To Settle or Not to Settle

Once a civil case goes to court, the legal costs rise exponentially. In most cases, therefore, the two sides participate in a bargaining process aimed at an out-of-court settlement. However, attorneys’ fees continue to rise as the negotiation progresses. “Typically bargaining is costly, and becomes more so the longer it lasts. So you have an incentive to reach a settlement as soon as possible,” Watanabe says. “In reality, though, people take a long time.”

Stringing Out Negotiations Both plaintiffs and defendants string out settlement negotiations for the same reason. “Each party thinks its chances of winning are better than the opposition’s,” Watanabe explains. In addition, the longer the process continues, the more likely it becomes that new evidence will arrive. “That’s a benefit of waiting which might benefit the individual or might not,” he continues. “But it benefits both parties as it makes settlement more likely.” Watanabe summarizes the thought process of parties involved in settlement talks: “If I keep it going, there will be more legal cost, but there might also be a benefit of learning,” he says. And that can point to an appropriate conclusion to the process. “When benefit of learning overtakes the costs of continuing litigation, settlement will occur,” he concludes.

Watanabe outlines the issue for both sides as one of continuously determining risk and benefit. “The risk is that if I keep going to the very end, I might lose the trial,” he says. “But the benefit is that as I go on, there is more and more information—which could lead to a conclusion beneficial to both parties.” In effect, he says, “both parties are fighting, but they’re both in the same boat. It’s fighting, but it’s not.”

How hard and how long should they fight? That is unclear. “The benefit of learning has not been studied very much,” Watanabe says. So he decided to develop a dynamic model that would provide a more detailed understanding of bargaining and would help him to assess the impact of suggested tort reforms on the entire process.

As the foundation for his model, Watanabe used an objective source of information: data on 5,379 medical malpractice claims against physicians collected by the Florida Department of Financial Services between October 1985 and July 1999. The reason for that choice: The Sunshine state’s insurance regulations demand more information on such claims than most regulatory authorities. In particular, they include details on the amounts involved in settlements and defendants’ total legal costs.

Modeling the “Dynamic Bargaining Game” In his working paper “Learning and Bargaining in Dispute Resolution: Theory and Evidence from Medical Malpractice Litigation,” Watanabe details the outcomes he expects his model of this “dynamic bargaining game” to predict. These include the plaintiff’s decision on whether to file a lawsuit and if so, the time to file; whether or not the case will be settled out of court; the time to resolution; the legal costs incurred; and the terms of settlement.

Having developed the model and proved that it fit all aspects of the data, Watanabe used it to elucidate the basic criteria for negotiations. “I find that the higher the rate at which new information arrives in bargaining, the shorter the time to settlement and the lower the legal costs,” he writes. “Furthermore, lower expected jury awards and less optimistic initial beliefs shorten settlement.”

Next, he applied the model to three policies that various parties have suggested to reform the medical liability system and reduce its costs. These were a cap of $250,000 on jury awards in medical malpractice cases; eliminating the contingency fee approach, under which plaintiffs pay nothing if they lose their cases but pay their lawyers a substantial portion of any settlement or court award; and the so-called English rule, which requires the loser in litigation to pay all the legal costs of the case. “I find that capping jury awards or eliminating the contingency fee arrangements significantly shortens the expected time to resolution and lowers the expected total legal costs,” Watanabe concludes. “ldquo;On the other hand, loser-pay-all allocations of legal fees delay resolution and increase costs.”

Watanabe emphasizes that he does not intend to “answer normative questions or to conduct welfare analysis on tort reform.” Rather, he states, “my paper provides a building block on normative questions about tort reform by developing a tool to quantify how changes in the law affect costs and time spent in litigation.”

Clash of Interests In a follow-up working paper, “Estimating the Degree of Expert’s Agency Problem: Case of Medical Malpractice Lawyers,” Watanabe applies the model to a specific issue related to lawyers working under contingency fee arrangements. The issue: How hard will those lawyers really work on behalf of their clients when their own financial interests clash with their clients’?

Lawyers under contingency fee arrangements in dispute resolution cases—where they receive a fraction of the recovered payment as compensation but bear the legal costs—are at odds with their clients’ interests. Lawyers will be less willing to pursue a case than their clients due to the burden of the legal costs and the relatively small payment that results from a settlement. That is because the longer the settlement negotiations continue, the higher the legal costs and thus the lower the net fees the lawyers will receive.

But does that preference translate into practice? After all, attorneys must consider factors other than maximizing their revenues. In particular, Watanabe explains, “they have reputation issues over the long term. They risk losing future clients if they are perceived as bargaining only for their own benefit.”

Relative Benefits Watanabe applied his model to the Florida malpractice cases with the goal of determining the relative benefit offered to plaintiffs and their lawyers by analyzing the amount of time taken to reach a settlement or drop a case along with the actual payments when settlements were agreed. “I tried to give estimates between zero and one [with zero meaning activity entirely in the client’s favor and one meaning decisions completely to the lawyer’s advantage] to find exactly where the lawyer’s objective is,” he notes. “I tried to estimate the weighting between the two.”

According to Watanabe’s analysis, “The plaintiff’s lawyers work more in their short-run interest than in the best interest of their clients.” While other factors such as reputational concern, professional liability, workload, and altruism may play a role in how medical malpractice lawyers approach cases, Watanabe’s study shows these do not play as strong a role as the short-term interests.

In other words, the analysis suggests that medical malpractice lawyers are generally working in their own interest, settling cases much earlier than they would if they were working selflessly for their clients. In particular, Watanabe says, “the lawyers are not working as hard as they would if they had themselves for clients.”