Economics of the Legal Process

1. Economics of the Legal Process

2. 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

3. 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% Settlement more likely P(liable) = 10% Settlement less likely

4. Administrative costs Cost of errors Wrong precaution levels Wrong activity levels The Legal Process • Previous assumptions: • Legal system works flawlessly • Legal system is costless • Objective: MinSocial Costs = ca + c(e) Damages = Actual Harm

5. A Legal Decision Tree Injury? What is the value of a legal claim? yes Sue? no yes end Settle or Exchange info? no end Bargain info settle end Don’t settle Trial settle end win lose Appeal end Handout win lose end end

6. Determining the # of Suits • The # of legal claims filed depends on: • # injuries • Cost of filing a complaint • Expected value of a legal claim Number of claims filed What does the relationship look like? Damages Awarded

7. Determining the # of Suits • Higher FC means: • Fewer lawsuits and lower ca • Larger # of injuries go unpunished, therefore higher c(e) Number of potential plaintiffs Class Action lawsuits? don’t sue sue Appropriate where individual harms are small but aggregate harms are large FC EVC

8. Client – Lawyer Problems • Asymmetric info • Lawyer knows the law • Client knows the facts • Optimal payment system • Hourly pay? • Per service charge? • Contingency fee?

9. 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? Impact on social costs? US vs Europe

10. 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

11. 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.”

12. 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”

13. 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” “discretionary review”