Tort Reform, Disputes and Belief Formation

We experimentally study the effects of the split-award tort reform, where the state takes a share of the plaintiff's punitive damage award, on litigants' beliefs and bargaining outcomes. In addition, we study the formation of litigants' beliefs in a strategic environment. Our results provide support for coherence-based reasoning theories: coherence shifts in litigants' background beliefs (elicited before a role is assigned and after commitment to a choice at the pretrial bargaining stage) suggest bi-directionality between choices and beliefs. Our findings also suggest role-specific bias in the updating of plaintiffs' beliefs about firm's negligence. Finally, our findings indicate that split-awards affect plaintiffs' beliefs about fairness and lower out-of-court settlement amounts.Tort Reform; Belief Formation; Split-Award Statute; Coherence-Based-Reasoning; Role-Specific Bias; Self-Serving Bias; Motivated Reasoning; Settlement; Litigation; Experiments; Debiasing through Law

Deterrence, Lawsuits and Litigation Outcomes under Agency Problems and Court Errors

Punitive damage awards have been widely criticized for their unpredictability (2004 Economic Report of the President) and for generating a plaintiff’s windfall (i.e., a payment in excess of the costs of pursuing the punitive claim), which promotes unnecessary litigation (Dodson, 2000), the escalation of liability insurance premiums and over-deterrence. In an attempt to overcome some of these negative effects, several US states have implemented different kinds of tort reform. Some reforms take the form of caps or limits on punitive damage awards while others, called “split-recoveriesâ€, have mandated that a share of the award be allocated to the plaintiff with the remainder going to the state. Our paper presents a strategic model of liability and litigation that incorporates agency problems between the plaintiff and its attorney and court errors on assessing liability. We extend Hylton’s (2002) theoretical framework by explicitly modeling the role of the plaintiff’s attorney and by deriving sufficient conditions for a unique universally-divine mixed-strategy perfect Bayesian equilibrium (Banks and Sobel, 1987). In this empirically relevant equilibrium, some defendants choose to be liable; some lawsuits are not meritorious (frivolous lawsuits); and, some lawsuits are dropped, some are resolved out-of-court and some go to trial. Our model allows for court errors on assessing the liability of defendants. Predictability of punitive awards is defined as the probability that a defendant will be erroneously found liable of punitive damages by the court. We derive analytically the optimal level of punitive awards under caps and split-recoveries. We also analyze the effect of predictability on deterrence and litigation outcomes and find a predictability threshold beyond which the deterrence effect of punitive awards vanishes. We then analyze the effect of split-recoveries and caps on the probability that firms choose to be liable, the probability that frivolous lawsuits are filed, and the probability that a lawsuit proceeds to the award stage of a trial. Consistent with Babcock and Pogarsky’s (1999) findings on caps, and with Landeo, Nikitin and Babcock’s (2004) findings on split-recoveries, our model predicts that caps and split-recoveries decrease the probability of trial. However, caps and split-recoveries also increase the likelihood that a firm chooses to be liable (and therefore, increase the probability of accidents) because they lower the expected litigation costs. The firm reacts to these lower expected costs by reducing expenditures on safety. Finally, split-recoveries and caps reduce the incentives for the frivolous plaintiffs to file a lawsuit. We establish sufficient conditions under which the overall welfare effect of these reforms is unambiguously positive, because the reduction in frivolous lawsuits and the reduction in litigation costs of meritorious plaintiffs and defendants offset the negative effect of increasing the likelihood of accidents.Settlement; Bargaining; Litigation; Asymmetric Information

Tort Reform, Disputes and Belief Formation

We experimentally study the effects of the split-award tort reform, where the state takes a share of the plaintiff's punitive damage award, on litigants' beliefs and bargaining outcomes. In addition, we study the formation of litigants' beliefs in a strategic environment. Our results provide support for coherence-based reasoning theories: coherence shifts in litigants' background beliefs (elicited before a role is assigned and after commitment to a choice at the pretrial bargaining stage) suggest bi-directionality between choices and beliefs. Our findings also suggest role-specific bias in the updating of plaintiffs' beliefs about firm's negligence. Finally, our findings indicate that split-awards affect plaintiffs' beliefs about fairness and lower out-of-court settlement amounts

Split-Award Tort Reform, Firm's Level of Care and Litigation Outcomes

In an attempt to reduce the liability insurance costs of firms, several US states have implemented many different kinds of tort reform. Some reforms take the form of caps or limits on punitive damage awards while others have mandated that a proportion of the award be allocated to the plaintiff with the remainder going to the state. These latter reforms, called “split-awards†have recently been implemented in Georgia, Illinois, Indiana, Iowa, Missouri, Oregon, and Utah. It is important to note that reforms that reduce the firm's expected litigation loss also affect the firm's expenditures on accident prevention (firm’s level of care), and therefore, the probability of accidents. Our paper presents a theoretical model that explores the effect of the split award on a wide range of economic and social outcomes – the level of care that firms choose in an effort to prevent accidents and lawsuits, the probability of an accident, the probability that a lawsuit proceeds to the award stage of a trial, and the social costs of accidents. Our model builds upon Pngâ's (1987) theoretical framework on liability and litigation and extends it in a number of ways. First, we incorporate the split-award statute into the framework. Second, we establish sufficient conditions for a unique litigation stage equilibrium that survives the universal divinity refinement (Banks and Sobel, 1987). Third, we find a sufficient condition for the positive relationship between the plaintiff's share of the punitive award and the probability of trial. Fourth, we study the effects of this statute on social cost of accidents and establish necessary and sufficient conditions for a reduction in social costs of accidents under the split-award regime. Previous studies of the split-award tort reform (Daughety and Reinganum, 2003; Kahan and Tuckman, 1995) are also extended by incorporating into the analysis the effects of this statute on the firm’s level of care and social costs of accidents. Consistent with Daughety and Reinganum (2003), we predict that, holding filing constant, a decrease in the plaintiff's share of the award decreases the conditional and unconditional probabilities of trial. Given that the split-award statute applies only when the case is settled in court, the parties have an incentive to settle out of court in order to cut out the state. In addition, we find that a reduction in the plaintiff's share of the award increases the probability of accidents. This effect arises because a decrease in the plaintiff's share reduces expected litigation costs. The firm reacts to these lower expected costs by reducing expenditures on safety. Conditions under which this reform reduces the social cost of accidents are derived.Settlement; Bargaining; Litigation; Asymmetric Information

Naked Exclusion: An Experimental Study of Contracts with Externalities

This paper reports the results of an experiment designed to assess the ability of an incumbent seller to profitably foreclose a market with exclusive contracts. We use the strategic environment described by Rasmusen, Ramseyer, and Wiley (1991) and Segal and Whinston (2000) where entry is unprofitable when sufficiently many downstream buyers sign exclusive contracts with the incumbent. When discrimination is impossible, the game resembles a stag-hunt (coordination) game in which the buyers' payoffs are endogenously chosen by the incumbent seller. Exclusion occurs when the buyers fail to coordinate on their preferred equilibrium. Two-way non-binding pre-play communication among the buyers lowers the power of exclusive contracts and induces more generous contract terms from the seller. When discrimination and communication are possible, the exclusion rate rises. Divide-and-conquer strategies are observed more frequently when buyers can communicate with each other. Exclusion rates are significantly higher when the buyers' payoffs are endogenously chosen rather than exogenously given. Finally, secret offers are shown to decrease the incumbent's power to profitably exclude.Bargaining with Externalities; Contracting with Externalities; Experiments; Exclusive Dealing; Antitrust; Discrimination; Endogenous Payoffs; Communication; Coordination Games; Equilibrium Selection

Shotgun Mechanisms for Common-Value Partnerships: The Unassigned-Offeror Problem

Shotguns clauses are commonly included in the business agreements of partnerships and limited liability companies (LLCs), but the role of offeror typically remains unassigned. In a common-value, one-sided asymmetric information setting, unequal and inefficient outcomes occur with an unassigned offeror. Experimental results are aligned with our theory

Tort Reform, Disputes and Belief Formation

We experimentally study the effects of the split-award tort reform, where the state takes a share of the plaintiff's punitive damage award, on litigants' beliefs and bargaining outcomes. In addition, we study the formation of litigants' beliefs in a strategic environment. Our results provide support for coherence-based reasoning theories: coherence shifts in litigants' background beliefs (elicited before a role is assigned and after commitment to a choice at the pretrial bargaining stage) suggest bi-directionality between choices and beliefs. Our findings also suggest role-specific bias in the updating of plaintiffs' beliefs about firm's negligence. Finally, our findings indicate that split-awards affect plaintiffs' beliefs about fairness and lower out-of-court settlement amounts

Naked Exclusion: An Experimental Study of Contracts with Externalities

This paper reports the results of an experiment designed to assess the ability of an incumbent seller to profitably foreclose a market with exclusive contracts. We use the strategic environment described by Rasmusen, Ramseyer, and Wiley (1991) and Segal and Whinston (2000) where entry is unprofitable when sufficiently many downstream buyers sign exclusive contracts with the incumbent. When discrimination is impossible, the game resembles a stag-hunt (coordination) game in which the buyers' payoffs are endogenously chosen by the incumbent seller. Exclusion occurs when the buyers fail to coordinate on their preferred equilibrium. Two-way non-binding pre-play communication among the buyers lowers the power of exclusive contracts and induces more generous contract terms from the seller. When discrimination and communication are possible, the exclusion rate rises. Divide-and-conquer strategies are observed more frequently when buyers can communicate with each other. Exclusion rates are significantly higher when the buyers' payoffs are endogenously chosen rather than exogenously given. Finally, secret offers are shown to decrease the incumbent's power to profitably exclude.

Naked Exclusion: An Experimental Study of Contracts with Externalities

This paper reports the results of an experiment designed to assess the ability of an incumbent seller to profitably foreclose a market with exclusive contracts. We use the strategic environment described by Rasmusen, Ramseyer, and Wiley (1991) and Segal and Whinston (2000) where entry is unprofitable when sufficiently many downstream buyers sign exclusive contracts with the incumbent. When discrimination is impossible, the game resembles a stag-hunt (coordination) game in which the buyers' payoffs are endogenously chosen by the incumbent seller. Exclusion occurs when the buyers fail to coordinate on their preferred equilibrium. Two-way non-binding pre-play communication among the buyers lowers the power of exclusive contracts and induces more generous contract terms from the seller. When discrimination and communication are possible, the exclusion rate rises. Divide-and-conquer strategies are observed more frequently when buyers can communicate with each other. Exclusion rates are significantly higher when the buyers' payoffs are endogenously chosen rather than exogenously given. Finally, secret offers are shown to decrease the incumbent's power to profitably exclude