Gains, Losses, and the Psychology of Litigation

Abstract

Every lawsuit is a gamble. This is well understood in the literature on the economics of litigation, which assumes that litigants make choices that are risk-averse or risk-neutral, depending upon size of the stakes in the litigation relative to their wealth. Research on the psychology of judgment and choice, however, has revealed that risk preferences depend upon a decision-maker's reference point rather than their wealth. When choosing among perceived gains, people make risk-averse choices, and when choosing among losses, people make risk-seeking choices. In general, this suggests that defendants will often adopt risk-seeking litigation strategies, while plaintiffs will often adopt risk-averse strategies. This theory has several implications: that settlement offers are consistently well below the expected value of a case; that reforms that increase the risks of litigation, such as fee-shifting, have asymmetric effects on plaintiffs and defendants; and that attorneys can promote or impede settlement by manipulating the perceptions of their clients as to whether they face gains or losses. Data from survey responses to hypothetical scenarios and from actual settlement decisions support this theory.