| The classic models of litigation in law and economics propose that settlement of civil lawsuits is a direct function of each party's perceived probability of winning, the expected awards, and the risk preferences of the parties. These models also suggest that litigants make settlement decisions that are either risk-neutral or risk-averse. A new model of litigation, based on an alternative theory of judgment and choice known as Prospect Theory, suggests instead that plaintiffs make risk-averse settlement choices, and defendants make risk-seeking settlement choices. Three studies tested this theory. First, an analysis of archival data revealed that when settlements failed, defendants were much worse off at trial, suggesting that the failure to settle resulted from rejecting settlement offers that were well below the expected value of the case--a risk-seeking strategy. In these data, the defendants' risk-seeking settlement decisions cost them an average of {dollar}66 thousand per case. Second, subjects viewing a hypothetical litigation from the perspective of a plaintiff were more likely to accept a risk-neutral settlement offer than were defendant subjects. This effect was reversed in a second hypothetical litigation in which the defendants chose among gains instead of losses, thereby suggesting that litigants' risk preferences depend upon whether they confront potential losses or gains. Third, data from a negotiation study showed that although an increase in risk does not affect the parties (as predicted by the Prospect Theory Model), both litigants expressed optimistic overconfidence about their chances of winning at trial. Defendants in particular were more optimistic about their prospects at trial than was justified by the background materials. Taken together, these three studies demonstrate that defendants are more willing to gamble on litigation than plaintiffs. This conclusion suggests deficiencies in the traditional models of litigation, and questions the value of using Expected Utility Theory as a basis for modeling the decision-making of legal actors. |
