Econ 522 Economics of Law Dan Quint Fall 2010 Lecture 20.
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Transcript of Econ 522 Economics of Law Dan Quint Fall 2010 Lecture 20.
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Last week, we said that to achieve efficiency, the legal process should minimizes the sum of two types of costs
Direct (administrative) costs – the tangible costs of administering the system, and
Error costs – the economic effect of any distortions caused by imperfections in the process
Last week…
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Stages of the legal process…decision to pursue a legal claimbargaining over out-of-court settlementspre-trial exchange of informationtrial itselfappeals process
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In a rational world, victim compares cost of filing a lawsuit to expected gain from suing
How to calculate expected value of a legal claim?
Why sue?
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Why sue?
Sue?
Settle immediately or exchange info?
Settle then or go to trial?
Win or lose at trial?
Appeal?
Don’t File File
Settle “Discovery”
Settle Trial
Win Lose
No Yes
Win or Lose Appeal?
Win Lose
Harm done: $100
70% chance you settle immediately
Average settlement is $50, legal costs of $1
Discovery process costs $3.30
70% chance you settle after discovery, average settlement is $50, legal costs of $1
Trial costs $20
Plaintiff wins with probability 50%, damages = harm
Appeal costs $20
Appeal succeeds with probability 10%, damages = harm
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Why sue?
Sue?
Settle immediately or exchange info?
Settle then or go to trial?
Win or lose at trial?
Appeal?
Don’t File File
Settle “Discovery”
Settle Trial
Win Lose
No Yes
Win or Lose Appeal?
Win Lose
$100 – $20 = $80 –$20
10% 90%
–$10$0
50% 50%
$100 – $20 = $80 –$20
$30
Harm done: $100
70% chance you settle immediately
Average settlement is $50, legal costs of $1
Discovery process costs $3.30
70% chance you settle after discovery, average settlement is $50, legal costs of $1
Trial costs $20
Plaintiff wins with probability 50%, damages = harm
Appeal costs $20
Appeal succeeds with probability 10%, damages = harm
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Why sue?
Sue?
Settle immediately or exchange info?
Settle then or go to trial?
Win or lose at trial?
Appeal?
Don’t File File
Settle “Discovery”
Settle Trial
Win Lose
No Yes
Win or Lose Appeal?
Win Lose
$100 – $20 = $80 –$20
10% 90%
–$10$0
50% 50%
$100 – $20 = $80 –$20
$30$50 – $1 = $49
70% 30%
70% * $49 + 30% * $30 = $43.30
Harm done: $100
70% chance you settle immediately
Average settlement is $50, legal costs of $1
Discovery process costs $3.30
70% chance you settle after discovery, average settlement is $50, legal costs of $1
Trial costs $20
Plaintiff wins with probability 50%, damages = harm
Appeal costs $20
Appeal succeeds with probability 10%, damages = harm
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Why sue?
Sue?
Settle immediately or exchange info?
Settle then or go to trial?
Win or lose at trial?
Appeal?
Don’t File File
Settle “Discovery”
Settle Trial
Win Lose
No Yes
Win or Lose Appeal?
Win Lose
$43.30 – $3.30
70% 30%
$50 – $1 $43.30
70% * $49 + 30% * $40 = $46.30
Harm done: $100
70% chance you settle immediately
Average settlement is $50, legal costs of $1
Discovery process costs $3.30
70% chance you settle after discovery, average settlement is $50, legal costs of $1
Trial costs $20
Plaintiff wins with probability 50%, damages = harm
Appeal costs $20
Appeal succeeds with probability 10%, damages = harm
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Why sue?
Sue?
Don’t File File
$46.30 $46.30 – filing costs$0
Harm done: $100
70% chance you settle immediately
Average settlement is $50, legal costs of $1
Discovery process costs $3.30
70% chance you settle after discovery, average settlement is $50, legal costs of $1
Trial costs $20
Plaintiff wins with probability 50%, damages = harm
Appeal costs $20
Appeal succeeds with probability 10%, damages = harm
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Why sue?
Sue?
Don’t File File
$46.30 – filing costs$0
Decision to sue If expected value of legal claim > filing costs, we expect victim to file a
claim If expected value of legal claim < filing costs, we expect victim not to
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So there are three things that directly influence the number of lawsuits The number of injuries The cost of filing a complaint The expected value of a claim
Holding everything else constant… More injuries should mean more claims Holding fixed the number of accidents, lower filing costs, or
higher expected value of claims, mean more claims But things can sometimes get more complicated…
Number of lawsuits
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Number of lawsuits
Number of lawsuits
Typical level of damages
not worth suing for most victims
more precaution fewer accidents
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Expected value of claims should vary widely
Filing costs
Probability
Expected value of claims
Filing Fee
SUE
DON’TSUE
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Recall the efficient legal system minimizes the sum of administrative costs and error costs
Higher filing fees fewer lawsuits lower administrative costs
But, higher filing fees more injuries go “unpunished”
greater distortion in incentives higher error costs
Filing fee is set optimally when these balance on the margin: Marginal cost of reducing fee = marginal benefit Administrative cost of an additional lawsuit = error cost of providing no
remedy in the marginal case
Filing costs
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Error costs If we’re only concerned with efficiency, we don’t care about
distributional effects That is, we don’t care if a particular victim is or isn’t compensated So the size of error costs depends on how much peoples’ behavior
responds to the incentives caused by liability
“The social value of reducing errors depends on whether the errors affect production or merely distribution” When errors have large incentive effects, filing fees should be low When errors have small incentive effects, efficiency requires higher filing
fees
Filing costs
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As long as there are any filing fees or other costs to litigation, some harms will be too low to justify a lawsuit When harm is small to each individual but large overall, one solution is a class action lawsuit
Filing costs
Probability
Expected value of claims
Filing Fee
SUE
DON’TSUE
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One or more plaintiffs bring lawsuit on behalf of a large group of people harmed in a similar way Example: California lawsuit over $6 bounced-check fee
Court must “certify” (approve) the class Participating in a class-action suit eliminates victim’s right to sue on his
own later If suit succeeds, court must then approve plaintiff’s proposal for dividing
up the award among members of the class
Class-action suits are desirable when individual harms are small but aggregate harms are large… Especially when avoidance of liability has strong incentive effect But there’s also a danger
Class Action Lawsuits
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Agency problem Client wants lawyer to work on case until marginal cost of more
work equals marginal benefit This is hard to achieve through a contract, because lawyers face
their own incentives One solution: 100% commission (client “sells lawsuit to lawyer”) But this is illegal Common solution: reputation
Lawyers and clients
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Stages of the legal process…decision to pursue a legal claimbargaining over out-of-court settlementspre-trial exchange of informationtrial itselfappeals process
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Trials are costly to both parties If both parties agree on expected outcome of a trial, both are better off
agreeing to out-of-court settlement on similar terms If two sides are relatively optimistic about their chances in court, this
may be impossible After lawsuit filed but before trial, parties have opportunity to negotiate a
settlement, and to exchange information relevant to trial Some information exchange is mandatory
“Discovery” process in U.S. – each side must supply opponent with evidence they plan to use, answer questions about case
In Europe, no pre-trial discovery; instead, first stage of trial involves similar sharing of information in front of judge
Does voluntary pooling of information promote settlement? Does involuntary pooling of information promote settlement?
Exchange of Information
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Parties tend to disclose information that corrects the other side’s relative optimism I hit you with my car I think your injuries were minor, damages might be $1,500 You know they were serious, have x-rays and doctor’s reports to prove it, know
damages will be $15,000 Going to trial costs us each $3,000 As things stand: I expect trial to cost me $4,500; you expect to gain $12,000; settlement
seems unlikely But you’re happy to show me your evidence Once I see it, I might offer a bigger settlement, we both avoid cost of trial
Parties tend to withhold information that would correct other side’s relative pessimism
Either way, voluntary exchange of information tends to encourage settlement
Voluntary exchange of information
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Cooter and Ulen:
Trials occur when the parties are relatively optimistic about their outcome, so that each side prefers a trial rather than settlement on terms acceptable to the other side.
When the parties are relatively optimistic, at least one of them is uninformed.
Pooling of information before trial that reduces relative optimism promotes settlement.
Furthermore, by revealing private information to correct the other side’s false optimism, the party making the disclosure increases the probability of settling on more favorable terms.
Voluntary exchange of information
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Involuntary disclosure will tend to reveal information the parties would otherwise choose to withhold This is usually information that corrects relative pessimism So forced disclosure may make settlement less likely
On the other hand, involuntary disclosure reduces uncertainty, makes two sides’ threat points more clear May make reaching a settlement easier
So overall effect is unclear Involuntary disclosure may also delay settlement until after
disclosure occurs
What about involuntary exchange of information?
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Disclosure (“discovery”) rule in the U.S. very extensive Parties reveal basic arguments they’ll make, evidence that supports
them, names of witnesses, nature of each witness’s testimony Each side can inspect other’s evidence, question its witnesses Witnesses or evidence not disclosed during discovery may not be
allowed at trial
Most European countries have little or no pre-trial discovery Europe: juries rarely used in civil cases Delays and interruptions less costly, more common Under civil law, judges take more active role in developing
arguments and exploring evidence
What about involuntary exchange of information?
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Voluntary disclosure encourages settlements Fewer trials, simpler/quicker trials lower administrative costs Settlement terms get closer to likely trial outcome; if this judgment would
likely be correct, this reduces error costs
Involuntary disclosure Might lead to more or fewer trials Should lead to simpler, shorter trials Discovery is also a costly process Overall effect on administrative costs could be positive or negative Pools much of the information that would come out at trial, so settlements
should deviate less from trial outcomes So involuntary disclosure should reduce error costs
Effect of information disclosure on administrative and error costs
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Stages of the legal process…decision to pursue a legal claimbargaining over out-of-court settlementspre-trial exchange of informationtrial itselfappeals process
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Plaintiff might accept settlements S when
S > Expected JudgmentPlaintiff – Legal CostsPlaintiff
Defendant might offer settlements S when
S < Expected JudgmentDefendant + Legal CostsDefendant
So settlement is possible when
EJP – LCP < EJD + LCD
which is when
EJP – EJD < LCP + LCD
Pre-Trial Bargaining
degree of relative optimism
combined legal costs
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Suppose parties agree on expected judgment EJ
If bargaining fails and case goes to trial, Plaintiff gets expected payoff EJ – LCplaintiff
Defendant gets expected payoff – EJ – LCdefendant
So these are threat points during bargaining Combined payoffs are – LCplaintiff – LCdefendant
If settlement is reached, combined payoffs are 0 So gains from cooperation are LCplaintiff + LCdefendant
If gains from cooperation are split evenly… Plaintiff’s payoff is (threat point) + ½ (gains)
= (EJ – LCplaintiff) + ½ (LCplaintiff + LCdefendant)
= EJ – ½ LCplaintiff + ½ LCdefendant
Pre-Trial Bargaining
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We just concluded… If the two parties agree on expected outcome of trial… …and successfully negotiate a settlement… …and divide gains from cooperation equally… then settlement = EJ – ½ LCP + ½ LCD
If going to trial is equally costly to both parties, this is just EJ – the expected judgment at trial
But if trial is more costly to defendant, this would be more
Pre-Trial Bargaining
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A nuisance suit is a lawsuit with no legal merit If it goes to trial, defendant will definitely win (EJ = 0) Sole purpose of a nuisance suit is to force a settlement Just found: “reasonable settlement” = EJ – ½ LCP + ½ LCD
So if LCP = LCD, nuisance suit is pointless – reasonable settlement would be 0
But suppose going to trial is very costly for defendant Publicity would be bad for defendant’s reputation Or, developer has to settle lawsuit to avoid delaying construction LCP is just legal fees
But LCD includes legal fees plus other costs
So even if lawsuit has no merit, defendant might feel forced to pay a settlement
Nuisance Suits
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Example Cost of going to trial is $5,000 for defendant, $1,000 for plaintiff Expected judgment = 0 Threat points are -5,000 and -1,000 Gains from cooperation are 6,000 If gains are split evenly, plaintiff’s payoff is (threat point) + ½ (gains)
= -1,000 + ½ (6,000)
= 2,000 So nuisance suit might lead to a settlement of $2,000, even though
expected judgment at trial is 0
Nuisance Suits
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Even without relative optimism, settlement negotiations may fail due to private information Ex: defendant made a faulty product, which injured lots of people Some sustained minor injuries, say $2,000 Some sustained major injuries, say $10,000 Before trial, defendant can’t tell scope of plaintiff’s injuries Suppose legal costs are $500 for each side If ½ of plaintiffs had major injuries, average injury = $6,000 So reasonably settlement offer might be $6,000 But if all defendants are offered a settlement of $6,000, the ones with minor
injuries will take it, and the ones with major injuries will go to trial Defendant has two choices:
Offer settlements large enough that everyone will accept But then even people with very minor injuries, or none, might sue Or offer only small settlements, and get stuck going to trial in many cases
Failures in negotiations
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Stages of the legal process…decision to pursue a legal claimbargaining over out-of-court settlementspre-trial exchange of informationtrial itselfappeals process
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In Europe… Judges in civil trials take active role in asking questions and
developing case “Inquisitorial system,” since judge asks questions
In U.S… Lawyers’ job to develop case Judge is more of a passive referee “Adversarial system,” since competing lawyers are adversaries
Trial
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Lawyers have a strong incentive to win at trial May be working on contingency Value reputation for winning
Judges have no stake in outcome of the trial Judges will (we hope) generally do what is right… …but have less motivation to work hard
“Judges have incentives to do what is right and easy; lawyers have incentives to do what is profitable and hard.”
Incentives
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In U.K., loser in a lawsuit often pays legal expenses of winner Discourages “nuisance suits” But also discourages suits where there was actual harm that may
be hard to prove
In U.S., each side generally pays own legal costs But some states have rules that change this under certain
circumstances
Who pays the costs of a trial?
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Rule 68 of Federal Rules of Civil Procedure“At any time more than 10 days before the trial begins, a party defending against a claim may serve upon the adverse party an offer [for a settlement]…
If the judgment finally obtained by the offeree is not more favorable than the offer, the offeree must pay the costs incurred after the making of the offer.”
“Fee shifting rule” Example
I hit you with my car, you sue Before trial, I offer to settle for $6,000, you refuse If you win at trial, but judgment is less than $6,000… …then under Rule 68, you would have to pay me for all my legal
expenses after I made the offer
Who pays the costs of a trial?
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Rule 68 does two things to encourage settlements: Gives me added incentive to make a serious settlement offer Gives you added incentive to accept my offer
But not actually as generous as it sounds Attorney’s fees not always included in fees that are covered
Asymmetric Plaintiff is penalized for rejecting defendant’s offer Defendant is not penalized for rejecting offer from plaintiff
Who pays the costs of a trial?
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Kathryn Spier, “Pretrial Bargaining and the Design of Fee-Shifting Rules” Game-theory analysis of Rule 68 and similar rules Shows that when parties have private information, fee-shifting rules
like this increase probability of settlement Then considers designing “perfect” rule to maximize number of
cases that would settle out of court Ideal rule is similar to two-sided version of Rule 68
Take each side’s most generous settlement offer Compute a cutoff If eventual judgment is below this cutoff, plaintiff pays both sides’ legal
fees; if above cutoff, defendant pays both sides’ fees
Who pays the costs of a trial?
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Trial has to answer two questions: Is defendant liable? If so, how much are damages?
Unitary trial considers liability and damages at same time Economies of scope
Segmented trial considers liability first, then damages later (if necessary) Damages phase may not be necessary
In U.S., judges have discretion over which type of trial
Unitary versus Segmented Trials
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Burden of proof: who is responsible for showing what at trial In criminal case, prosecutor’s burden to show defendant is guilty,
not defendant’s burden to show he’s innocent Similarly, in civil case, plaintiff’s burden to make case Under negligence rule, plaintiff has to prove defendant was
negligent (rather than defendant having to show he was not) Under contributory negligence, once defendant is shown to be
negligent, it’s defendant’s burden to show plaintiff was also negligent
Burden of proof
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Standard of proof: degree of certainty to which something must be shown in court In criminal cases, “beyond a reasonable doubt” – very high standard In civil cases, plaintiff usually has to prove case by “a preponderance
of the evidence” Much lower standard –interpreted as anything over 50% certainty
For punitive damages to be awarded, high standard of proof is often required: “clear and convincing evidence”
Efficient level depends on relative costs of two types of errors Finding someone liable when they should not be Finding someone not liable when they should be
Standard of proof
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Rules for what evidence court can pay attention to
Textbook gives examples where rules seem inconsistent, if goal is simply to maximize probability of “right outcome”
When we focus on efficiency, we care only about outcomes, not about process
But in real-world legal system, process is important in its own right
Rules of evidence
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Stages of the legal process…decision to pursue a legal claimbargaining over out-of-court settlementspre-trial exchange of informationtrial itselfappeals process
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In U.S., three levels of federal courts District courts, circuit courts of appeals, Supreme Court (Many state court systems also have three levels, but this varies by
state) Parties in district court cases have right of appeal
Circuit court is required to consider their appeal Parties in circuit court cases do not
Supreme Court has discretionary review – chooses which cases to hear
In common law countries, appeals courts tend to only consider certain issues Appeals generally limited to matters of law Matters of fact generally not considered
Appeals
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Recall goal of legal system Minimize administrative costs + error costs
Clearly, appeals process increases administrative costs So only efficient if it reduces error costs
Reasons why appeals process may reduce error costs Appeals courts are more likely to reverse “wrong” decisions than
“right” decisions… …which leads to losing parties appealing more often when decision
was “wrong”
Appeals
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Stages of the legal process…decision to pursue a legal claimbargaining over out-of-court settlementspre-trial exchange of informationtrial itselfappeals process