Threats to Sue and Cost Divisibility Under Asymmetric Information

Abstract

The early literature on litigation and settlement assumed that a plaintiff's threat to litigate is credible only when her litigation value - the difference between the expected judgment and her litigation costs - is positive. More recently, however, Bebchuk (1996) has suggested that even if the plaintiff's litigation value is negative, divisibility of her litigation costs may render credibility to her threat to sue. We show that Bebchuk's result is limited to environments where there is relatively little asymmetric information. When a defendant holds private information concerning his liability he can deter small value suits by engaging in a stonewalling strategy, consistently refusing to settle, even if the plaintiff's costs are very finely divided.

Keywords: Litigation; Asymmetric information, Defendant, Negative expected value, Settlement

JEL Classification: C72, C78, D82, K41