Exploiting Future Settlements: A Signalling Model of Most-Favored-Nation Clauses In Settlement Bargaining
Abstract"Most-favored-nation" (hereafter, MFN) clauses have been used in analyses of international trade, durable goods monopoly pricing, and franchise contracting to address a repeat player's time-inconsistency problem. Recent work by Spier (forthcoming and 2002) has extended this perspective to the settlements of litigation by (for example) one defendant with a collection of plaintiffs. We examine a different motivation for the use of MFNs in settlement bargaining. We argue that a non-repeat player can use an MFN to extend her reach into subsequent bargaining games. That is, an early-bargaining plaintiff can use an MFN to modify the subsequent bargaining game between the defendant and a later-bargaining plaintiff in a manner that improves the early plaintiff's payoff. Moreover, we will identify two routes through which this improvement is achieved. The obvious route is that, if the MFN is triggered by the later settlement, the early plaintiff receives an additional payment. The less obvious route is that the early plaintiff's incentives for information-revelation can be enhanced by the potential for a future payment, so that the defendant can resort to trial on a less-frequent basis. Using a signaling model, we find that the repeat player (the defendant) is indifferent about the MFN, while the later plaintiff is always worse off when an MFN constrains her settlement bargaining with the defendant. Although MFNs can never provide a Pareto improvement in this model, we demonstrate that plausible circumstances exist under which total surplus is increased by an MFN.
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Bibliographic InfoPaper provided by Vanderbilt University Department of Economics in its series Vanderbilt University Department of Economics Working Papers with number 0221.
Date of creation: Aug 2002
Date of revision: Oct 2002
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Settlement bargaining; signalling; most-favored-nation clauses;
Other versions of this item:
- Andrew F. Daughety & Jennifer F. Reinganum, 2004. "Exploiting Future Settlements: A Signalling Model of Most-Favored-Nation Clauses in Settlement Bargaining," RAND Journal of Economics, The RAND Corporation, vol. 35(3), pages 467-485, Autumn.
- C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- K40 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - General
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