Psychological barriers to litigation settlement: an experimental approach.

• Author: Korobkin, Russell

INTRODUCTION

Most civil lawsuits in the United States are settled out of court through negotiation rather than in court through adjudication.[1] Nevertheless, the disputes that do go to trial impose substantial costs on litigants[2] and the country.[3] The high costs of pursuing a claim to a trial verdict have led most commentators to hypothesize that trials represent mistakes - breakdowns in the bargaining process - that leave the litigants and society worse off than they would have been had settlement been reached.[4] The emphasis courts have placed on encouraging settlements and discouraging trials implies that the judicial system agrees.[5]

In attempting to create a general framework for explaining why settlement attempts fail and trials occur, commentators have developed two primary explanations, both of which assume that the disputants are rational actors. Proponents of the standard economic models of settlement hypothesize that because settlement is almost always less costly than trial, parties will reach agreement out of court as long as they agree on the expected value of a trial; the litigation costs they save represent joint gains of trade achieved through settlement, which the litigants can then distribute between themselves. Conversely, trials will occur when one or both parties miscalculate the likely outcome of the trial.[6] Other commentators - focusing on the distributive bargaining issues that arise when the parties recognize that they would create joint gains by reaching out-of-court agreement but must determine how to divide that savings - hypothesize that disputants fail to settle when one or both parties employ rational distributive bargaining strategies that lead to impasse, as they will on some occasions.[7]

We have no quarrel with either of these theories, but we believe that they fail to explain the full range of litigation negotiation failures. While they are elegant in their simplicity, their explanatory power is limited by the narrow assumptions about human behavior on which they rely. When individuals engaged in litigation must choose between settling a lawsuit out of court and seeking a trial verdict, we predict that they will not always act in the rational way that the economic and strategic bargaining models assume. We hypothesize that even in the absence of miscalculation and strategic bargaining, psychological processes create barriers that preclude out-of-court settlements in some cases. Specifically, we predict that psychological effects will impact how litigants perceive, understand, and respond to settlement offers in the following three ways:

How the offer is framed will affect settlement rates ("framing"). People avoid risk when they choose between options they understand as gains, but they prefer risk when they select between choices viewed as losses.[8] Therefore, we predict that settlement rates will depend on whether the offeree understands a given settlement offer as a gain or loss. If an offeree views accepting an offer as a gain, he is likely to prefer settlement - the less risky alternative - to trial; if he sees the offer as a losing proposition, he is likely to prefer trial - the more risky option.

The status of the relationship between the parties will affect settlement rates ("equity seeking"). People want what they are legally entitled to, but they also want recognition of their claim's validity.[9] Therefore, given the same legal rights, we predict that litigants will be more likely to reject a settlement offer if they view the offeror as morally blameworthy or as disrespectful of their claim.

Who makes the offer will affect settlement rates ("reactive devaluation"). People do not like to do things their adversaries want them to do.[10] Therefore, a settlement offer that a litigant would evaluate favorably in the abstract or when suggested by an ally or neutral third party is more likely to meet with disfavor when proposed by the adversary.

In this article, we seek to substantiate "psychological barriers,"[11] as illustrated by the constructs described above, as a third explanation for the failure of legal disputants to settle out of court.[12] Although we are not the first to hypothesize that psychological processes can, in theory, affect legal dispute negotiations,[13] we attempt to give more definition to the otherwise vague contours of the psychological barriers hypothesis by bringing empirical data to bear on the question.[14] To achieve this end, we conducted a series of nine laboratory experiments - involving nearly 450 subjects[15] - designed to isolate the effects of the three psychological processes outlined above on parties' decisions about whether to accept settlement offers or to opt for formal adjudication. Our results substantiate the basic hypothesis that non-value-maximizing considerations can affect decisions about whether to settle or try disputes, and our experimental findings cast light on the circumstances under which psychological barriers are more or less likely to affect settlement possibilities. The clearer understanding that stems from empirical research, we believe, will benefit future research on the impact of psychological barriers to litigation settlement.

Part I of this article describes the dominant rational actor paradigms of legal dispute resolution and suggests a theoretical role for the psychological barriers hypothesis. Part II describes the research methodology employed in our experiments. Parts III, IV, and V review the results of our experiments on how the psychological constructs of framing, equity seeking, and reactive devaluation can affect litigation settlement negotiations. Part VI discusses some of the implications of our findings for practitioners seeking to resolve litigation in the economic interests of their clients. Finally, the article concludes with a discussion of how an understanding of the effect of psychological processes on litigation settlement combines with the insights provided by existing economic models to create a richer understanding of how litigants perceive, think about, and respond to settlement offers.

1. Rational Actor Settlement Theories

   1. The Standard Economic Account of Settlement

      According to standard economic explanations of the trial-versus-settlement decision, a defendant will be willing to settle for an amount equal to the cost of an adverse trial judgment multiplied by the percentage chance of losing the case, plus trial costs, minus out-of-court settlement costs. A plaintiff will be willing to accept a settlement offer in the amount of a favorable judgment multiplied by the likelihood of a favorable judgment, minus trial costs, plus out-of-court settlement Costs.[16] Lawsuits will settle if the defendant's maximum offer is higher than the lowest offer the plaintiff will accept.[17]

      The clearest articulation of the assumptions behind the standard economic model is offered by George Priest and Benjamin Klein.[18] The Priest & Klein model assumes that litigants form rational estimates of the economic consequences of both trial and out-of-court settlement, compare the two, and act solely on the basis of that information. According to the simple version of the model, the plaintiff and defendant estimate their chances of success in court, the level of damages likely to be awarded, the costs of trial, and the costs of settlement before deciding whether to settle the dispute out of court.[19] As long as the costs of trial are higher than the costs of settlement,[20] and as long as both sides make an identical estimate of the likely outcome of the trial, the case should settle.[21] In effect, both parties in such a case agree on the risk-discounted value of a jury verdict, so they have no incentive to incur the high costs of trial.[22]

      If the parties' predictions regarding the outcome of a trial differ, Priest and Klein predict that the dispute will settle out of court anyway, provided that the difference in expectations is smaller than the plaintiff's and the defendant's combined differential between the cost of trial and the cost of settlement.[23] A simple example makes the logic of this prediction clear: Consider an automobile accident that leads to a negligence lawsuit in which the plaintiff believes she has a 40% chance of winning a $100,000 judgment at trial, while the defendant believes the plaintiff has only a 30% chance of winning a $100,000 judgment. The plaintiff will then value a trial judgment at $40,000, while the defendant will expect a trial judgment to cost him $30,000. If plaintiff 's and defendant's combined cost of litigating to a verdict, less their combined costs of settling the dispute out of court, is greater than $10,000, both sides will be better off settling the dispute out of court for an amount between $30,000 and $40,000. For example, if the plaintiff and the defendant expect that litigating the matter to a trial verdict will cost each of them $20,000 more in attorney's fees than if they settle out of court, the plaintiff should accept a settlement of greater than $20,000, and the defendant should favor any settlement of less than $50,000. The $10,000 difference between the plaintiff's and defendant's estimates of the value of a trial should not prevent a settlement that could produce $40,000 of joint savings.

      Conversely, the model predicts that if the costs of trial minus the costs of settlement are less than the difference between the two parties' estimates of the value of trial, the dispute will proceed to trial.[24] In the above example, if each party anticipates that a trial will cost it $2,000 more in costs than a settlement, the defendant will offer no more than $32,000 as a settlement and the plaintiff will accept no less than $38,000. There will then exist no mutually advantageous bargaining range and, thus, no possibility of settlement.

      One important assumption of the Priest & Klein model is that the parties are risk neutral -...