Professor proves bargaining procedure saves time and money

04/23/04

Everyone learns the negotiation dance soon enough. Buyers generally bid low while vendors set their prices high. Ideally, the two meet somewhere in the middle. But this process takes time. With courtrooms across North America clogged with lawsuits, a University of Alberta professor of economics believes that introducing a new bargaining procedure into the judicial system would reduce the number of lawsuits and save taxpayers money.

Dr. Claudia Landeo and Dr. Linda Babcock of Carnegie Mellon University have proved that when plaintiffs and defendants reveal the amounts they are willing to settle for to an independent third party, lawsuits are settled more quickly and more frequently. Their research is published recently in the Journal of Economic Behavior and Organization.

"There are so many lawsuits filed right now, and they come at a great cost to society, so even if we could reduce the number of lawsuits in the courts, even if it was just by one per cent, then it would save taxpayers a lot of money," Landeo said. "And this research shows us an effective way to settle cases more efficiently."

Legal bargaining usually begins when one side makes an offer to the other. Once the first offer is tendered, both parties stake their ground and the boundaries for the case are irreversibly set, based on each party's perception of the strength of its own case. Landeo and Babcock experimentally tested what would happen if an escrow settlement model--a third party model--were introduced and both the plaintiff and defendant were induced to submit their true settlement desires at the outset.

If the offer from the defendant is higher than the offer from the plaintiff, then the case is settled immediately, with the plaintiff receiving an amount equal to the average of the two proposals. If the offer from the plaintiff is higher than the offer from the defendant, then the third party simply keeps both offers confidential and the lawsuit continues as it was before the offers were made.

Using this method, Landeo and Babcock found that cases were settled much more quickly and with settlement rewards closer to the true damages. In fact, 69 per cent of all cases were settled out of court using escrow settlement compared to 49 per cent when bargaining did not include the escrow component. Litigation costs using the escrow model were also reduced by 37 per cent.

The escrow settlement model was developed in the 1980s by Gertner and Miller, two economists in the U.S. It is impossible to test the effectiveness of their model using actual lawsuits because most settlement outcomes are partially or totally unobserved by researchers and therefore data sources are rarely available.

However, Landeo and Babcock found a way to test the Gertner and Miller model using experimental economics methods and special computer software they've developed. Their experiments involved inviting test subjects to a computer lab, where they served as either plaintiffs or defendants. The computers were programmed to operate according to the escrow settlement model for the experimental group. Subjects in the control group bargained without the escrow component. Roles and groups were randomly assigned, and subjects were paid according to their performance in the experiment.

Currently, there are private businesses that act as confidential, third-party judges. These businesses are rarely used, however, because the party proposing to use the service is signaling a desire to settle early and, therefore, is showing the weakness of its case. In order to maximize the benefits of the escrow component, "the escrow settlement model should be built into the legal system so that it is the first step in every case," Landeo said.

"It is one simple, inexpensive way that we can make the system much more efficient and save a lot of money."

Source: Eurekalert & others

Last reviewed: By John M. Grohol, Psy.D. on 21 Feb 2009
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