Differing perceptions

Another very simple approach to addressing the question of why cases go to trial is to introduce the concept of differing perceptions. The basic idea in this approach is that parties may have different beliefs regarding the plaintiff's probability of success at trial, p. If these differences in perception are sufficiently large, then they can eliminate any expected gains from settling out of court.

To see how this can happen, suppose that the parties are alike except for their perceptions of the probability of the plaintiff's victory. Let us return to our example of the residents and the factory. Suppose that the expected benefit to the residents from going to trial is:

and the expected benefits for the factory are:

Where we have assumed that both parties face identical costs of going to trial ordinarily, in the absence of differing perceptions, we would have pR = pF. Suppose that the costs of negotiating a settlement out of court are zero. Then the payoff to the residents from settling out of court is:

whereas the payoff to the factory from settling out of court is:

where again T is a transfer between the parties. The residents will be willing to settle out of court as long as they gain from doing so, which requires:

or:

On the other hand, the factory will be willing to settle out of court as long as they gain from doing so, which requires:

or:

Thus, the gains from settlement will be positive as long as both inequalities are satisfied, which requires:

or:

When there are identical perceptions, we have p = p and the inequality in (11.19) must always be satisfied. However, when perceptions differ, it is no longer necessarily the case that (11.19) will hold. For example, suppose that p = 0.9, p = 0.1, the costs of going to trial for each party are C = 0.1, and that u (Q) =-JQ. Let Q = 2. Then the

efficient production level is Q * = Q = 1. The left-hand side of (11.19) is

equal to 2.2, whilst the right-hand side is equal to V2 < 2.2 if there are common perceptions. However, if p = 0.9, and pF = 0.1 the right-hand side is equal to 1.8 x-j2 = 2.55 > 2.2. Thus, differing perceptions can eliminate the possibility of efficiency-enhancing gains from trade, making it attractive for the parties to instead engage in costly conflict.

 
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