Contracting on Litigation

47 Pages Posted: 16 Apr 2016 Last revised: 23 May 2019

See all articles by Kathryn E. Spier

Kathryn E. Spier

Harvard University - Law School - Faculty; National Bureau of Economic Research (NBER)

J.J. Prescott

University of Michigan Law School

Date Written: June 20, 2018

Abstract

Two risk-averse litigants with different subjective beliefs negotiate in the shadow of a pending trial. Through contingent contracts, the litigants can mitigate risk and/or speculate on the trial outcome. The opportunity for contingent contracting decreases the settlement rate and increases the volume and costs of litigation. These contingent contracts mimic the services provided by third-party investors, including litigation funders and insurance companies. The two litigants (weakly) prefer to contract with the external capital market when third-party investors are risk neutral and the capital market is transaction-cost free. However, contracting with third parties further decreases the settlement rate, increases the volume and costs of litigation, and may increase the aggregate cost of risk bearing. In this sense, third-party involvement in litigation can reduce social welfare.

Keywords: Litigation; Settlement; Pretrial Bargaining; High-Low Agreements; Contingent Fees, Litigation Finance; Litigation Funding; Insurance; Heterogeneous Beliefs; Belief-Neutral Welfare Criterion; Non-Common Priors

JEL Classification: K41, G32, D84, D86

Suggested Citation

Spier, Kathryn E. and Prescott, J.J., Contracting on Litigation (June 20, 2018). RAND Journal of Economics, Vol. 50, No. 2, 2019; U of Michigan Law & Econ Research Paper No. 16-009. Available at SSRN: https://ssrn.com/abstract=2765033 or http://dx.doi.org/10.2139/ssrn.2765033

Kathryn E. Spier (Contact Author)

Harvard University - Law School - Faculty ( email )

1575 Massachusetts
Hauser 302
Cambridge, MA 02138
United States
(617) 496-0019 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

J.J. Prescott

University of Michigan Law School ( email )

3170 South Hall
701 S. State St.
Ann Arbor, MI 48109
United States
734-763-2326 (Phone)

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