Econ 522 – Lecture 20 (April 16 2009)
Cooter and Ulen wrap up the chapter on torts with an empirical assessment of the tort
system in the U.S.
The general gist of their conclusion:
 while critics claim that juries routinely hand out excessive rewards and that the
tort system is out of control, it actually functions reasonably well
 With the exception of occasional, well-publicized outliers, damage awards are
generally not unreasonable
 and liability has led to decreases in accidents in a variety of industries.
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In the 1990s, tort cases passed contract cases as the most common form of lawsuit
Most tort cases are handled at the state level
o in 1994, 41,000 tort cases were resolved in federal courts, while 378,000
were resolved by state courts in the largest 75 counties alone.
Among these cases, most involve a single plaintiff (in contrast with contract
cases, where many more involve multiple plaintiffs)
Among the cases within the 75 largest counties in the U.S.,
 about 60% had to do with auto accidents
 about 17% were “premises liability”, for example, slip and falls in restaurants,
businesses or government offices
 about 5% were medical malpractice
 about 3% were product liability
Punitive damages are historically very rare
 between 1965 and 1990, out of all product liability cases, punitive damages were
awarded 353 times
 the average award was $625,000 (in 1990 dollars), reduced to $135,000 on
appeal, with average punitive damages only slightly higher (1.2 times)
compensatory damages.
Many states impose a limit on punitive damages, or impose a higher standard of evidence
for awarding them
 In general, civil suits require a “preponderance of evidence,” which is generally
interpreted as anything over 50% certainty
 In some states, punitive damages require “clear and convincing” evidence, a
higher standard, though still lower than the “beyond a reasonable doubt” standard
used in criminal law.)
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Cooter and Ulen give a few scary statistics about medical malpractice
 a study in New York in the 1980s found 1% of hospital admissions involved
serious injury due to negligent care
 some estimates suggest that “defensive medicine” – procedures undertaken purely
to prevent possible lawsuits – account for 5% of total health care costs
 A number of states have considered caps on damages that can be awarded for
medical malpractice, although in some cases, these rules have had the opposite
effect as intended.
Cooter and Ulen cite a recent product liability survey of CEOs finding that “liability
concerns caused 47% of those surveyed to drop one or more product lines, 25% to stop
some research and development, and 39% to cancel plans for a new product.”
The liability standard in many product-related accidents is “strict products liability”,
which holds that a manufacturer is liable if the product is determined to have been
defective. This can take three forms:
 a defect in design – as in cases where the design of a car’s gas tank made it liable
to explode
 a defect in manufacture – a bolt is left off a lawn mower during assembly, or not
tightened all the way; a piece flies off and injures a user
 a defect in warning – the manufacturer fails to warn consumers about the
dangers the product poses
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One might expect precaution to be pretty unilateral – the manufacturer designs
and builds the product – and so a strict liability rule might make sense
However, there are elements of bilateral precaution
People get injured turning their lawnmowers sideways to trip hedges.
C&U suggest holding manufacturers strictly liable for defective design,
manufacture, or warnings, but not liable when victims misuse the product or
“voluntarily assume the risk of injury”
(This is strict liability with a defense of contributory negligence)
(Basically, holding the manufacturer liable in these cases means forcing them to
provide insurance for their customers, which is probably inefficient.)
They discuss attempts to reform product liability laws, in response to rising rates for
liability insurance; some states put caps on damages. They give some unconvincing
numbers, but point out that product-liability insurance costs are on the order of a quarter
of a cent for each dollar of purchase price, which doesn’t seem all that problematic.
As I mentioned the other day, if you’re interested, the paper by Schwartz spends some
time looking at evidence of the effect of tort law – that is, how actual accident rates have
responded to changes in liability rules – in a number of different industries.
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vaccines
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Recall a silly example from several lectures ago:
I stop a friend to chat in the street, he later gets hit by a falling safe that wouldn’t
have hit him if we hadn’t talked
In a sense, I caused his death
but I didn’t raise the ex-ante probability of it happening (I was as likely to cause
him to miss the safe as to get hit by it), so I shouldn’t be held liable.
Liability for vaccines is sort of an analogous situation
Many vaccines for diseases are based on a weakened version of the disease itself,
causing your body to develop a natural immunity to it.
Thus, while they make you much less likely for you to acquire the disease, there
is usually a very slim chance of contracting the disease directly from the vaccine.
For example, the Sabin polio vaccine, which replaced the weaker Salk vaccine
and basically wiped out polio, also causes 1 out of every 4,000,000 people who
receive the vaccination to contract polio.
A 1974 case established that the maker had to warn its consumers about this risk;
since then, vaccines always come with warnings about the risks.
Since then, however, a couple of people have been awarded damages after their
children developed polio from the vaccine.
If liability cannot be avoided through due care and warnings, it ends up being
built into the cost of the drug.
Worse, it discourages companies from developing beneficial vaccines.
The book gives a couple of examples – a 1976 outbreak of swine flu, and a more
recent shortage of a vaccine against whooping cough – where a company refused
to market a vaccine because it could not get liability insurance.
In the first case, the government stepped in, basically ordering the company to
produce the vaccine and assuming liability for itself.
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Cooter and Ulen wrap up with a brief discussion of mass torts – situations where many
people have been harmed in the same way, by the same plaintiff.
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Since the health risks of asbestos became widely known, over 600,000 people
have come forward with lawsuits against 6000 different defendants
Many of the claimants do not yet have, and may never get, an asbestos-related
disease.
Complicating things is that every state has a statute of limitations, a time by
which actions must be started.
One estimate is that asbestos litigation has already cost $50 billion, with less than
half of that actually going to the victims; estimates are that future litigation will be
even more costly.
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They don’t give much content about mass torts, other than to point out that courts
have shown a willingness to use some creativity in handling the situations
o One example: the case of DES, a drug administered to pregnant women in
the 1950s to prevent miscarriages, which was later found to lead to
cervical cancer and other problems
o It was impossible to establish which firm had produced the dose that was
given to a particular woman
o The California Supreme Court introduced the concept of “market share
liability” – all manufacturers of DES were held liable for the harm, in
proportion to their market share at the time.
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In this case, as in many others, victims did not all sue individually; large groups
of plaintiffs were handled together.
This is the idea of a class action lawsuit – a simultaneous lawsuit brought by lots
of plaintiffs who were all harmed in the same way
We’ll come back to this
On the one hand, this gets around the problem of small, dispersed harms
o Remember our example from earlier: if a firm’s actions do $100 of
damage to each of 10,000 people, it won’t be worth anyone’s time to sue
o But if someone can sue at once on behalf of all 10,000, the lawsuit will get
brought, which means there is an incentive to take efficient precaution
On the other hand…
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the legal system
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Over the last two months or so, we’ve
o developed theories of property and nuisance law, contract law, and tort
law
o we’ve looked at how rules of legal liability create incentives
o and thought about how these rules can be chosen to achieve efficient, or
close to efficient, results
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In general, we tried to set one party’s liability for damages equal to the harm he
caused to the other party
o damages in nuisance law
o expectation damages in contract law
o compensatory damages in tort law
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That way, he would internalize the externality he was causing, and therefore make
efficient decisions
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Implicitly, we were making two big assumptions:
o the legal system works flawlessly
o the legal system costs nothing
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The first assumption we made explicitly – by assuming we could set damages
precisely in relationship to actual harm
o In tort law, we even examined the effect on incentives when it is violated
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The second assumption we made implicitly
o By ignoring the costs of the legal system in figuring efficiency
o And also by ignoring the private costs of litigation when considering the
parties’ incentives.
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Today and next Tuesday, we will relax these assumptions, and explicitly consider
the details of the legal system and the incentives it creates.
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We begin with an example from a book by Mitch Polinsky, “An Introduction to
Law and Economics”
I hit you with my car and did $10,000 worth of damage. (Sorry.)
You and I both know that I was negligent
But we also both know that courts aren’t perfect
o If we go to trial, there’s an 80% chance I’ll be held liable, and a 20%
chance I won’t
o If I am held liable, damages will be correctly set at $10,000
o So if we go to trial, you expect to recover (on average) 80% X $10,000 =
$8,000.
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However, if we go to trial, we’ll both have to hire lawyers, and lawyers are
expensive
o Suppose going to trial will cost each of us $3,000
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So now your expected net gain from going to trial is $8,000 – $3,000 = $5,000
Similarly, my expected cost if we go to trial is $8,000 + $3,000 = $11,000
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Of course, since a trial will (in expectation) cost me $11,000 and earn you $5,000,
it’s possible we can agree to settle without going to court.
o Any settlement between $5,000 and $11,000 makes both of us better off.
o So perhaps this will happen.
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However, it’s also possible we disagree about the likely outcome of a trial
o You probably have some private information about the degree of your
injuries
o I probably have some private information about how recklessly I was
driving
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First, suppose I’m more pessimistic about my chances at trial than you
o That is, you think I’m 80% likely to be found liable, but I think it’s more
like 90%
o So you perceive your expected gain from trial to be $5,000
o But I perceive my expected cost to be 90% X $10,000 + $3,000 = $12,000
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This makes the range of possible settlements we’d both agree to even wider, and
makes settling more likely.
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On the other hand, suppose I’m more optimistic about my chances
o You still think I’m 80% likely to be held liable, but I think it’s more like
10%
o Your expected gain from trial is still $5,000
o But now my expected cost, given my beliefs, is 10% x $10,000 + $3,000 =
$4,000
So now we’re very unlikely to settle.
Finally, even if our beliefs are compatible, that is, even if there is a range of
settlements which would make us both better off than going to trial, the private
information we both have might lead to a failure to settle.
o Recall from before, that if each of our threat points are private
information, we might fail to reach an agreement because one of us tries to
hold out for too big a share.
So even if we both had the same beliefs about the likely outcome of a trial, private
information could lead us to fail to settle.
This leads us to a few quick observations:
 When there are litigation costs, if we agree on the likely outcome of a trial, there
will always be gains from settling out of court, and a range of settlements we
would both prefer to trial
 If the two sides are relatively pessimistic – the injurer perceives his expected
liability to be higher than the victim – settlement is even more likely
 If the two sides are relatively optimistic – the injurer perceives his expected
liability to be lower than the victim – settlement may be impossible
 Even if the two sides have the same beliefs or are relatively pessimistic, private
information may lead to failures in bargaining
Recall that under a strict liability rule, the injurer bore the cost of accidents, and therefore
internalized these costs and took efficient precaution
 But this assumed the cost of being sued was equal to the damage done
 With unpredictable courts and litigation costs, the private cost of being sued for
damages can be either greater or less than the actual cost of the accident
 So this could lead to either too much or too little precaution.
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But it’s trickier than that as well
 Suppose we believe that settlement talks are likely to break down, and most cases
will end up going to trial
 Then the total social cost of an accident includes the resources expended during a
trial
 That is, rather than $10,000, the cost of an accident might really be $16,000 – the
harm done, plus the cost of a trial
 If accidents do more harm, this means more precaution is cost-justified – the
optimal level of precaution is higher than before!
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We’ve already spent a lot of time looking at how incentives respond to the private
cost of accidents, so we’ll put that question aside for now.
However, in the next couple of lectures, we’ll go into greater detail about the legal
process itself – how these costs are incurred, and the effects this has.
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Cooter and Ulen point out that the legal process has a large number of steps: Once an
injury has occurred….
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The victim can decide to sue or decide not to
The victim and injurer can immediately settle out of court, or else begin the
process of preparing for trial
o In the U.S., one of the first steps in preparing for a trial involves
exchanging information relevant to the case – more on this shortly
Once information has been exchanged, the two sides still have an opportunity to
bargain again over an out-of-court settlement, and can either settle or go to trial
At trial, the victim (now the plaintiff) might win or lose
The losing side at the original trial can choose to appeal or not
Over the next lecture and a half, we’ll look more closely at each of these steps.
But first, it will help to have in mind what the theoretical goal of the legal process should
be.
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Recall that the economic essence of tort law was to minimize the total social cost
of accidents
o counting both the cost of the accidents themselves, and the costly actions
that were taken to prevent them
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Similarly, in economic terms, the goal of the legal process is to minimize its total
social costs.
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These costs come in two varieties: direct (administrative) costs, and error costs.
Administrative costs are obvious.
 If a legal process is going to require judges, you have to hire judges.
 If it’s going to require courtrooms, you have to build a courthouse.
 If it’s going to require jurors, you’ll have to pay the jurors.
 The more complex the process is, the more it is likely to cost.
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Error costs are less obvious.
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Any legal process will be imperfect
o some defendants will not be found liable when they should be
o damages will sometimes be set incorrectly
o and so on.
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We can think of an error as any judgment that differs from the theoretically
perfect judgment
o That is, any result that is different the judgment a court would impose if it
were infinitely wise and had perfect information
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An error in computing damages after the fact will affect distribution but not
efficiency
o That is, after the fact, me paying you very high damages, or not being
found liable when I should be, will matter to us
o But since the damage is already done, it won’t affect efficiency
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But anticipated errors also affect the costs that each side perceives as stemming
from their actions
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And therefore change incentives, and may lead to actions which are not efficient.
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Error costs are the costs of any distortions in actions (precaution, activity levels,
etc.) due to imperfect incentives caused by flaws in the legal system
o An example we already saw: if courts make errors in sometimes not
finding injurers liable, this may lead to lower precaution, which is
inefficient
o This inefficiency – however much the results differ from what would
happen if damages were always set correctly – is an error cost
Theoretically, then, we can see the goal of a legal process as minimizing the sum of these
two costs
 the direct costs of administering a legal process
 plus the economic effects of errors due to that process.
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Next, we look more closely at each of the different stages we already mentioned:
 the decision to pursue a legal claim or not
 the decision to settle immediately or exchange information
 the decision to settle then or go to trial
 the trial itself
 the appeals process
We begin with the question of whether or not to sue
 In a rational world, this comes down to calculating the amount you expect to gain
from suing, and comparing it to the cost
 Looking at the problem from the victim’s point of view, we can turn all the
questions above into a decision tree
 Then assign values and probabilities to the different outcomes
 And then calculate the overall expected value of a legal claim.
SUE?
Don’t File
File
SETTLE IMMEDIATELY OR EXCHANGE INFO?
Settle
“Discovery”
SETTLE OR GO TO TRIAL?
Settle
Trial
WIN OR LOSE AT TRIAL?
Win
Lose
APPEAL?
Win
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Lose
(In the U.S., before going to trial, the two sides in a lawsuit go through “pre-trial
discovery” – basically, the two sides exchange information they have that is
relevant to the case.
This could be doctor’s reports about the extent of injury, police reports about the
accident, lists of witnesses each side intends to call, and so on
In many European countries, there is no pre-trial discovery, and instead, the first
part of the trial itself involves a “giving of proofs,” in which the two sides offer
evidence to support the basic facts of their claim.)
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We’ll stick with the example from the textbook
To keep the arithmetic simple, the are numbers unrealistically small – you can
think of these as hundreds of dollars.
They assume that the damage done was $100.
Starting at the bottom of the tree, they suppose that if the plaintiff (the victim)
loses at trial, an appeal will cost $20, and will be successful 10% of the time
o That is, 10% of the time you’ll win the appeal and get a judgment of $100;
the rest of the time, you’ll get nothing
o But either way, you pay the costs of $20
So an appeal has an expected value of
10% X $100 + 90% X 0 – $20 = –$10
so the victim expects not to appeal if he loses at trial.
Now go back a step.
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Suppose going to trial costs $20, and you’ll win with probability ½.
So with probability ½, you’ll win a judgment of $100, and with probability ½,
you’ll win nothing.
So the expected value of going to trial, knowing that you don’t plan appeal if you
lose, is
½ (100) + ½ (0) – 20 = $30
Now go back another stage, and consider bargaining for a settlement.
 Suppose that it’s out of your hands whether bargaining will be successful or not
o 70% of the time, you’ll reach a settlement, for an average of $50, and
incur costs of $1
o The other 30% of the time, talks will break down, and you’ll go to trial.
 So now the expected value of reaching this stage is
70% * ($50 - $1) + 30% * ($30) = $43.30
 So the expected benefit of reaching the stage where you’ve already initiated a suit,
failed to settle initially, and already gone through discovery, is $43.30
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Now go back another stage, to the initial decision to settle immediately or go through
discovery.
 Again, Cooter and Ulen assume this is not a decision but a random chance
o With 70% probability, you’ll reach a settlement (averaging $50, and
costing $1 in legal costs)
o And with 30% probability, negotiations will fail.
 They assume the discovery process costs $3.30
 So the expected value of getting to this stage is
70% X ($50 – 1) + 30% * ($43.30 – 3.30) = $46.30
So the expected gain from beginning the process (filing a lawsuit) is $46.30
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If this is greater than the cost of filing, we expect the victim to file
If the cost of filing is greater than $46.30, we expect the victim not to
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Obviously, the exact numbers are arbitrary, but the general idea seems reasonable
For each injury that occurs
o each accident, each breached contract, each invasion of property, each
nuisance
o We expect a claim to be filed if the expected value of the claim exceeds
the filing cost.
This also suggests that there are three things that will directly influence the number of
claims:
 the number of injuries that occur
 the cost of filing a complaint
 the expected value of a claim
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Obviously, holding everything else constant, more injuries should lead to more
claims
And per accident, lower filing costs, or a higher expected value of claims, should
lead to more claims as well
However, the textbook gives a cool of example of how things can get more
complicated
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Think about the number of legal complaints filed, as a function of the level of
damages typically awarded by the court.
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When damages are very low, defendants have no reason to agree to generous
settlements, and so the expected value of a claim will be low
o since all the “upside” of a claim comes from either court-imposed
damages or a settlement.
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As damages rise, the expected value of a claim rises, and so the number of
lawsuits should rise as well
o more people find it worthwhile to file lawsuits
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However, as damages rise, the cost of accidents to injurers rises as well
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This will lead to greater precaution (or to less breach of contracts, or fewer
nuisance activities)
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When damages get very high, injurers will go to great length to either prevent
accidents or avoid liability
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So the number of accidents will be low, and so the number of claims will be low
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Therefore, as a function of damages, the number of claims filed might have an
inverted-U shape.
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filing costs
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Obviously, different injuries in different situations are different, so the expected
value of claims should vary widely
So we can think of there being some big probability distribution of different
values for different types of claims
Whatever this distribution, filing costs basically divide this distribution into those
where the victim will find it worthwhile to sue, and those where he won’t
Higher filing costs mean fewer actions (at least on a per-injury basis).
In the U.S., courts do charge fees for filing a claim and for subsequent stages of
the process, but these fees are much less than the actual cost to the state
o that is, the state bears much of the cost of the legal process, but does
charge some fees
In some civil law countries, the state charges no fees at all for using the civil
courts
Coming back to our earlier point: economically, the ideal legal system is one that
minimizes the sum of administrative costs and error costs
Higher filing fees mean fewer actions, and therefore lower administrative costs
But higher filing fees also mean a greater number of injuries will go unpunished,
leading to a greater distortion in incentives and therefore greater error costs
The filing fee is set optimally when these two exactly balance on the margin:
o that is, when the administrative cost of an additional complaint is equal to
the error cost of providing no remedy in the marginal case (the case which
is right on the border between justifying a lawsuit and not justifying a
lawsuit)
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The size of error costs depends on how strongly peoples’ behavior responds to
the incentives caused by liability
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The textbook puts this another way:
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the social value of reducing errors depends upon whether the errors affect
production or merely distribution.
o Recall with contract law, we discussed the difference between “productive
information” and “redistributive information”
o The distinction here in the same
o The question is whether errors introduced by the legal system only affect
who gets how much of the pie, or whether the errors lead to a shrinking of
the pie as well
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In some situations, failing to provide a remedy for a harm will impact distribution,
but will not change anyone’s behavior
o This might be the case with lawsuits involving hunting accidents
o My reasons for not wanting to shoot my friend probably have very little to
do with how worried I am about paying his widow if I kill him.
o So failing to “punish” the marginal hunting accident might be bad for
widows and good for hunters…
o …But it won’t have any impact on the number of accidents
o So the social cost of these errors is very small
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On the other hand, consider a contract setting where I paid up front for you to
provide a valuable service
o Whether or not you want to live up to your end of the deal might depend
very much on whether you think I’ll bother to sue you if you walk away
o So failing to “punish” the marginal breach might have a substantial impact
on production – it affects whether you actually perform the service, or
even whether I agree to the contract in the first place.
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So we conclude that when errors have large incentive effects, filing fees should
be kept low
And when errors have small incentive effects, efficiency requires higher filing
fees.
The textbook goes on to make some obvious, and uninteresting, points about the
effect of the number of lawyers on the supply of legal services, and therefore on
price. Feel free to read about it if you like.
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As long as there are any filing fees or other litigation costs, there will be some situations
where the harm done to each victim is below the threshold to justify a complaint
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One solution when the harm is small to each individual but large overall is one we
mentioned earlier: a class action lawsuit
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This is where one or more plaintiffs bring a lawsuit on behalf of a large group of
people harmed in a similar way
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The book gives the example of a California man who sued his bank over a $6 fee
for bouncing a check
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$6 obviously exceeds the costs of pursuing the claim, so he sued on behalf of all
the bank’s customers who were charged the same fee.
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In order for a class-action suit to proceed, the court must decide to “certify” the
class
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This has to be done thoughtfully, since participation in a class-action suit
extinguishes each victim’s right to sue later
o (Some class action suits do allow individuals to choose whether to
participate or opt out, preserving their right to sue on their own.)
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If a class-action suit succeeds – if it leads to either a settlement or a judgment at
trial – the court must then approve the plaintiff’s proposal for distributing the
award to the other members of the class.
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Efficiency suggests that class-action lawsuits are desirable when individual
harms are small but aggregate harms are large, since these cases might
otherwise go unpunished
And especially desirable if the avoidance of liability will have a strong incentive
effect
However, there’s also a view that class-action suits come with a danger
o In some scenarios, a “class” might be so large that losing at trial would be
so catastrophic for the defendant
o Then even if the claim is dubious, maybe the defendant can’t take the risk
at trial, and would basically be forced to settle
o These have been referred to as “blackmail settlements”
o (We’ll come back to this idea shortly – “nuisance suits”
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This last point brings us to the next one: the agency problem between lawyer and client
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Ideally, the client wants the lawyer to work on his case until the marginal cost of
more work (the opportunity cost of the lawyer’s time) equals the marginal benefit
(in increased expected value of a settlement or judgment)
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However, this is very hard to achieve via a contract.
o A lawyer being paid by the hour has an incentive to do too much work
o A lawyer paid for each individual service has an incentive to do them
quickly and sloppily
o A lawyer working on contingency – for example, a lawyer who receives
30% of the eventual judgment or settlement – internalizes some but not all
of the benefit of working, but all of the cost, and so has an incentive to
work too little.
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One solution to this problem would be for lawyers to work on 100% commission
That is, they could pay the client some up-front amount, and then get to keep
whatever settlement or judgment they get – functionally, the client sells their legal
claim to the lawyer
The lawyer would then internalize the full cost and full benefit of additional
effort, so they would work the optimal amount
Of course, this creates a different problem
o The client, who is probably a key witness, now has no incentive to testify
or assist in the case
Also, as it happens, this kind of arrangement is illegal, pretty much everywhere
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Since the lawyer tends to know more about the law than the client, the client can’t
always tell when he’s getting good advice, or whether more (or less) effort would
be optimal
In addition, there is some randomness to the legal process, so a lawyer’s effort
level can’t always be judged by the outcome of the case.
Given these problems, people often choose lawyers based on reputation and longrun relationships
Established firms have an incentive to maintain their reputation by hiring good
lawyers and getting them to do good work
Given that, clients are willing to pay a premium to hire a firm with an established
reputation.
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Exchange of information

We’ve already said: trials are costly for both parties

So if the two parties can anticipate the likely outcome of a trial, and come to a
settlement with similar terms, they both end up doing better

One of the obvious ways that this can fail to happen is if the two sides disagree
about the likely outcome of a trial.

The parties might disagree about the chance the defendant is held liable at all, or
about the likely size of damages

In our usual risk-neutral world, all that matters is the expected value of the
judgment each side expects

As we said before, when the plaintiff’s view of the expected judgment is higher
than the defendant’s view, the two sides are relatively optimistic
o That is, each one has beliefs favoring their own interests
o When the two sides are relatively optimistic, the range of settlements that
both of them would agree to is smaller than if they shared the same beliefs
o It may not even exist – that is, there may be no settlement which both the
defendant and the plaintiff would agree to over a trial.
Once a suit has been filed but before it goes to trial, the parties have the
opportunity to negotiate a settlement, as well as to exchange information relevant
to the trial
In addition to voluntary sharing of information, there is some required sharing
In the U.S., this is the “discovery” process: each side must supply the other side
with the evidence they plan to use, and answer questions about the case
(So named because each party has the right to “discover” facts the other party has
about the case.)
In Europe, there is no discovery pre-trial, but the first stage of the trial involves a
similar sharing of information in front of the judge.
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

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
Cooter and Ulen ask two distinct questions about the effect of information exchange:


does voluntary pooling of information promote settlements out of court?
does involuntary pooling of information promote settlements out of court?
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First, we consider voluntary pooling – that is, information one of the parties would
willingly share without being required to.








In general, parties tend to disclose information that corrects the other side’s
relative optimism
For example, suppose I hit you with my car, and we both know I’ll be held liable
I am relatively optimistic: I think you likely sustained only minor injuries, and
that damages might be $1,500
You know that you sustained more serious injuries, and have x-rays and doctors’
reports to prove it; given this information, damages will likely instead be set at
$15,000
Suppose going to trial would cost us each $3,000
As things stand, since I expect a trial to cost me $4,500, I have no reason to offer
a settlement larger than that
Since you expect to gain $12,000 from a trial, you have no reason to accept a
settlement smaller than that.
So settlement looks unlikely



But you’re more than happy to show me the x-rays and doctors’ reports
Once I see this evidence, I might agree that damages will be close to $15,000
Given that, I might be willing to offer a settlement close to that level, saving us
both the cost of going to trial.

So when the information you have corrects my relative optimism, you’re happy to
share it with me; and this encourages settlement.

On the other hand, suppose we started our relatively pessimistic
o I heard something go “crunch” when I hit you and am worried I broke
your hip, and expect damages to be $15,000
o You know the crunch was your iPod, and your actual injuries were minor.
o I might be willing to offer a fairly high settlement; you might be willing to
accept a reasonably low one; a settlement seems likely
o You have no reason to voluntarily inform me your injuries were minor, as
this would likely make me lower my settlement offer
In general, parties tend to withhold information that would correct the other
side’s relative pessimism
And since relative pessimism makes settlement likely, this withholding of
information likely encourages settlement.
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
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Cooter and Ulen explain these results in the following way:
Trials occur when the parties are relatively optimistic about their outcome, so that
each side prefers a trial rather than settlement on terms acceptable to the other
side.
When the parties are relatively optimistic, at least one of them is uninformed.
Pooling of information before trial that reduces relative optimism promotes
settlement.
Furthermore, by revealing private information to correct the other side’s false
optimism, the party making the disclosure increases the probability of settling on
more favorable terms.
The same intuition holds in reverse for information which corrects false pessimism –
revealing the information is bad for the discloser, and discourages settlement.
So voluntary disclosure will naturally lead to sharing of information that corrects false
optimist, but not information that corrects false pessimism
And in both cases, this promotes settlement
So that’s voluntary disclosure. What about involuntary (forced) disclosure?

Involuntary disclosure will tend to reveal the information that the parties would
otherwise choose to withhold
o We just said, this will tend to be information that corrects relative
pessimism
o In this way, forced disclosure may make settlement less likely

On the other hand, involuntary disclosure reduces uncertainty, and makes the two
sides’ threat points more clear
o In this way, it may make reaching a settlement easier

So the overall effect is unclear.

(One other thing, of course, is that the existence of a disclosure rule may make
some make parties less willing to settle before disclosure, since they know they
won’t be forced to disclose any harmful information, and want to see what the
other side is forced to reveal. So involuntary disclosure may delay settlement
until after disclosure occurs.)
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
The disclosure rule in the U.S. is very extensive
o Well before trial, both parties reveal the basic arguments it will make, the
evidence that supports them, the names of witness, and the nature of each
witness’s testimony
o Witnesses or evidence that are not disclosed ahead of time may not be
allowed at trial
o Each side can inspect the other side’s evidence and question its witnesses.

Most European countries have little or no pre-trial discovery
o Part of this difference may stem from the constitutional right in the U.S. to
request a trial by jury
o Jury trials are costly – the jurors are taken away from their jobs – so there
is more value in having the trial proceed quickly and without interruption
once it begins
o Pre-trial discovery makes this more likely.

In Europe, juries are rarely used in civil cases
o So delays and interruptions are less costly, and much more common
o In addition, in European civil law, judges take a more active role in
developing arguments and exploring evidence
o In the U.S., the judge plays a more passive role, serving as a referee
between the two opposing sides.
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We can also consider the effects of voluntary and involuntary disclosure on the two types
of costs we considered earlier – administrative costs and error costs.

Voluntary disclosure, we said, encourages settlements, and therefore decreases the
number of trials

In addition, having more information out in the open ahead of time should ideally
simplify and quicken the trial itself

So we expect voluntary disclosure to reduce administrative costs.

In addition, as information is shared, the parties get closer to agreeing on the
likely outcome of a trial, so the terms of a settlement likely get closer to the result
of a trial

If we believe that the judgment at trial would likely be correct, this reduces the
size of errors in outcomes, and therefore reduces error costs.

So voluntary disclosure should reduce both administrative and error costs,
reducing the overall social costs of the legal process.

Involuntary disclosure, we said, does not predictably encourage or discourage
settlement – it’s ambiguous whether it will lead to more or fewer trials

Pre-trial discovery is expected to lead to simpler, shorter trials

However, discovery is also a costly process

It’s unclear whether the overall effect on administrative costs is positive or
negative.

Even more than voluntary disclosure, though, involuntary disclosure pools much
of the information that would come out at trial; so when settlements occur, we
expect them to deviate less from the likely outcome at trial

So we expect involuntary disclosure to reduce error costs
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