Playing against an Apparent Opponent: Incentives for Care, Litigation, and Damage Caps under Self-Serving Bias
This paper presents a strategic model of incentives for care and litigation under asymmetric information and self-serving bias, and studies the effects of caps on non-economic damages. We contribute to the theoretical law and economics literature by providing the first assessment of the effects of self-serving bias on incentives for care and social welfare, and the first evaluation of the effects of damage caps on incentives for care in an environment that allows for biased litigants. We also contribute to the behavioral economics literature by generalizing the perfect Bayesian equilibrium concept to strategic environments with biased players. Our main findings are as follows. First, our results suggest that the defendant’s bias decreases his expenditures on accident prevention, and hence, increases the likelihood of accidents. Second, both litigants’ biases increase the likelihood of disputes. Third, our results indicate that, although self-serving bias help litigants commit on tough negotiation positions, it is economically self-defeating for the informed plaintiff. The plaintiff’s self-serving bias dilutes the first-mover advantage observed in environments in which only asymmetric information is considered. Fourth, our findings suggest that that the plaintiff’s bias is always welfare reducing. The defendant’s bias is welfare reducing if under-deterrence is present. We then illustrate the benefits of incorporating self-serving bias into the theoretical analysis of tort reform by studying the effects of caps on non-economic damages. We find that damage caps decrease the defendant’s level of care if the biased defendant perceives the cap as relatively low. Importantly, we find that the positive effect of damage caps on lowering the likelihood of disputes, commonly attributed to this tort reform, might not necessarily be observed in environments with biased litigants: Caps might induce higher likelihood of disputes if the defendant perceives the cap as relatively low, and the plaintiff perceives the cap as relatively high. As a result, caps on non-economic damages might be welfare reducing.
|Date of creation:||01 Jun 2012|
|Date of revision:||01 Oct 2012|
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