152 0.01 0.00 433 4 0.05 0.13 1 99-100 0 30,864 280 0.01 0.00 280 31,152 31,152 0.01 0.00 283 3 0.05 0.12 0 100 + 0 30,864 0 0.00 0.00 0 31,152 31,152 0.00 0.00 0 0 0.05 0.12 0 Total Lost Personal Income 61,104

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Reference Guide on Estimation of Economic Damages security benefits based on a longer period and higher level of contributions to social security. The parties agree that the plaintiff would have retired at age 70 absent the accident. 3. Is there disagreement about how earnings should be discounted to present value? Because personal lost earnings damages may accrue over the remainder of a plaintiff’s working life, the issues of predicting future inflation and discounting earnings to present value are likely to generate quantitatively important disagreements. As we noted in Section VI.D, projections of future compensation can be calculated in constant dollars or escalated terms. In the first case, the interest rate used to discount future constant-dollar losses should be a real interest rate—the difference between the ordinary interest rate and the projected future rate of inflation. All else being the same, the two approaches will give identical calculations of damages. In our example, both the plaintiff and defendant use constant dollars and use a real rate of interest for discounting. However, the plaintiff calculates the real rate of interest as 1%, relying on the implied rate from inflation-adjusted Treasury bonds. In contrast, the defendant uses a discount rate of 5% based on the historic real rate of return to investments in general. 4. Is there disagreement about subsequent unexpected events? Disagreements about subsequent unexpected events are likely in cases involving personal earnings, as discussed in general in Section VIII.E. For example, the plaintiff may have suffered a debilitating illness that would have caused him to quit his job a year later even if the wrongful act had not occurred. Alternatively, the plaintiff may have been laid off as a result of employer hardship a year later notwithstanding the wrongful act. In these examples, the defendant may argue that damages should be limited to one year. The plaintiff might respond that subsequent events were unexpected at the time of the termination and therefore should be excluded from consideration in the calculation of damages. Thus, the plaintiff would argue that damages should be calculated without consideration of these events. In our example, the defendant points out that the unemployment rate for construction workers was 50% beginning six months after the accident. The plaintiff argues that the unemployment rate for construction workers at the time of the accident was only 19% and therefore the revised unemployment rate after the accident is irrelevant. 5. Is there disagreement about retirement and mortality? Closely related to the issue of unexpected events is how future damages should reflect the probability that the plaintiff will die or decide to retire. Sometimes an 495

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Reference Manual on Scientific Evidence expert will assume a work-life expectancy and terminate damages at the end of that period. Tables of work-life expectancy incorporate the probability of both retirement and death. Another approach is to multiply each year’s lost earnings by the probability that the plaintiff will be alive and working in that year. That probability declines gradually with age and can be inferred from data on labor force participation and mortality by age. In our example, the plaintiff projects that his life expectancy was reduced by 3.5 years and uses revised survival rates as a result. The defendant disagrees, argu- ing that the survival tables relied upon by the plaintiff are unreliable. However, both agree that the plaintiff would have worked until age 70 absent the accident because the unemployment rate for CPAs is essentially zero in the area where the plaintiff lives. 6. Is there a dispute about mitigation? Actual earnings before trial, although known, may be subject to dispute if the defendant argues that the plaintiff took too long to find a job or the job taken was not sufficiently remunerative. Even more problematic may be the situation in which the plaintiff continues to be unemployed. Parties disputing the length of job search frequently offer testimony from job placement experts. Testimony from a psychologist also may be offered if the plaintiff has suffered emotional trauma as a result of the defendant’s actions. Recovery from temporarily disabling injuries may be the subject of testimony by experts in vocational rehabilitation. In our example, the plaintiff argues that he is disabled and unable to work for the remainder of his life. The defendant argues that the plaintiff could have finished his education and could then have worked as a CPA. Both provide the testimony from experts in vocational rehabilitation to support their conclusions. 7. Is there disagreement about how the plaintiff’s career path should be projected? The issues that arise in projecting but-for and actual earnings after trial are similar to the issues that arise in measuring damages before trial. In addition, the parties are likely to disagree about the plaintiff’s future increases in compensation. A dam- ages analysis should be internally consistent. For example, the compensation paths for both but-for and actual earnings should be based on consistent assumptions about general economic conditions, about conditions in the local labor market for the plaintiff’s type of work, the age-earnings profile for the career path, and particularly about the plaintiff’s likely increased skills and earning capacity. The analysis probably should project a less successful career for mitigation if it is pro- jecting a slow earnings growth absent the harm. In our example, the plaintiff argues that he would have worked as a CPA but for the accident but that he is too injured to complete his education and work as a CPA. The defendant argues that working as a CPA is a viable option for the 496

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Reference Guide on Estimation of Economic Damages plaintiff. Although there is a disagreement about how much the plaintiff would have earned as a CPA, the plaintiff’s argument that he is too disabled to work accounts for most of the damages. As shown in Tables 4 and 5, the plaintiff is seeking just over $1 million while the defendant calculates that damages are only $61,000. Differences of this magnitude between quantifications of lost personal earnings by plaintiffs and defendants are common. Our example illustrates some of the main reasons for the large differences. B. Lost Profits for a Business Claims for lost profits for a business generally arise from a lost stream of revenue. However, lost profits can also arise from increased costs. As an example, a breach of a supply contract may increase the victim firm’s costs. Generally, an expert will likely be most involved in cases in which the plaintiff is seeking recovery for expectation, reliance, or restitution damages. Most damages studies will follow Figure 1 where earnings are the lost profits. For explication, the following is an example of a business lost profits case: Plaintiff HSM makes cell phone handsets. Defendant TPC is a cell phone carrier. By denying HSM technical information and by informing HSM’s potential customers that HSM’s handsets are incompatible with TPC’s network, TPC has imposed economic losses on HSM. TPC asserts that HSM has failed to mitigate its losses and overstates its lost revenues. Trial is set for the end of 2010. The respec- tive damages analyses are shown in Tables 6 and Table 7 and discussed below. Table 6. HSM’s Damages Analysis (Dollars in Millions) (2) (3) (4) (5) (6) (7) (8) But-For But-For But-For Actual Lost Discount Year Revenue Costs Earnings Earnings Earnings Factor Damages 2008 $561 $374 $187 $34 $153 1.21 $185 2009 600 400 200 56 144 1.14 164 2010 639 426 213 45 168 1.07 180 2011 681 454 227 87 140 1.00 140 2012 726 484 242 96 147 0.96 141 2013 777 518 259 105 153 0.92 142 2014 828 552 276 116 160 0.89 142 2015 882 588 294 127 167 0.85 143 Total $1236 497

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Reference Manual on Scientific Evidence Table 7. TPC’s Damages Analysis (Dollars in Millions) (2) (3) (4) (5) (6) (7) (8) But-For But-For But-For Mitigated Lost Discount Year Revenue Costs Earnings Earnings Earnings Factor Damages 2008 $404 $303 $101 $79 $22 1.21 $27 2009 432 324 108 85 23 1.14 26 2010 460 345 115 81 34 1.07 36 2011 492 369 123 98 25 1.00 25 2012 524 393 131 108 23 0.87 20 2013 560 420 140 119 21 0.76 16 2014 596 447 149 130 19 0.66 12 2015 636 477 159 143 16 0.57 9 Total $171 1. Is there a dispute about projected revenues? Projecting lost revenues can be straightforward if the disrupted revenue stream occurs immediately following the bad act and the firm recovers relatively quickly. More complex cases can arise if the effect is delayed or the recovery is slow, intermittent, or nonexistent. In the example above, the plaintiff’s expert would argue that revenues would have been higher absent TPC’s conduct and thus projects revenues based on the revenue growth prior to the bad act, which reflects increasing sales and increas- ing prices. The projected revenue for the plaintiff is shown in Table 6, column 2. The defendant’s expert would argue that HSM’s projections use a growth factor that improperly includes the period when HSM initially entered the market and, therefore, projects HSM’s sales using the growth rate for the previous 2 years and assumes that prices would have remained unchanged. TPC’s projection of HSM’s revenue is shown in Table 7, column 2. Some additional examples of complexities can found in antitrust cases. For example, assume a company is disadvantaged because a rival has constructed barriers to entry by entering into contracts that require customers to use its add- on products such as ink for a printer. In such cases, the plaintiff’s expert may assert that the only suppliers in the but-for market for printer ink would consist of the defendant and the plaintiff, and that the profit would reflect pricing for a duopoly. The defendant may respond that there would be five firms in addition to the plaintiff who would have entered the market as suppliers, and that therefore the pricing would be close to that of a highly competitive market. Other complexities may arise in intellectual property cases where the rev- enue stream is reduced because the intellectual property for a product has been misappropriated. In these cases, the expert may need to identify how much of the 498

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Reference Guide on Estimation of Economic Damages plaintiff’s revenue stream should be attributed to the misappropriated intellectual property and how much should be attributed to other aspects of the product. For example, our printer manufacturer may believe that its printers are popular because of its proprietary method to increase the printing speed. However, the defendant may argue that the increase in printing speed has little to do with the popularity of the plaintiff’s printer but rather the sharpness of the printing. Or the defendant may argue that at the time of the bad act the plaintiff’s product was the fastest printer, but 2 years later, a noninfringing printer is faster and the plaintiff’s sales therefore would have dropped to zero. The projection of the revenue stream is likely to be the most controversial part of any damages estimate in a business case because it requires so many assump- tions on the part of both experts with respect to the other players in the market and customer demand. 2. Are the parties disputing the calculation of marginal costs? Another area of dispute that can arise is the measurement of marginal costs. Generally, if the business is an ongoing concern, then the costs can be deter- mined from existing data. Often this is done either by directly modeling the costs needed for the additional revenues or using regression analysis that captures how costs have varied with revenues. The relevant concept is the measure of costs that would have been expended to generate the lost revenues. In our example, plaintiff’s expert would project that the additional costs would reflect the marginal cost ratio that was derived from a regression model of costs against revenues. The defendant’s expert might use the average ratio of costs to revenues, arguing that this would be more appropriate because additional work- ers and equipment would have been needed to generate the increased revenues. The projected costs for both parties are shown in column 3 of Tables 6 and 7. Costs are often expressed as a percentage of revenues, which simplifies the projection of costs. However, this approach can be problematic if there is reason to believe that the profit rate will change over time. The rate may change because the change in revenues will be so large as to require that an increasing percentage of fixed costs will need to be included, the mix of costs will change over time, or the components of cost will grow at disparate rates. If computing costs as a per- centage of revenues is not viable, then the projected costs should reflect the same assumptions about growth and inflation that were used in the revenue projection. 3. Is there a dispute about mitigation? Defendant’s expert may argue that the plaintiff’s actual profits are understated because the plaintiff failed to mitigate its losses. For example, the plaintiff’s losses may have been minimized by closure of its business. Or the plaintiff perhaps should have invested in alternative facilities while its business was interrupted because it could not use its existing facilities. 499

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Reference Manual on Scientific Evidence In our example, the defendant’s expert would argue that HSM could have mitigated its losses by obtaining the technical information it needed from other sources and could have counteracted TPC’s disparagement with vigorous market- ing. HSM’s actual earnings are shown in column 5 of Table 6, and TPC’s calcula- tion of HSM’s earnings with mitigation are shown in column 5 of Table 7. 4. Is there disagreement about how profits should be discounted to present value? Generally, interest for lost earnings prior to trial is computed at a statutory rate, often not compounded. In our example, trial is at the end of year 2010 and the statutory rate is assumed to be 7% simple (i.e., without compounding). If the prejudgment rate is not set by law, economists favor the use of the cost of borrowing for the defendant, because damages are a forced loan to the defendant by the plaintiff.90 The rate used to discount future losses back to the time of the trial is not set by law and substantial disputes will arise about the discount rate. Generally, economists believe that the discount rate should equal the after-tax cost of capital for the plaintiff. In our example, HSM argues that the proper discount rate should be based on a 4%, after-tax interest rate, obtained by applying HSM’s corporate tax rate to TPC’s medium-term borrowing rate. TPC, however, believes that the proper discount rate should be HSM’s cost of capital, reflecting HSM’s cost of equity and cost of debt. Column 7 of Tables 4 and 5 shows the respective discount rates after trial. The resulting damages are shown in column 8 of Tables 6 and 7. 5. Is there disagreement about subsequent unexpected events? Disagreements about subsequent unexpected events are likely in cases involving lost profits. For example, the market for the plaintiff’s goods may have suffered a substantial contraction a year after the bad act, with plaintiff likely to be forced into bankruptcy even if the wrongful act had not occurred. Or the costs of the plaintiff may have increased dramatically a year later because of shortages that would have necessitated that the plaintiff retool its business even if the wrongful act had not occurred. The plaintiff might respond that subsequent events were unexpected at the time of the bad act and so should be excluded from consider- ation in the calculation of damages. Plaintiff, therefore, would argue that damages should be calculated without consideration of these events. The defendant would respond that damages should be limited to 1 year because the unexpected events would have forced the closure of the plaintiff’s business. This topic is discussed more fully in Section VIII.E. 90. See James M. Patell et al., Accumulating Damages in Litigation: The Roles of Uncertainty and Interest Rates, 11 J. Legal Stud. 341–64 (1982). 500

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Reference Guide on Estimation of Economic Damages Glossary of Terms appraisal. A method of determining the value of the plaintiff’s claim on an earn- ings stream by reference to the market values of comparable earnings streams. For example, if the plaintiff has been deprived of the use of a piece of prop- erty, the appraised value of the property might be used to determine damages. avoided cost. Cost that the plaintiff did not incur as a result of the harmful act. Usually it is the cost that a business would have incurred in order to make the higher level of sales the business would have enjoyed but for the harmful act. but-for analysis. Restatement of the plaintiff’s economic situation but for the defendant’s harmful act. Damages are generally measured as but-for value less actual value received by the plaintiff. capitalization factor. Factor used to convert a stream of revenue or profit into its capital or property value. A capitalization factor of 10 for profit means that a firm with $1 million in annual profit is worth $10 million. compound interest. Interest calculation giving effect to interest earned on past interest. As a result of compound interest at rate r, it takes (1 + r)(1 + r) = 1 + 2r + r2 dollars to make up for a lost dollar of earnings 2 years earlier. constant dollars. Dollars adjusted for inflation. When calculations are done in constant 1999 dollars, it means that future dollar amounts are reduced in proportion to increases in the cost of living expected to occur after 1999. discount rate. Rate of interest used to discount future losses. discounting. Calculation of today’s equivalent to a future dollar to reflect the time value of money. If the interest rate is r, the discount applicable to 1 year in the future is: discount rate = 1/(1 + r). The discount for 2 years is this amount squared; for 3 years, it is this amount to the third power, and so on for longer periods. The result of the calculation is to give effect to compound interest. earnings. Economic value received by the plaintiff. Earnings could be salary and benefits from a job, profit from a business, royalties from licensing intellec- tual property, or the proceeds from a one-time or recurring sale of property. Earnings are measured net of costs. Thus, lost earnings are lost receipts less costs avoided. escalation. Consideration of future inflation in projecting earnings or other dollar flows. The alternative is to make projections in constant dollars. expectation damages. Damages measured on the principle that the plaintiff is entitled to the benefit of the bargain originally made with the defendant. 501

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Reference Manual on Scientific Evidence fixed cost. Cost that does not change with a change in the amount of products or services sold. mitigation. Action taken by the plaintiff to minimize the economic effect of the harmful act. Also often refers to the actual level of earnings achieved by the plaintiff after the harmful act. nominal interest rate. Interest rate quoted in ordinary dollars, without adjust- ment for inflation. Interest rates quoted in markets and reported in the finan- cial press are always nominal interest rates. prejudgment interest. Interest on losses occurring before trial. present value. Value today of money due in the past (with interest) or in the future (with discounting). price erosion. Effect of the harmful act on the price charged by the plaintiff. When the harmful act is wrongful competition, as in intellectual property infringement, price erosion is one of the ways that the plaintiff’s earnings have been harmed. real interest rate. Interest rate adjusted for inflation. The real interest rate is the nominal interest rate less the annual rate of inflation. regression analysis. Statistical technique for inferring stable relationships among quantities. For example, regression analysis may be used to determine how costs typically vary when sales rise or fall. reliance damages. Damages designed to reimburse a party for expenses incurred from reliance upon the promises of the other party. restitution damages. Damages measured on the principle of restoring the eco- nomic equivalent of lost property or value. variable cost. Component of a business’s cost that would have been higher if the business had enjoyed higher sales. See also avoided cost. 502