The Managerial Economics of Civil Litigation

Abstract

As the United States has become a more litigation society, executives are finding more of their time and their firms' resources consumed by litigation. This paper attempts to assist their decision making with regard to legal matters by looking at the following questions: Under what conditions should a potential plaintiff litigate a specific issue? Under what conditions should a defendant faced with a lawsuit respond forcefully to it? How can legal expenses be budgeted and controlled by both sides? What are the most likely conditions under which both plaintiff and defendant would be willing to seek out of court settlement? The research determines the economic requisites of both a plaintiff's decision to litigate an issue and the corresponding defendant's decision on how to respond to the suit. These decisions are viewed as both commensurate and competitive with other managerial operating decisions, e.g., capital budgeting and market expansion, that make demands upon the firm's resources. Models from economics and learning theory are employed both to illustrate the relationship between expenditures on a civil suit and the probability of success and to show how litigation costs should be budgeted and controlled. The research also shows both the conditions under which it is advantageous for both sides to seek an out of court settlement and the means to estimate the probability of out of court settlements in civil litigation in general. This latter is shown under the most general conditions to be a minimum of 0.66 and to rise as the participants in the litigation become more risk averse.