Sinking Costs to Force or Deter Settlement

Abstract

This article develops a simple but general model of suit and settlement given symmetric information. Plaintiffs and defendants can choose when and to what extent they sink litigation costs through the use of retainers and detailed pleading. I demonstrate sharp asymmetries in the ability of plaintiffs and defendants to use sunk costs strategically to obtain or deter nuisance-value settlements. The model accounts for the roles of the merits, litigation costs, and bargaining power; incorporates complaints and answers for which parties’ investments in pleading detail are endogenously determined; permits strategic default by the defendant; and nests several existing models of negative-expected-value litigation as special cases. It generates testable, counterintuitive, empirical predictions, and facilitates normative analysis. For example, the model predicts that plausibility pleading standards will have modest effects in deterring low-merit suits but may be harmful to plaintiffs and defendants settling stronger cases. (JEL K41)