Economics of the Legal Process

Car Accident I hit you with my car and cause $10,000 in damages We both believe that there’s an 80% chance I’ll be

held liable if we go to trial

Suppose going to trial cost each of us $3000

There’s room to negotiate a settlement

You expect to recover: (0.80)($10,000) = $8000

Your net gain from going to trial = $8000 - $3000 = $5000

My expected cost of going to trial = $8000 + $3000 = $11,000

Car Accident What if one of us has private information?

Suppose I’m more pessimistic about a trial’s outcome?

Suppose I’m more optimistic about a trial’s outcome?

P(liable) = 90%

P(liable) = 10%

Settlement more likely

Settlement less likely

The Legal Process Previous assumptions:

Legal system works flawlessly Legal system is costless

Objective: Min Social Costs = ca + c(e)

Damages = Actual Harm

Administrative costs Cost of errors

Wrong precaution levelsWrong activity levels

A Legal Decision TreeInjury?

Sue?

Settle or Exchange info?

Bargain

Trial

Appeal

end

end

end

end

end

end end

win

win

lose

lose

yes

yes

no

no

settle

settleDon’t settle

info

What is the value of a legal claim?

Handout

Determining the # of Suits The # of legal claims filed depends on:

# injuries Cost of filing a complaint Expected value of a legal claim

Damages Awarded

Number of claims filed

d~

What does the relationship look like?

Determining the # of Suits

Higher FC means: Fewer lawsuits and lower ca

Larger # of injuries go unpunished, therefore higher c(e)

EVC

Number of potential plaintiffs

FC

Class Action lawsuits?

Appropriate where individual harms are small but aggregate harms are large

suedon’t sue

Client – Lawyer Problems Asymmetric info

Lawyer knows the law Client knows the facts

Optimal payment system Hourly pay? Per service charge? Contingency fee?

Exchange of Information Pre-trial “discovery” phase

Voluntary pooling of info Parties tend to reveal info that corrects the other

side’s relative optimism Parties tend to withhold info that corrects the other

side’s relative pessimism Involuntary pooling of info

Correcting relative pessimism makes settlement less likely

But it does reduce overall uncertainty which makes settlement more likely

You reveal your medical x-rays to show severe

damages

Was that crunching sound a broken hip?

US vs Europe

Impact on social costs?

Pre-Trial Bargaining Plaintiff will accept settlement S if: S > EJP – LCP

Defendant will offer settlement S if: S < EJD + LCD

What does a “reasonable” settlement look like?

Where: S = settlement EJP = expected judgment LCP = litigation costs

S > $8000 - $3000 = $5000

S < $8000 + $3000 = $11,000

Trial Europe: inquisitorial system US: adversarial system

Who pays the costs of trials? US: each side pays their own costs United Kingdom: loser pays all costs

“Judges have incentives to do what is right and easy; lawyers have incentives to do what is profitable and hard.”

Trial Unitary trials: liability and damages Segmented trials: liability then damages

Burden of proof Criminal cases: “innocent until proven guilty” Civil cases: plaintiff typically has burden

Standard of proof Civil cases: “preponderance of the evidence” Criminal cases: “beyond a reasonable doubt”

Appeal Federal courts:

District courts (94)

Circuit courts of appeal (12) Supreme Court

Matters of law vs Matters of fact

Impact on social cost: ca + c(e)

“right of appeal”

“discretionaryreview”