Economics of the Law: Torts, Contracts, Property, Litigation

This chapter and the next examine the decision by the parties to a legal dispute as to whether to settle out of court or go to trial. For the purposes of the analysis, the specific nature of the dispute is not relevant; all that matters is that one party -- the plaintiff -- is seeking some amount of money from the other party -- the defendant -- as compensation for damages the latter imposed on the former. ¹ Economists are interested in the resolution of legal disputes for at least three reasons. First, the manner in which they are resolved has an important effect on the cost of operating the legal system. Second, economic theory is useful in explaining and predicting how rational litigants will resolve disputes and can therefore offer suggestions for lowering the cost of litigation. Finally, the manner in which parties resolve disputes has implications for the structure of legal rules, which in turn affects investments in the future by individuals to avoid disputes in the first place.

The fact is that the vast majority of civil cases are settled or dropped before they go to trial. For example, the data on civil litigation in table 8.1 shows that only 5 percent or less of all civil cases commenced in U.S. district courts between 1987 and 1993 eventually went to trial. The most recent available state court data, from 1988, similarly indicate that the trial rate for civil cases disposed of in state courts was quite low, at 9.2 percent. ² These results turn out to be quite consistent with what economic theory predicts, given rational behavior of litigants, low costs of bargaining compared to trials, and symmetric (though not necessarily perfect) information. Indeed, if we assume, as seems plausible, that trials cost more than settlements in terms of transaction costs, then it becomes difficult to explain why any disputes go to trial. Thus, the primary question to be answered in this chapter is, why do trials ever occur? In the following sections I review several models that have been used in the literature to answer this question. I go on to use the results of these models to examine several related issues, including the impact of various cost-allocation rules and the practice of pretrial discovery on the trial rate and cost of litigation. I also address the question of whether the common tends to evolve in the direction of efficiency without the conscious help of judges or litigants.

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