Split-Award Tort Reform, Firm's Level of Care and Litigation Outcomes

In an attempt to reduce the liability insurance costs of firms, several US states have implemented many different kinds of tort reform. Some reforms take the form of caps or limits on punitive damage awards while others have mandated that a proportion of the award be allocated to the plaintiff with the remainder going to the state. These latter reforms, called “split-awards†have recently been implemented in Georgia, Illinois, Indiana, Iowa, Missouri, Oregon, and Utah. It is important to note that reforms that reduce the firm's expected litigation loss also affect the firm's expenditures on accident prevention (firm’s level of care), and therefore, the probability of accidents. Our paper presents a theoretical model that explores the effect of the split award on a wide range of economic and social outcomes – the level of care that firms choose in an effort to prevent accidents and lawsuits, the probability of an accident, the probability that a lawsuit proceeds to the award stage of a trial, and the social costs of accidents. Our model builds upon Pngâ's (1987) theoretical framework on liability and litigation and extends it in a number of ways. First, we incorporate the split-award statute into the framework. Second, we establish sufficient conditions for a unique litigation stage equilibrium that survives the universal divinity refinement (Banks and Sobel, 1987). Third, we find a sufficient condition for the positive relationship between the plaintiff's share of the punitive award and the probability of trial. Fourth, we study the effects of this statute on social cost of accidents and establish necessary and sufficient conditions for a reduction in social costs of accidents under the split-award regime. Previous studies of the split-award tort reform (Daughety and Reinganum, 2003; Kahan and Tuckman, 1995) are also extended by incorporating into the analysis the effects of this statute on the firm’s level of care and social costs of accidents. Consistent with Daughety and Reinganum (2003), we predict that, holding filing constant, a decrease in the plaintiff's share of the award decreases the conditional and unconditional probabilities of trial. Given that the split-award statute applies only when the case is settled in court, the parties have an incentive to settle out of court in order to cut out the state. In addition, we find that a reduction in the plaintiff's share of the award increases the probability of accidents. This effect arises because a decrease in the plaintiff's share reduces expected litigation costs. The firm reacts to these lower expected costs by reducing expenditures on safety. Conditions under which this reform reduces the social cost of accidents are derived.