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The effect of third-party funding of plaintiffs on settlement

  • Andrew Daughety

    ()

    (Department of Economics and Law School, Vanderbilt University)

  • Jennifer Reinganum

    ()

    (Department of Economics and Law School, Vanderbilt University)

In this paper we use a signaling model to analyze the effect of (endogenously-determined) third-party non-recourse loans to plaintiffs on settlement bargaining when a plaintiff has private information about the value of her suit. We show that an optimal loan (i.e., one that maximizes the joint expected payoff to the litigation funder and the plaintiff) induces full settlement. Furthermore, in contrast with the more standard (no-loan) settlement bargaining models, there is no revelation of information created by the bargaining process: all plaintiff types (where the plaintiff's type is her level of harm) make the same demand and, since no types go to trial, private information is not revealed. Implementation of the loan may entail a very high interest rate; we show that a high (enough) rate is necessary if one wants to obtain full settlement for all types of plaintiffs even when there is asymmetric information. We also find that plaintiffs' lawyers benefit from such financing, as it reduces their costs by eliminating the need to take the case to trial due to bargaining breakdown. We further show that regulation of such loans, in the form of caps on the interest charged, may result in settlement failure or elimination of the litigation-funding industry itself.

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Paper provided by Vanderbilt University Department of Economics in its series Vanderbilt University Department of Economics Working Papers with number 13-00001.

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Date of creation: 13 Feb 2013
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Handle: RePEc:van:wpaper:13-00001
Contact details of provider: Web page: http://www.vanderbilt.edu/econ/wparchive/index.html

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  1. Kirstein, Roland & Rickman, Neil, 2003. ""Third Party Contingency" contracts in settlement and litigation," CSLE Discussion Paper Series 2003-09, Saarland University, CSLE - Center for the Study of Law and Economics.
  2. Aghion, Philippe & Hermalin, Benjamin, 1990. "Why Legal Restrictions on Private Contracts Can Enhance Efficiency," Department of Economics, Working Paper Series qt4j76f10g, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  3. Leshem Shmuel, 2009. "Contingent Fees, Signaling and Settlement Authority," Review of Law & Economics, De Gruyter, vol. 5(1), pages 435-460, June.
  4. Paul Oyer, 2006. "Initial Labor Market Conditions and Long-Term Outcomes for Economists," Journal of Economic Perspectives, American Economic Association, vol. 20(3), pages 143-160, Summer.
  5. 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.
  6. Tom Coupé, 2003. "Revealed Performances: Worldwide Rankings of Economists and Economics Departments, 1990-2000," Journal of the European Economic Association, MIT Press, vol. 1(6), pages 1309-1345, December.
  7. John J. Siegfried & Wendy A. Stock, 1999. "The Labor Market for New Ph.D. Economists," Journal of Economic Perspectives, American Economic Association, vol. 13(3), pages 115-134, Summer.
  8. Aghion, Philippe & Hermalin, Benjamin, 1990. "Legal Restrictions on Private Contracts Can Enhance Efficiency," Journal of Law, Economics and Organization, Oxford University Press, vol. 6(2), pages 381-409, Fall.
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