Academic journal article Harvard Law Review

Risk-Preference Asymmetries in Class Action Litigation

Academic journal article Harvard Law Review

Risk-Preference Asymmetries in Class Action Litigation

Article excerpt

The world is full of risks. One of the ways society seeks to reduce those risks is through the tort system. (1) Anyone who has had the misfortune to be party to a lawsuit knows, however, that litigation itself is not without risks. (2) Class action litigation is even riskier for litigants than the paradigmatic two-party case: the stakes are higher, the issues are more complex, and more people stand to lose. Class actions also pose risks to society. A well-calibrated class action system can deter costly accidents. But an erratic or skewed system can be dangerous: Imposing too much liability can destroy jobs and deprive consumers of desirable products. Imposing too little liability may leave corporations free to inflict tremendous harm on the public. This Note argues that improving the tort system's ability to reduce societal risk requires managing individual risk preferences within the tort system itself.

Any comprehensive account of the class action tort system must be informed by an understanding of how people make decisions when confronted with risk. Traditional economic models often oversimplify reality by ignoring the role of lawyers in suit and settlement decisions (3) and by attributing a stable risk preference--either risk neutrality or risk aversion--to litigants. (4) Empirical research shows that human risk preferences are far more complicated. An accurate account of risk preferences is necessary because the natural frame of litigation creates risk-preference asymmetries that can yield inefficient outcomes. Furthermore, the attorney's role in suit and settlement is central because many lawyers--particularly plaintiffs' attorneys in class actions--have different risk preferences than their clients do. This Note applies the vast body of empirical research on risk preferences to class actions in order to provide insights and suggest reforms.

Part I applies prospect theory's four-fold pattern of risk preferences to class action litigants and concludes that plaintiffs and defendants are likely to have asymmetrical risk preferences dependent on the strength of the legal claims presented. Part I further argues that both firms and plaintiffs' attorneys are likely to have muted risk preferences or to behave as if risk neutral.

Part II asserts that risk-preference asymmetries are of particular concern in class action litigation because they may lead to settlements that either overdeter or underdeter tortious behavior. Part III applies the framework of risk-preference asymmetries to two commonly criticized phenomena in class action litigation--blackmail and sweetheart settlements--and finds that both scenarios emerge from low-merit lawsuits. Finally, Part IV applies these insights to recommend reforms likely to minimize the inefficiencies created by risk-preference asymmetries.

I. RISK-PREFERENCE ASYMMETRIES

Litigation is risky by any definition. In economic terms, "risk" simply "refers to a situation where the outcome is not certain, but where the probability of each possible outcome is known or can be estimated." (5) Litigation presents risk because parties can estimate the probability that a trial will result in one of at least two outcomes: a finding of liability or no liability.

Because risk is an inherent feature of litigation, the parties' attitudes toward risk will inevitably affect their litigation decisions. Commentators developing economic suit-and-settlement models often rely on an expected utility theory that attributes risk neutrality or risk aversion to both plaintiffs and defendants. (6) These models fail to capture what empirics have long demonstrated: that plaintiffs and defendants likely have asymmetric risk preferences. (7) One basis for risk-preference asymmetries between plaintiffs and defendants emerges from prospect theory, an empirically demonstrated account of how people make decisions in uncertain situations. (8) Prospect theory posits that human decisions vary based upon certainty, probability of outcome, magnitude of outcome, and framing of the potential outcomes as gains or losses. …

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