Litigation with negative expected value suits: An experimental analysis

• Published date: 01 June 2024
• Author: Cary Deck,Paul Pecorino,Michael Solomon
• Date: 01 June 2024
• DOI: http://doi.org/10.1111/jels.12382

ORIGINAL ARTICLE

Litigation with negative expected value suits: An

experimental analysis

Cary Deck

1,2

| Paul Pecorino

1

| Michael Solomon

3

1

Department of Economics, Finance and Legal Studies, University of Alabama, Tuscaloosa, Alabama, USA

2

Economic Science Institute, Chapman University, Orange, California, USA

3

Department of Economics, Colby College, Waterville, Maine, USA

Correspondence

Cary Deck and Paul Pecorino, Department of Economics, Finance and Legal Studies, University of Alabama,

Box 870224, Tuscaloosa, AL 35487-0224, USA.

Email: cary.deck@ua.edu and ppecorin@ua.edu

Abstract

The existence of lawsuits providing plaintiffs a negative expected value (NEV) at trial has

important theoretical implications for signaling models of litigation. The signaling equi-

librium possible when there are no NEV suits breaks down because plaintiffs with NEV

suits do not have a credible threat to proceed to trial, which undermines the ability to sig-

nal type. Using a laboratory experiment, we analyze behavior with and without the possi-

bility of NEV suits. Absent NEV suits, behavior largely follows predicted patterns.

However, the possibility of NEV suits is not found to cause the signaling equilibrium to

unravel or to cause the dispute rate to increase. Plaintiffs only drop NEV lawsuits three-

fourths of the time, the rejection rate by defendants for revealing demands rises less than

predicted and, contra theory, the rejection rate on demands in the semi-pooling range

remains unchanged.

KEYWORDS

dispute resolution, laboratory experiment, negative expected value lawsuits

INTRODUCTION

When the expected cost of proceeding to trial exceeds the expected judgment at

trial, a plaintiff is said to have a negative expected value (NEV) suit. There is an

extensive theoretical literature on NEV suits which suggests that they can raise

the incidence of costly trials in the presence of asymmetric information. We pro-

vide the first controlled laboratory experiment exploring the effects of NEV suits

in a setting with asymmetric information. We do this in the context of a

DOI: 10.1111/jels.12382

©2024 Cornell Law School and Wiley Periodicals LLC.

244 J Empir Leg Stud. 2024;21:244–278.

wileyonlinelibrary.com/journal/jels

signaling game, in which the informed party makes a pre-trial demand on the

uninformed party. We find important directional changes as predicted by theory

when NEV suits are introduced although the magnitude of these changes is

much smaller than predicted. However, contrary to the predictions of theory,

we do not observe a total breakdown of the signaling equilibrium in the NEV

treatment. In addition, the overall dispute rate falls in the NEV treatment as

compared to treatments with only positive expected value (PEV) suits, in con-

trast to the prediction that it would increase.

Our experiment is based on a two-type version of the Reinganum and Wilde

(1986) signaling model of litigation. In two treatments, both high type, A

H

, and

low type, A

L

, plaintiffs have PEV suits, where plaintiff type is associated with

whether the plaintiff would receive a high or low award at trial. In our NEV

treatment, the A

L

plaintiff has an NEV suit, while A

H

continues to have a PEV

suit. In all our treatments, if an offer is rejected, the plaintiff has an opportunity

to drop the suit and is predicted to do so if and only if she has an NEV suit.

Theoretical results from Farmer and Pecorino (2007) show that the possibility

of NEV suits causes the signaling equilibrium to unravel. Among other predic-

tions, in the NEV treatment all plaintiff demands are expected to be rejected.

Thus, in that treatment all A

L

-type plaintiffs end up dropping their cases while

all A

H

-type plaintiffs proceed to trial so that the overall dispute rate equals the

proportion of A

H

-type plaintiffs. By contrast, when all plaintiffs have PEV suits,

some plaintiffs of both types are predicted to settle and the overall dispute rate

is predicted to be at least weakly lower than in the NEV treatment.

As predicted by theory, behavior in the two PEV treatments is quite similar,

while behavior in the NEV treatment differs substantially from the other two

treatments. Several of the changes we observe are in the direction predicted by

the theory, but the magnitudes of these changes are smaller than predicted.

First, A

L

plaintiffs, who, as predicted, rarely drop their case in the PEV treat-

ments, drop their case about 75% of the time in the face of a rejection in the

NEV treatment, where the theoretical prediction is 100%. Second, revealing

demands by A

L

plaintiffs are about 25 percentage points more likely to be

rejected in the NEV treatment than in the other treatments. These rejection rates

rise from about 15% in the two PEV treatments to about 40% in the NEV treat-

ment, whereas the theoretical prediction is that the rejection rate increases from

0% to 100%.

1

However, on one important dimension, a predicted change is not

observed. Specifically, the rejection rate on demands in the semi-pooling region,

associated with all A

H

plaintiffs as well as bluffing A

L

plaintiffs, are essentially

unchanged in the NEV treatment as compared to the PEV treatments.

2

These

rejection rates range from 74% to 80% across the three treatments and are not

1

Under the theory, low revealing demands should be accepted 100% of the time in the PEV treatments. However,

excess disputes, that is, disputes not predicted by the theory are common in settings such as this. Pecorino and Van

Boening (2018) report dispute rates of 10% for low type, revealing demands. See their tab. 5.

2

The semi-pooling range consists of demands by the A

H

player which give her nonzero surplus if accepted.

LITIGATIONWITH NEGATIVEEXPECTED VALUESUITS 245

statistically different from one another. Since most A

L

plaintiffs drop their suit

in the face of rejection in the NEV treatment and because high demands face no

higher a rejection rate than in the other treatments, we do not observe an overall

increase in the dispute rate when NEV suits are possible. On the contrary, we

find dispute rates to be significantly lower in this setting.

Although our results provide support for some key predictions of a signaling

model with NEV suits, we do not observe a total breakdown of the

signaling equilibrium. Part of the reason for this is that 25% of the cases in

which a demand is rejected and the plaintiff has an NEV suit proceed to trial.

This, in turn, weakens defendant’s incentive to reject all demands. One possible

motivation for A

L

plaintiffs with an NEV suit proceeding to trial in the face of

rejection is malice (Guha, 2016,2019). We explore the counterintuitive result

that malice can increase settlement after presenting our empirical results.

BACKGROUND

NEV suits can arise from a case that has merit, but for which the stakes are so

small relative to the costs of going to trial that it is unprofitable for the plaintiff

to proceed. Alternatively, NEV suits can arise from nuisance suits, which are

suits without any merit. Regardless of the merit of NEV suits, there is a consis-

tent implication from the theoretical literature that such suits can raise the over-

all dispute rate, quite possibly by a large amount.

In Bebchuk (1984), an uninformed plaintiff makes a settlement demand to

an informed defendant. For this screening model, Bebchuk assumes that all

plaintiffs have PEV suits; however, Nalebuff (1987) extends the model to con-

sider plaintiffs with NEV suits. Under the equilibrium derived by Bebchuk

(1984), a plaintiff might find that she does not have a credible threat to proceed

to trial in the face of a rejection. The reason is that defendants with weak cases

accept the settlement demand, leaving stronger defendants to proceed to trial. It

cannot be an equilibrium for the plaintiff to drop the suit in the face of rejection,

because then all defendants would reject the settlement demand. This forces the

plaintiff to make a more aggressive equilibrium offer which is rejected by a

wider range of defendants. This not only increases the plaintiff’s expected payoff

at trial among the defendants who reject, but also results in more trials. Hence,

the presence of NEV plaintiff types may lead to increased disputes.

Bebchuk (1988) is also a screening model, but it posits that an uninformed

defendant makes an offer to an informed plaintiff, where some fraction of these

plaintiffs has NEV suits. If the fraction of plaintiffs with NEV suits is suffi-

ciently high, the equilibrium changes from an interior one with substantial set-

tlement to one where the defendant offers 0 and thereby takes all PEV plaintiffs

to trial. This may be done because the defendant knows all NEV plaintiffs will

drop their case prior to trial, resulting in a 0 cost for the defendant. By contrast,

246 LITIGATION WITH NEGATIVE EXPECTED VALUE SUITS