economic analysis of litigation and the legal process

NBER WORKING PAPER SERIES

ECONOMIC ANALYSIS OF

LITIGATION AND THE LEGAL PROCESS

Steven Shavell

Working Paper 9697

http://wendang.chazidian.com/papers/w9697

NATIONAL BUREAU OF ECONOMIC RESEARCH

1050 Massachusetts Avenue

Cambridge, MA 02138

May 2003

Research support from the John M. Olin Center for Law, Economics, and Business is gratefullyacknowledged. The views expressed herein are those of the authors and not necessarily those of the NationalBureau of Economic Research.

©2003 by Steven Shavell. All rights reserved. Short sections of text not to exceed two paragraphs, may bequoted without explicit permission provided that full credit including ©notice, is given to the source.

Economic Analysis of Litigation and the Legal Process

Steven Shavell

NBER Working Paper No. 9697

May 2003

JEL No. D00, D6, D8, K00, K4This paper contains the chapters on litigation and the legal process from a general, forthcomingbook, Foundations of Economic Analysis of Law (Harvard University Press, 2003). In chapter 17,I consider the basic theory of litigation. Here I describe the three phases of litigation: its initiationthrough suit, the determination of whether the parties will settle their case or proceed to trial, and,if trial results, the trial expenditures. I also analyze the social desirability of their decisions, a majortheme being that the private incentives to litigate may diverge from what is socially desirable. Inchapter 18, I extend the basic theory of litigation, examining among other issues the bringing ofnegative value suits, shifting of legal fees to losers at trial, lawyer-client fee arrangements, and theinfluence of insurers on litigation. Then, in chapter 19, I discuss several general aspects of the legalprocess not considered in the basic theory and its extensions, including private systems ofadjudication, the value of accuracy in adjudication, the appeals process, and the function of legaladvice.

Steven Shavell

Harvard Law School

1575 Massachusetts Avenue

Hauser Hall 508

Cambridge, MA 02138

and NBER

shavell@law.harvard.edu

Table of Contents

Economic Analysis of Litigation and the Legal Process

Chapter 17. Basic Theory of Litigation

1. Bringing of Suit

2. Fundamental Divergence Between the Private and the Socially Desirable Level of Suit

3. Settlement versus Trial

4. Divergence between the Private and the Socially Desirable Level of Settlement

5. Trial and Litigation Expenditure

Chapter 18. Extensions of the Basic Theory of Litigation

1. Negative Value Suits

2. Sharing of Information Prior to Trial

3. Forced Disclosure of Information Prior to Trial: Discovery

4. Shifting of Legal Fees to the Loser at Trial

5. Difficulty of Statistical Inference from Trial Outcomes

6. Elements of Trial Outcomes Apart from the Judgment

7. Role of Lawyers in Litigation

8. Role of Insurers in Litigation

Chapter 19. General Topics on the Legal Process

1. Public versus Private Legal Systems

2. Accuracy of the Legal Process

3. Appeals and the Legal System

4. Legal Advice and the Role of Lawyers in the Legal System

Summary Table of Contents of

Foundations of Economic Analysis of Law

(forthcoming 2003, Harvard University Press)

Chapter 1. Introduction

Part One. Accident Law

Chapter 2. Liability and Deterrence: Basic Theory

Chapter 3. Liability of Firms

Chapter 4. Extensions of the Basic Theory

Chapter 5. Liability, Risk-bearing, and Insurance

Chapter 6. Liability and Administrative Costs

Part Two. Property Law

Chapter 7. Definition, Justification, and Emergence of Property Rights

Chapter 8. Division of Property Rights

Chapter 9. Acquisition and Transfer of Property

Chapter 10. Conflict and Cooperation in the Use of Property: The Problem of Externalities Chapter 11. Public Property

Chapter 12. Property Rights in Information

Part Three. Contract Law

Chapter 13. Overview of Contracts

Chapter 14. Contract Formation

Chapter 15. Production Contracts

Chapter 16. Other Types of Contract

Part Four. Litigation and the Legal Process

Chapter 17. Basic Theory of Litigation

Chapter 18. Extensions of the Basic Theory of Litigation

Chapter 19. General Topics on the Legal Process

Part Five. Public Law Enforcement and Criminal Law

Chapter 20. Deterrence with Monetary Sanctions

Chapter 21. Deterrence with Nonmonetary Sanctions

Chapter 22. Extensions of the Theory of Deterrence

Chapter 23. Other Functions of Sanctions: Incapacitation, Rehabilitation, Retribution Chapter 24. Criminal Law

Part Six. General Structure of the Law

Chapter 25. The General Structure of the Law and Its Optimality

Part Seven. Welfare Economics, Morality, and the Law

Chapter 26. Welfare Economics and Morality

Chapter 27. Implications for the Analysis of Law

Chapter 28. Income Distributional Equity and the Law

Chapter 29. Commonly-Raised Questions about Economic Analysis of Law

Economic Analysis of Litigation

and the Legal Process

(part of Foundations of Economic Analysis of Law)

Steven Shavell

©2003. Steven Shavell. All Rights Reserved.

Chapter 17

BASIC THEORY OF LITIGATION

In this chapter, I take up the basic theory of litigation. Three stages will be considered. In the first, the party who has suffered a loss decides whether to bring a suit. A party who brings a suit is, of course, the plaintiff, and the party who is sued is the defendant. In the second stage, the plaintiff and the defendant decide whether or not they will settle the case -- in the event of a settlement, the plaintiff agrees to drop the suit, usually in exchange for a payment from the defendant. If a settlement is not reached, the third stage, that of trial, occurs.

In each stage, I discuss how the parties behave and then how this compares to what is socially desirable. A theme that I emphasize is that the private incentives of parties in litigation may diverge significantly from socially appropriate incentives, given that litigation is a costly activity.

1. Bringing of Suit

1.1 Definition of suit. By a suit, I will mean the taking of a costly initial step that is a prerequisite to further legal proceedings and trial. One may interpret suit as a formal legal action, such as the filing of a complaint, or as an action short of that, notably, the hiring of a lawyer. Bringing a suit involves costs; the plaintiff will expend time and energy and possibly incur a bill for legal services and filing fees.

1.2 Private incentive to sue. The plaintiff will sue when his cost of suit is less than his expected benefits from suit.1 The plaintiff’s expected benefits from suit involve possible

settlement payments or gains from trial. However, for the purposes of this and the next section on suit, it will be sufficient to assume simply that there is an expected benefit from suit, without inquiring into its determination.

From the simple description of suit, note that suit is more likely the lower the cost of suit, the greater the likelihood of winning at trial, and the greater the plaintiff’s award conditional on winning. Suit is also more likely the less averse to risk the plaintiff is and the more averse the defendant is.

1.3 Volume of suit and its costs. About 2.3 million non-criminal cases were filed in federal courts in 2000, and approximately 20.1 million non-criminal cases were filed in state 1In this chapter it will be assumed that parties are risk-neutral unless otherwise noted.

Chapter 17 – Page 1