Costly Signaling, Pleading, and Settlement

Abstract

This paper develops a game-theoretic model that explores the use of costly signals in a litigation environment with private information held by the plaintiff. I compare the costly signaling model with the canonical models of settlement through screening (Bebchuk 1984) and settlement signaling (Reinganum and Wilde 1986), and show that the costly signaling model compares favorably to these models along several dimensions, suggesting that it merits further exploration as a tool for studying suit and settlement. Under plausible conditions, costly signaling (rather than other signaling or screening mechanisms) will emerge endogenously in litigation, and its results are more robust to changes in modeling assumptions. I apply the costly signaling model to study the effects of filing fees and heightened pleading standards, and find counterintuitive and policy-relevant results: steeply raising the costs of litigation through filing fees or heightened pleading standards may lower the total costs of litigation without reducing the number and size of settlements obtained by plaintiffs; but from a private welfare perspective, raising pleading standards may hurt plaintiffs even if their case outcomes are unaffected.