The Economics of Litigation Finance

Abstract

We study the economics of litigation with a particular focus on litigation finance. Based on an extensive data set covering civil lawsuits reported by U.S. Federal Courts since 1977, we first present a set of stylized empirical facts about lawsuits at the trial phase. Grounded in these insights, we build a base model for a lawsuit at the trial phase and a model extension that includes litigation finance. Using these models, we arrive at three main insights about the implications of litigation finance. First, compared to law firms, litigation funders prefer high-risk litigation, which can enable access to justice but also challenges the legal system by increasing the number of lawsuits. Second, litigation finance disproportionately benefits small law firms and plaintiffs in non-contingency arrangements. Third, the presence of litigation finance increases the total amount spent on litigation and these costs are carried by the funder alone as cost sharing between funders and law firms is sub-optimal.

Keywords: litigation finance, third-party funding, economics of litigation, investment

JEL Classification: K41, G11, G23, C55