Financing the Litigation Arms Race
77 Pages Posted: 19 Nov 2020 Last revised: 1 Jul 2022
Date Written: June 5, 2022
Using a dynamic model of litigation, we show that the increasingly popular practice of third-party litigation financing has ambiguous implications for total ex-post litigant surplus. A defendant and a plaintiff bargain over a settlement payment. The defendant takes costly actions to avoid deadweight losses associated with large transfers to the plaintiff. Litigation financing bolsters the plaintiff, leading to larger deadweight losses. However, by endogenously deterring the defendant from taking costly actions, litigation financing can nonetheless improve the joint surplus of the plaintiff and the defendant. In contrast to popular opinion, litigation financing does not necessarily encourage high-risk frivolous lawsuits.
Keywords: law and finance, litigation financing, dynamic bargaining, real options
JEL Classification: C73, C78, G23, K41
Suggested Citation: Suggested Citation