Deterrence, Lawsuits and Litigation Outcomes under Agency Problems and Court Errors
Punitive damage awards have been widely criticized for their unpredictability (2004 Economic Report of the President) and for generating a plaintiffâ€™s windfall (i.e., a payment in excess of the costs of pursuing the punitive claim), which promotes unnecessary litigation (Dodson, 2000), the escalation of liability insurance premiums and over-deterrence. In an attempt to overcome some of these negative effects, several US states have implemented different kinds of tort reform. Some reforms take the form of caps or limits on punitive damage awards while others, called â€œsplit-recoveriesâ€ , have mandated that a share of the award be allocated to the plaintiff with the remainder going to the state. Our paper presents a strategic model of liability and litigation that incorporates agency problems between the plaintiff and its attorney and court errors on assessing liability. We extend Hyltonâ€™s (2002) theoretical framework by explicitly modeling the role of the plaintiffâ€™s attorney and by deriving sufficient conditions for a unique universally-divine mixed-strategy perfect Bayesian equilibrium (Banks and Sobel, 1987). In this empirically relevant equilibrium, some defendants choose to be liable; some lawsuits are not meritorious (frivolous lawsuits); and, some lawsuits are dropped, some are resolved out-of-court and some go to trial. Our model allows for court errors on assessing the liability of defendants. Predictability of punitive awards is defined as the probability that a defendant will be erroneously found liable of punitive damages by the court. We derive analytically the optimal level of punitive awards under caps and split-recoveries. We also analyze the effect of predictability on deterrence and litigation outcomes and find a predictability threshold beyond which the deterrence effect of punitive awards vanishes. We then analyze the effect of split-recoveries and caps on the probability that firms choose to be liable, the probability that frivolous lawsuits are filed, and the probability that a lawsuit proceeds to the award stage of a trial. Consistent with Babcock and Pogarskyâ€™s (1999) findings on caps, and with Landeo, Nikitin and Babcockâ€™s (2004) findings on split-recoveries, our model predicts that caps and split-recoveries decrease the probability of trial. However, caps and split-recoveries also increase the likelihood that a firm chooses to be liable (and therefore, increase the probability of accidents) because they lower the expected litigation costs. The firm reacts to these lower expected costs by reducing expenditures on safety. Finally, split-recoveries and caps reduce the incentives for the frivolous plaintiffs to file a lawsuit. We establish sufficient conditions under which the overall welfare effect of these reforms is unambiguously positive, because the reduction in frivolous lawsuits and the reduction in litigation costs of meritorious plaintiffs and defendants offset the negative effect of increasing the likelihood of accidents.
|Date of creation:||11 Aug 2004|
|Date of revision:|
|Contact details of provider:|| Phone: 1 212 998 3820|
Fax: 1 212 995 4487
Web page: http://www.econometricsociety.org/pastmeetings.asp
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:ecm:latm04:74. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.