Litigation, Settlement and the Market for Lawyers


Chapter 3 examined situations in which parties to a dispute could potentially (if transaction costs were sufficiently low) negotiate over an economic outcome and, by doing so, exhaust all gains from trade. Moreover, under certain assumptions (for example, quasi-linearity of utility functions), the final outcome and the size of the aggregate gains from trade were independent of the initial allocation of property rights or legal rule than was in place. This is the essence of the Coase Theorem.

But how does this 'negotiation' or 'bargaining' process take place? And if parties always negotiate, why is it that even though the vast majority of disputes settle out of court, not all of them do? Haggling, threats, offers, counteroffers, proposals, objections, counterproposals, counterobjections are part and parcel of many economic transactions and most legal disputes. This chapter goes inside the 'black box' of the legal negotiation process and examines how bargaining rules and institutions may affect observed outcomes. The incentive to file lawsuits and settle out of court are also examined under various cost-allocation rules, with the English and American rules presented as special cases.

The chapter is structured as follows. Sections 11.2 and 11.3 study the two common approaches to bargaining that have been explored in the economic literature. Section 11.4 examines the economics of legal disputes and the gains from settling out of court, and explores some reasons why parties might go to court. Section 11.5 presents a general model of legal conflict which can be used to address a wide variety of questions around the economics of litigation. Section 11.6 applies this setup to the market for lawyers, and explores the efficiency properties of this market, assuming that legal services are demanded solely for the purposes of redistributing existing resources. Section 11.7 explores a related but slightly different set of issues: legal complexity and variability, but reaches similar conclusions to the analysis in section 11.6. Section 11.8 returns to the set of questions presented back in Chapter 1, and explores the final issue outlined there: the common law efficiency hypothesis.

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