Exploiting Future Settlements: A Signaling Model of Most-Favored-Nation Clauses in Settlement Bargaining

42 Pages Posted: 2 Nov 2002

See all articles by Andrew F. Daughety

Andrew F. Daughety

Department of Economics, Vanderbilt University

Jennifer F. Reinganum

Vanderbilt University - College of Arts and Science - Department of Economics

Date Written: October 2002

Abstract

"Most-favored-nation" (hereafter, MFN) clauses have been used in analyses of international trade, durable goods monopoly pricing, and franchise contracting to address a repeat player's time-inconsistency problem. Recent work by Spier (forthcoming and 2002) has extended this perspective to the settlements of litigation by (for example) one defendant with a collection of plaintiffs.

We examine a different motivation for the use of MFNs in settlement bargaining. We argue that a non-repeat player can use an MFN to extend her reach into subsequent bargaining games. That is, an early-bargaining plaintiff can use an MFN to modify the subsequent bargaining game between the defendant and a later-bargaining plaintiff in a manner that improves the early plaintiff's payoff. Moreover, we will identify two routes through which this improvement is achieved. The obvious route is that, if the MFN is triggered by the later settlement, the early plaintiff receives an additional payment. The less obvious route is that the early plaintiff's incentives for information-revelation can be enhanced by the potential for a future payment, so that the defendant can resort to trial on a less-frequent basis. Using a signaling model, we find that the repeat player (the defendant) is indifferent about the MFN, while the later plaintiff is always worse off when an MFN constrains her settlement bargaining with the defendant. Although MFNs can never provide a Pareto improvement in this model, we demonstrate that plausible circumstances exist under which total surplus is increased by an MFN.

Keywords: Settlement Bargaining, Signaling, Most-Favored-Nation Clauses

JEL Classification: K40, D82, C70

Suggested Citation

Daughety, Andrew F. and Reinganum, Jennifer F., Exploiting Future Settlements: A Signaling Model of Most-Favored-Nation Clauses in Settlement Bargaining (October 2002). Available at SSRN: https://ssrn.com/abstract=346260 or http://dx.doi.org/10.2139/ssrn.346260

Andrew F. Daughety (Contact Author)

Department of Economics, Vanderbilt University ( email )

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HOME PAGE: http://my.vanderbilt.edu/andrewdaughety/

Jennifer F. Reinganum

Vanderbilt University - College of Arts and Science - Department of Economics ( email )

Box 1819 Station B
Nashville, TN 37235
United States
615-322-2937 (Phone)
615-343-8495 (Fax)

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