Settlement of Litigation May Increase or Decrease Deterrence and Social Welfare

Although the obvious effect of settlement is to save litigants the costs of trial, settlement also influences deterrence—and for two reasons. First, because settlement is agreed upon by plaintiffs, it raises their expected return from litigation and thus the probability of suit. This augments deterrence. Second, because settlement is agreed upon by defendants, it lowers their expected costs of litigation and therefore dilutes deterrence. The primary objective of the article is to identify the net effect of settlement on deterrence and on social welfare in a model of accidents, liability, and litigation. The conditions for the bringing of suit in the model are not only that plaintiffs be willing to go to trial, but also that their anticipated settlements would exceed their pretrial costs.