Exploiting Plaintiffs through Settlement: Divide and Conquer

Abstract

Che and Spier [2008] describe how a defendant can exploit pecuniary externalities among victims (would-be plaintiffs) to reduce her total settlement costs. There are two types of externalities among victims/plaintiffs. First, there is a fixed amount of total harm, D, that has been suffered by Ν victims. At trial, a plaintiff's award will be his share of the total damages; that is, DIN. Thus, a larger number of victims reduces a single victim's incentive to join a class action and go to trial. Second, the η plaintiffs who go to trial share the cost of trial, Cp, equally. Thus, a larger number of plaintiffs increases a single victim's incentive to join the plaintiff class. Overall, a plaintiff expects a payoff of D/N Cp/n from trial; this payoff is higher if there are fewer victims and more plaintiffs. The trial-cost externality allows the defendant to settle selectively with different victims for different amounts, taking advantage of how settlement with some victims raises the cost of proceeding for those remaining. The reward externality has implications for how the defendant's ability to exploit them varies with the number of victims. The defendant's exploitation of these externalities results in a lower total payment and thus in reduced incentives for care. Several strategies that victims/plaintiffs might employ in order to defeat the defendant's exploitation are discussed. These include requiring a unanimous vote to accept any settlement offer; a commitment to consider only non-discriminatory offers; or making side payments within the class. Alternative game forms are also considered, under the assumption that no victim has a credible threat to go to trial alone. The use of sequential offers allows the defendant to reduce her total payment to zero. To see this, suppose there are Ν = 3 victims and that η 2 plaintiffs are required for a credible threat of trial. The defendant can offer the first victim zero, essentially by (credibly) threatening to settle with the remaining two victims. Having settled with the first victim (at zero), the defendant can offer the second victim zero, essentially by (credibly) threatening to settle with the third victim. Finally, having settled with the first two victims (for zero), the defendant can offer zero to the third victim, who does not have a credible threat to go to trial alone.