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Exploiting Future Settlements: A Signalling Model of Most-Favored-Nation Clauses in Settlement Bargaining

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  • Andrew F. Daughety

    (Vanderbilt University)

  • Jennifer F. Reinganum

    (Vanderbilt University)

Abstract

Most-favored-nation (MFN) clauses have been used to address a repeat player's time-inconsistency problem in international trade, durable-goods monopoly pricing, franchise contracting, and settlement bargaining. We argue that a nonrepeat player (an early-bargaining plaintiff) can use an MFN to profitably modify the subsequent bargaining game between the defendant and a later-bargaining plaintiff. If an MFN is triggered (which can happen in equilibrium), the early plaintiff receives an additional payment. Less obviously, the early plaintiff's incentives for information revelation are enhanced by this potential payment, so the defendant can resort to trial less frequently. Conditions exist such that an MFN increases total surplus.

Suggested Citation

  • 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.
    • Handle: RePEc:rje:randje:v:35:y:2004:3:p:467-485
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    References listed on IDEAS

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    1. Andrew F. Daughety & Jennifer F. Reinganum, 2002. "Informational Externalities in Settlement Bargaining: Confidentiality and Correlated Culpability," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 587-604, Winter.
    2. Choi, Jay Pil, 1995. "Optimal tariffs and the choice of technology Discriminatory tariffs vs. the 'Most Favored Nation' clause," Journal of International Economics, Elsevier, vol. 38(1-2), pages 143-160, February.
    3. Jennifer F. Reinganum & Louise L. Wilde, 1986. "Settlement, Litigation, and the Allocation of Litigation Costs," RAND Journal of Economics, The RAND Corporation, vol. 17(4), pages 557-566, Winter.
    4. Cooper, Thomas E. & Fries, Timothy L., 1991. "The most-favored-nation pricing policy and negotiated prices," International Journal of Industrial Organization, Elsevier, vol. 9(2), pages 209-223, June.
    5. Stephan, Levy, 2004. "Best-price Guarantees as a Quality Signal," MPRA Paper 13466, University Library of Munich, Germany, revised 02 Nov 2004.
    6. Aghion, Philippe & Bolton, Patrick, 1987. "Contracts as a Barrier to Entry," American Economic Review, American Economic Association, vol. 77(3), pages 388-401, June.
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    Cited by:

    1. Kathryn E. Spier, 2003. "“Tied to the Mast”: Most-Favored-Nation Clauses in Settlement Contracts," The Journal of Legal Studies, University of Chicago Press, vol. 32(1), pages 91-120, January.
    2. Rohan Pitchford & Mark L. J. Wright, 2012. "Holdouts in Sovereign Debt Restructuring: A Theory of Negotiation in a Weak Contractual Environment," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(2), pages 812-837.
    3. Guo, Di & Hua, Xinyu & Jiang, Kun, 2017. "Agency and strategic contracts: Theory and evidence from R&D agreements in the pharmaceutical industry," International Journal of Industrial Organization, Elsevier, vol. 54(C), pages 37-64.
    4. Marco, Alan C. & Walsh, Kieran J., 2006. "Bargaining in the shadow of precedent: the surprising irrelevance of asymmetric stakes," Vassar College Department of Economics Working Paper Series 81, Vassar College Department of Economics.
    5. Yeon-Koo Che & Kathryn E. Spier, 2008. "Exploiting Plaintiffs through Settlement: Divide and Conquer," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 164(1), pages 4-23, March.

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    More about this item

    JEL classification:

    • 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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