QUESTION 5 – PRE-TRIAL BARGAINING (from final exam, Fall 2007) ECON522

QUESTION 5 – PRE-TRIAL BARGAINING (from final exam, Fall 2007)

An accident has occurred, causing $10,000 in harm to the victim. The amount of harm done is undisputed and easy to prove; punitive damages are not applicable, so any damage award would be for exactly $10,000.

This type of accident is governed by strict liability, so the injurer is legally responsible, but it may be difficult to prove in court that he caused the harm. The victim can hire a lawyer for $3,000 and go to trial, in which case he would have a 40% chance of winning. He could also hire an expert witness to testify. This would ensure victory at trial, but would cost an additional $10,000, for a total of $13,000. Going to trial costs the defendant (injurer) $5,000, regardless of whether the plaintiff (victim) hires an expert witness. Assume that neither party pays any legal expenses if an out-of-court settlement is reached.

First, consider the usual American rule where each party pays its own legal fees.

(a) If the case goes to trial, will the plaintiff hire an expert witness or not?

(b) Given your answer to (a), calculate

i. each party’s threat point during pre-trial negotiations (which is its noncooperative payoff if the case goes to trial)

ii. the gains from cooperation if a pre-trial settlement is reached

iii. the settlement that would occur if the two parties agreed to divide the gains from cooperation evenly

(c) In this scenario, would the American rule lead to over-, under-, or efficient precaution on the part of the injurer?

Next, consider the usual British rule where the losing party pays both sides’ legal fees (including the cost of the expert witness, if he was hired).

(d) If the case goes to trial, will the plaintiff hire an expert witness?

(e) Given your answer to (d), answer the same three questions as before: calculate

i. each party’s threat point ii. the gains from cooperation

iii. the settlement that would occur if gains from cooperation were divided evenly

(f) In this scenario, would the British rule lead to over-, under-, or efficient precaution on the part of the injurer?

Finally, consider the following cost-shifting rule, similar in spirit to Federal Rule 68. If the case goes to trial and no damages are awarded, each side pays its own expenses. If damages are awarded and are lower than a settlement offer the plaintiff (victim) refused, the plaintiff pays both sides’ expenses. If damages are higher than a settlement offer the defendant (injurer) refused, the defendant pays both sides’ expenses.

(g) What will happen if the case goes to trial after the defendant offers to settle for $10,001? Is the plaintiff better off accepting this offer or going to trial?

(h) What will happen if the case goes to trial after the plaintiff offers to settle for $9,999? Is the defendant better off accepting this offer or going to trial?

(i) What do you expect to happen in pre-trial negotiations?

(j) In this scenario, would this cost-shifting rule lead to over-, under-, or efficient precaution on the part of the injurer?