Academic journal article Economic Inquiry

Strategic Decisions on Lawyers' Compensation in Civil Disputes

Academic journal article Economic Inquiry

Strategic Decisions on Lawyers' Compensation in Civil Disputes

Article excerpt

I. INTRODUCTION

A plaintiff and a defendant usually bargain to settle a civil dispute. When they cannot reach a settlement, the case goes to trial. Naturally, through the settlement and trial stages, the litigants behave strategically. A few researchers study such a situation by developing contest models. (1) Examples include Plott (1987), Katz (1988), Farmer and Pecorino (1999), Wfirneryd (2000), and Hirshleifer and Osborne (2001). There exists, however, some discrepancy between the contest models and the mainstream articles in the law and economics literature. The contest models deal with "the legal battle itself" (to use the words of Hirshleifer and Osborne 2001). By contrast, the mainstream articles focus on one or some of the important aspects of the negotiation and litigation process such as the likelihood of settlement, the reasons for lawsuits, the efficient levels of precautions, the burden of proof, the comparison of alternative fee shifting systems, and the compensation for lawyers in the presence of an agency problem. (2)

This article attempts to reconcile the two strands a bit further. To do so, we develop a contest model in which the negotiation and litigation stages are combined, as in the previous contest models, but unlike the previous ones, two lawyers--one for a plaintiff and the other for a defendant are introduced. Using this contest model with delegation, we are able to analyze some of the important issues in legal disputes. For instance, a plaintiffs lawyer in the United States routinely charges one-third of the award if his client wins and nothing if his client loses. A natural question--which we can address using our model is then why the lawyer's contingent fee is not one-half of the award, nor two-thirds, but one-third. Using our model, we can also address the following issues. Does the plaintiff have an incentive to choose an hourly fee arrangement if feasible? Does delegation to the lawyers increase the total legal expenditure of the plaintiff and defendant compared with the case of no delegation?

Why do a plaintiff and a defendant hire lawyers in litigation? A straightforward reason for such delegation is that a litigant can benefit by hiring a lawyer who has more capacity than herself. (Throughout the article, we use "she" to refer to a litigant and "he" to refer to a lawyer.) Another explanation is that a litigant can benefit by achieving strategic commitments through delegation. Specifically, the litigant can change her opponent's behavior in her favor by using a lawyer whose objective function differs from hers. Baik and Kim (1997) consider a contest model that carries both aspects of delegation for the first time in the delegation literature. But the idea that strategic delegation benefits a "main" player has long been emphasized in many contexts. Examples include Schelling (1960), Fershtman and Judd (1987), Katz (1991), and Warneryd (2000).

This article extends the delegation model of Baik and Kim (1997) to the case where a plaintiffs lawyer works on a contingent-fee basis but a defendant's lawyer on an hourly fee basis. (3) We assume that the litigants and lawyers are risk neutral. To be more precise, our two-stage game runs as follows. In the first stage, knowing that the defendant adopts the hourly fee, the plaintiff determines the contingent-fee fraction for her lawyer and announces it publicly. In the second stage, the lawyers exert their effort simultaneously and independently to win the lawsuit. The plaintiff's lawyer chooses the effort level on his own, but the effort level of the defendant's lawyer is chosen by the defendant. The defendant has to incur a monitoring cost because she hires her lawyer under the hourly fee. We use logit-form probability-of-winning functions.

After solving for the subgame-perfect equilibrium of the game, we first derive the condition on relevant parameters under which delegation to the lawyers brings both litigants more payoffs compared with the case of no delegation. …

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