THE TERMS OF SETTLEMENT: IMPLICATIONS FOR THE DESIGN OF OFFER-OF-SETTLEMENT RULES

318_mediumOur analysis has normative implications. The main effect of the law on outcomes is through its influence on settlement terms. Therefore, in designing an offer-of-settlement rule we should take into account the rule’s potential effect on the terms of settlement. The model developed in this paper enables us to identify this effect.

One interesting implication of the analysis is the possibility of designing rules to eliminate or reduce the divergence between settlement terms and the expected judgment. While settlement terms are always chosen in anticipation of the expected judgment at trial, they might well diverge from it rather than mimic it. To be sure, the legal system, recognizing that settlement outcomes might diverge from the expected judgment, might set the expected judgment not at the level of the desired outcome but rather at the level that would result in settlement terms close to the desired outcome (see Bebchuk (1997)). In many contexts, however, it is reasonable to assume that the legal system has set expected judgments at the level that is equal to the desired outcomes. In such cases, it would be desirable to have settlement terms mimic the expected outcome of the trial — that is, to eliminate the divergence between these terms and the expected judgment.

As we have seen, one important possible source of divergence (though, as discussed below, not the only source) is asymmetric litigation costs. In the absence of an offer-of-settlement rule, settlement terms (compared with the expected judgment) tend to favor the party with lower litigation costs. Fee-shifting rules, we have seen, can be designed to address this effect of asymmetric litigation costs. Under the conditions that we have identified, it is possible to design rules that would move settlements toward the expected damages. Furthermore, the design of these rules does not require public officials to have information that would be difficult to obtain ex ante (for example, which party is expected to have lower litigation costs).