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 = $ $3000 = $5000 My expected cost of going to trial = $ $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 = c a + c(e) Damages = Actual Harm Administrative costsCost of errors Wrong precaution levels Wrong activity levels

A Legal Decision Tree Injury? Sue? Settle or Exchange info? Bargain Trial Appeal end win lose yes no settle Don’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 What does the relationship look like?

Determining the # of Suits  Higher FC means: Fewer lawsuits and lower c a 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 > EJ P – LC P  Defendant will offer settlement S if: S < EJ D + LC D  What does a “reasonable” settlement look like? Where: S = settlement EJ P = expected judgment LC P = litigation costs S > $ $3000 = $5000 S < $ $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: c a + c(e) “right of appeal” “discretionary review”