Econ 522Economics of Law

Dan Quint

Fall 2009

Lecture 21

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Midterm is graded – pick it up at end of class

HW3 due next Tuesday (December 8)

Logistics

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The legalprocess

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Formulated the goal of the legal process Minimize social costs, which consist of: Administrative costs, and Error costs

Broke the legal process into a series of steps, and discussed a couple of them

Today: More on the legal process A bit on crime and criminal law (more Thursday)

Tuesday, we…

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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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CriminalLaw

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Criminal intended to do wrong

Case brought by government, not individual plaintiff

Harm done tends to be public as well as private

Standard of proof is higher

If found guilty, defendant will be punished

Criminal law differs from civil law in several ways

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As of 2005, over 2,000,000 prisoners, nearly 5,000,000 more on probation or parole Up from ~500,000 in 1980 93% male In federal prisons, 60% are drug-related Incarceration rate of 0.7% is 7 times that of Western Europe

Cooter and Ulen estimate social cost of crime $100 billion spend annually on prevention and punishment 1/3 on police, 1/3 on prisons, 1/3 on courts, prosecutors, public defenders,

probation officers, etc. Estimate another $100 billion on private crime prevention Estimate total social cost to be $500 billion, or 4% of GDP

Crime in the U.S.

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Crime rates (relative to population) in the U.S… Decreased steadily from mid-1930s to early 1960s Increased sharply in 1960s and 1970s In 1980s,

Nonviolent crimes committed by adults dropped sharply Violent crimes committed by adults dropped slightly Violent crimes by young people went up

Violent and nonviolent crime rates dropped sharply in 1990s, continued to drop more slowly since 2000

Nonviolent crime rate in U.S. now similar to Europe

Crime in the U.S.

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Criminals in the U.S… Disproportionally young males

Crime rates generally follow trend in fraction of population age 14-25 Both violent criminals and victims disproportionally African-American Relatively small number of people commit large fraction of violent

crimes Tend to come from dysfunctional families… …have relatives who are criminals… …do poorly in school… …be drug- and alcohol-abusers… …live in poor/chaotic neighborhoods… …and being misbehavior at young age

Crime in the U.S.

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Hard to answer empirically, because two effects

Deterrence When punishment gets more severe, crime rates may drop because

criminals are afraid of being caught

Incapacitation When punishment gets more severe, crime rates may drop because

more criminals are already in jail

Kessler and Levitt: natural experiment Voters in California in 1982 passed ballot initiative adding 5 years per

prior conviction to sentence for certain crimes Found immediate drop of 4% in crimes eligible for enhanced sentences

Do harsher punishments deter crime?

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Imprisonment has several effects: Deterrence Punishment Opportunity for rehabilitation Incapacitation

When is incapacitation effective? When supply of criminals is inelastic

(When there isn’t someone else waiting to take criminal’s place) And when it changes number of crimes a person will commit,

rather than just delaying them

Imprisonment

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Direct costs of holding someone in maximum-security prison estimated at $40,000/year

In some states, prisoners do useful work Attica State Prison (NY) had metal shop Minnesota firm employs inmates as computer programmers Medium-security prisons in Illinois make marching band uniforms But legal limitations

1980-1990: most state and federal courts moved away from judicial discretion toward mandatory sentencing Recent move in opposite direction

Imprisonment

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Sharp drop in crime rate in U.S. in 1990s

Several explanations: deterrence and incapacitation decline of crack cocaine, which had driven much of crime in 1980s economic boom more precaution by victims change in policing strategies

Donohue and Levitt give a different explanation: abortion

Why did U.S. crime rate fall in 1990s?

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Donohue and Levitt U.S. Supreme Court legalized abortion in early 1973 Number of legal abortions ~ 1,000,000/year (compared to birth rate of

3,000,000) Violent crimes largely committed by males of certain ages Donohue and Levitt argue legalized abortion led to smaller “cohort” of

people in high-crime age group starting in early 1990s Evidence:

Most of drop was reduction in crimes committed by young people Five states legalized abortion three years before Roe v Wade, saw drop in

crime rates begin earlier States with higher abortion rates in late 1970s and early 1980s had more

dramatic drops in crime from 1985 to 1997, no difference before Argue this explains 50% of drop in crime in 1990s

Half of that from cohort size, half from composition

Why did U.S. crime rate fall in 1990s?

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Model of criminal law, what does efficient criminal system look like?

Thursday…

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Mean 73, median 74.5, std dev 12

Again, in very approximate terms…

> 80 roughly AB or A

70-80 roughly B

60-70 roughly BC

below 60 roughly C or worse

last names A-L last names M-Z

Second midterm