Litigation Economics: “Taking a Financial Position in Your Opponent in Litigation”
The economics of litigation continue to receive more attention. For example, an April, 29, 2016 post at CLS Blue Sky Blog brings news of a new litigation economics article by Albert H. Choi, the Albert C. BeVier Research Professor of Law at the University of Virginia Law School, and Kathryn E. Spier, the Domenico de Sole Professor of Law at Harvard Law School. The post builds on their recent paper, “Taking a Financial Position in Your Opponent in Litigation,” which is free on SSRN.
One part of the CLS article is pasted below; all parts deserve a read.
“We begin by analyzing a setting with symmetric information, where the plaintiff, the defendant, and capital market know all the relevant parameters, such as the size of the damages, cost of litigation, and the probability of plaintiff winning. By taking a short position in the defendant’s stock, the plaintiff can transform what would otherwise be a negative expected value claim into a positive expected value one. This, in turn, implies that more cases will be filed ex ante. While some of these claims may be meritorious and socially valuable, others may not be. Indeed, through a sufficiently short position, the plaintiff can credibly threaten to bring any suit to trial, even an entirely frivolous one where everyone agrees that the plaintiff’s chances of prevailing in litigation are (near) zero. Short selling improves the plaintiff’s bargaining power for positive expected value claims as well, leading to larger settlement payments by the defendant. Conversely, when taking a long position in the defendant’s stock, the plaintiff’s threat to go to trial and bargaining position are compromised. After presenting the basic results, we consider five extensions of the symmetric information analysis: (1) a less efficient financial market that is initially unaware of the lawsuit; (2) differential litigation stakes in which the damages that the defendant pays are larger than the plaintiff’s recovery; (3) the loser-pays-the-costs rule; (4) endogenous litigation cost, where the amount of resources spent on litigation depend on the stake; and (5) plaintiff risk aversion. We show, in particular, that the loser-pays-the-costs rule can function as an effective screening device that keeps plaintiffs from accumulating financial positions to file frivolous claims.”