Optimism & Expenditures: The Effect on Settlements
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Ben Depoorter
Abstract
This article challenges the conventional wisdom in economic models of litigation that optimism necessarily increases the likelihood of trial and that pessimism increases the chances of settlement. We show that optimism may, to the contrary, expand the settlement range. By increasing the perceived value at stake in litigation, optimism may induce parties to invest additional resources in a dispute, which increases the overall bargaining range. Because of the strategic nature of litigation expenditures, optimistic litigants may spend an amount that outweighs the negative impact of optimism on the bargaining surplus. Whether optimism increases or decreases the settlement rate ultimately depends on whether, in concrete instances, the negative effects of optimism on the bargaining surplus outweigh the positive effects created by the additional investments in litigation. Our results provide counterintuitive insights into the selection of disputes for litigation. (JEL K00, K21).
Acknowledgements
We are grateful to workshop and conference participants at Yale Law School, Haifa University, Erasmus University Rotterdam, University of Illinois at Urbana-Champaign, and Stanford Law School. For comments and discussion we would also like to thank Emmanuela Carbonara, Andrew Daughety, Guiseppe Dari-Mattiaci, Gerrit De Geest, Michael Faure, John de Figueiredo, Oren Gazal-Ayal, Keith Hylton, Jonathan Masur, Alan Miller, Gideon Parchomovsky, Mitch Polinsky, Jennifer Reinganum, Barak Richman, Eli Salzberger, Ted Sichelman, and Thomas Ulen.
A.1 Interior Nash Equilibria
The first-order conditions are:
From this, it follows that:
Putting this result back into the first order conditions provides:
A.2 Participation Constraints
The participation constraint for the plaintiff is:
The participation constraint for the defendant is:
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