Disclosure and Discovery with Fairness

Abstract

Two standard results in the litigation literature are that an informed party will not make a costly voluntary disclosure in a screening game and that the uninformed party will not engage in costly discovery in the signaling game. Both of these results rely on the assumption that the party making the offer can extract the entire surplus of settlement from the party receiving the offer. If the recipient of the offer has a demand for fairness, then the equilibrium offer will contain some monetary surplus. However, if utility is a continuous function of the surplus contained in the offer, the standard results from the literature are unchanged. Even though the equilibrium offer contains some surplus, it still pins the recipient of the offer to her dispute level of utility. As a result, the recipient of the offer will not engage in a costly transfer of information. The standard results can be overturned if the perceived fairness of the offer is a discontinuous function of the surplus it contains. In this model offers are coded as either fair or unfair, where all unfair offers impose a fixed utility penalty on the recipient if she accepts it. In such a model, the recipient of the offer will obtain a utility surplus (relative to her dispute level of utility) if the offer is perceived as fair. If this surplus is large enough, she will be willing to initiate a costly transfer of information.