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M. Bayes D. Kovenock C. de Vries The Economic Journal 115, (2005)

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Motivation Difference in suits filed and expenditures between different legal systems. The US is generally viewed as having an excessive number of lawsuits compared to other nations

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Motivation What design features lead to lower legal expenditures and fewer lawsuits? Does reducing legal expenditures reduce the social cost of litigation?

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Tort Reform in the US In 1991 VP Quayle proposed a modification to the legal system Loser required to pay winner’s legal costs up to own cost level.

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Tort Reform in the US 2004 Economic Report of the President Americans spend twice as much on torts than on new automobiles

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Figure 1: Tort Expenditures as a Percentage of GDP

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Previous Literature Spier (1992) Reinganum and Wilde (1986) Schweizer (1989) Hughes and Snyder (1995)

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Previous Literature Spier (1992) Costly for plaintiff to go to court These costs do not influence court decision Plaintiff always wins Amount won is randomly assigned

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Previous Literature Reinganum and Wilde (1986) Schweizer (1989) Probability of winning is exogenous Independent of legal expenditures

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Previous Literature Reinganum and Wilde (1986) Schweizer (1989) Model is useful for determining incentives to go to court instead of settling out of court

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Previous Literature Reinganum and Wilde (1986) Schweizer (1989) Model does not allow comparisons to situations where parties can improve probability of winning Hiring better attorneys Use of expert witnesses

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Previous Literature Hughes and Snyder (1995) Optimism Model Exogenous beliefs concerning merit of case These beliefs determine whether parties settle Expected payoffs from trial can be determined

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Legal Systems Across the world, variations in legal systems create different contests These contests differ in the costs associated with winning and losing the court case

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Legal Systems American Litigants pay own expenses British Loser pays own expenses and all of winner’s Continental Loser pays own expenses and a fraction of the winner’s

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Legal Systems Qualye – Loser pays own costs and reimburses winner up to loser’s cost level Marshall – Winner pays own costs and reimburses loser for all of loser’s costs Matthew – Winner pays own expenses and transfers an amount the is proportional to own expenses to loser

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Two views of the justice system Winning is determined solely be expenditures Winning is independent of expenditures and is determined solely by the merit of the case presented.

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The Model An auction-theoretic model of litigation Each party i has a private valuation v i Valuation is an independent random draw from a distribution function with continuous density Distribution of valuations is common knowledge

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The Model

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Legal ownership of an asset is in dispute Role of court is to examine evidence and award the asset to the party presenting the best case

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The Model Each party has costs for gathering and presenting evidence Legal expenditures of party i are e i e i ≥ 0

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The Model The court’s only observation is of the quality of the cases presented. Quality (q i ) is a continuous, strictly increasing function of legal expenditure

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The Model Note:

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The Model Underlying Assumptions: Symmetric production technologies Both parties have similar claim to asset

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The Model Payoff depends on: Outcome of trial Fee shifting rules

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The Model Payoff function for agent i are fee shifting parameters

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The Model Best case wins Independent of ‘truth’. Truth is unobservable to the court. (The only observation of the court is of the quality of the case)

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The Model Court cases are neither taxed nor subsidized

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The Model Implications of A3: due to internalized costs and therefore:

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The Model Using the relations from A1, A2, and A3 and substituting into this payoff function:

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The Model Proposition 1: The payoff function

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Legal Systems Revisited American Litigants pay own expenses British Loser pays own expenses and all of winner’s Continental Loser pays own expenses and a fraction of the winner’s

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Legal Systems Revisited Note that the British System is the limit of the Continental System as beta goes to zero

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Legal Systems Revisited Qualye – Loser pays own costs and reimburses winner up to loser’s cost level Marshall – Winner pays own costs and reimburses loser for all of loser’s costs Matthew – Winner pays own expenses and transfers an amount the is proportional to own expenses to loser

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Legal Systems Revisited Summary

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Legal Outlays at Trial Characterize closed-form expressions for equilibrium expenditures Uses the auction-theoretic model

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Legal Outlays at Trial Expected payoff expression

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Legal Outlays at Trial Value from winning Value from losing Thus

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Legal Outlays at Trial Differentiation with respect to e i yields F.O.C.

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Comparative Statics Equilibrium expenditures are decreasing in beta. Higher beta requires winner to pay more Which reduces the benefit of spending Leading to less vigorous court battles

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Comparative Statics Which is an incomplete ordering of the legal systems in question

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Crossing Functions Equilibrium spending under the American and Marshall functions cross As do American and Quayle functions Because these functions cross expenditure rankings are not possible

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Revenue Equivalence Theorem Let U(v) be expected utility in the unique SE Let P(v) be the corresponding probability of winning

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Revenue Equivalence Theorem Internalization of legal costs implies that net payments across types are E[e(v)] Noting that in SE: P(v) = F(v)

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Revenue Equivalence Theorem Using results standard in the mechanism design literature (Klemperer, 1999):

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Revenue Equivalence Theorem But since the litigant with the highest value always wins, the utility of a litigant with the lowest valuation U(0) =

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Revenue Equivalence Theorem Substitution and taking expectations yields:

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Revenue Equivalence Theorem Equating these two expressions and integrating yields:

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Revenue Equivalence Theorem To summarize:

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Proposition 4 While actual expenditures depend on both alpha and beta, expected expenditures are independent of alpha and strictly decreasing in beta. Expected total expenditure (TC) is thus also independent of alpha and decreasing in beta.

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Total Expected Expenditures which can be used to create a full ranking of expected total expenditure by legal system

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Ranking by total expected expenditure In systems with lower expected total cost, the expected payoff is higher, leading to:

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Ranking by expected payoff This ranking is dependent on beta, the amount of his or her own legal expenditures the winner pays.

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Tradeoffs in Beta Higher betas result in lower equilibrium expenditures. Higher betas results in higher payoffs, increasing incentive to file lawsuits.

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“… systems which generate lower expected expenditures result in higher expected payoffs from litigation, and, therefore, result in more cases being brought to trial”

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Incentives to Litigate Modeled as a Prisoner’s Dilemma

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American System Litigation dominates conceding for any player with a positive valuation. Ex ante legal outlays are maximized when beta = 1

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Ex Ante Legal Outlays Take into account both: Ex post expenditures per trial Incentive to litigate

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Maximum at beta = 1, the American System

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Conclusions Litigation systems with lower equilibrium legal expenditures per trial provide a greater incentive for parties to file lawsuits than systems with higher equilibrium expenditures

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Future Directions Lack of statistics comparing different systems Future research can generate this data Difficulties in cross-cultural comparisons

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Future Directions Capture difference in merit of suits: by allowing for asymmetric legal production functions

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Future Directions Incorporate work by Che and Gale (1998) on budget constrained players to analyze a more complex type of problem.

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Future Directions In any case, there are many ways in which this model can be extended to provide a more detailed picture of the incentives to litigate and the equilibrium characteristics of court cases.

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Comments

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Imperfectly Discriminating Courts What are differences in equilibrium of this model and a model wherein the court is not perfectly discriminating?

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Imperfectly Discriminating Courts Do the perceptions of a nation’s citizens as to the efficiency of the court system alter how they approach the filing of lawsuits in a systematic way?

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