Settlement, Litigation, and the Allocation of Litigation Costs

This article examines a model of settlement and litigation in which the plaintiff makes a settlement demand based upon his true level of damages; the defendant infers the plaintiff's true damage level and decides whether to go to trial. When both parties share common beliefs about the likelihood of judgment in favor of the plaintiff (but not necessarily about the expected award) and when the plaintiff retains the entire settlement, then the system for allocating litigation costs does not affect the equilibrium probability of trial. If either of these two assumptions is violated, then the litigation cost allocation system becomes an important determinant of the equilibrium probability of trial.