Litigation, Economics of Basic Framework

This article begins by introducing the basic economic framework for studying litigation and out-of-court settlement. One set of issues addressed is positive (or descriptive) in nature. Under what conditions will someone decide to file suit? When do cases settle out of court? Normative issues are also addressed. Are these private litigation decisions in the interest of society more broadly? Next, the article surveys some of the more active areas in the litigation literature including rules of evidence, loser-pays rules, appeals, contingent fees for attorneys, alternative dispute resolution, class actions, and plea bargaining. Litigation refers to the process of taking an argument to a court of law where a decision will be made. The discipline of economics has provided researchers – economists and legal scholars alike – with useful tools and frameworks for thinking about litigation. Is there too much litigation or too little? Why do some lawsuits go to trial while many others settle before trial? Should the losing party be required to reimburse the winning party's legal expenses? The first part of this article presents the main frameworks for studying the economics of litigation. The second part surveys just some of the active topics in the literature. The decision to litigate Suppose there are two litigants: one plaintiff and one defendant. The plaintiff is the injured party who seeks compensation; the defendant is the party who is potentially responsible for the plaintiff's injuries. A plaintiff will rationally choose to bring suit when the expected gross return from litigation, x, exceeds the cost of pursuing the case, c p. The gross return, x, represents the expected judgment at the end of a long and costly trial or a settlement that takes place at some time prior to the trial. It could also reflect other issues, such as the impact that a court decision will have on future cases or the plaintiff's concern for her business reputation. In general, the plaintiff's cost of pursuing the case, c p , and the defendant's cost of fighting back, c d , would influence the gross return, x, and could be modelled in a similar way to other economic contests (Dixit, 1987). For the moment, however, we will treat them as exogenous. The plaintiff's incentive to bring suit typically diverges from what is best for society as a whole (see Shavell, 1982b; 1997). Consider a situation where accidents are totally avoided if the defendant …