When we experience something bad or unpleasant, we want the party which causes the accident to pay compensation and/or get punished. Sometimes it is not so easy to tell the differences between these two terms. I think that the main difference is compensation is a transfer of benefits and punishment will generate a loss-loss result.
When a compensation is paid, a benefit of a payer is transferred to the payee to make the gains of both parties more fair. However, punishment is different. The party who wants to punish the other party or a third party (e.g. a regulator) has a cost to punish though the negative effect of punishment can be greater than the cost.
Then frequent punishment will reduce the entire welfare, since punishment does not produce any positive output for any party. However, we know punishment is necessary in the real world. This is because the existence of punishment allows people to re-evaluate the payoff from misconduct and reduce the probability of misconduct. It may not completely eliminate misconduct because some people may feel there is a probability that their misconduct will not be observed.
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