Financing the Litigation Arms Race
68 Pages Posted: 19 Nov 2020 Last revised: 30 Aug 2021
Date Written: November 19, 2020
Using a dynamic model of litigation, we show that the increasingly popular practice of third-party litigation financing has ambiguous welfare implications. 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