Trial and Settlement: A Study of High-Low Agreements
This paper presents the first systematic theoretical and empirical study of high-low agreements in civil litigation. A high-low agreement is a private contract signed by litigants before trial that constrains the future damage payment to lie between a minimum and a maximum bound. Whereas the existing literature describes litigation as a choice between trial and settlement, high-low agreements - a relatively new phenomenon in civil litigation - introduce partial or incomplete settlements. In the theoretical model, trial is both costly and risky. When litigants have divergent subjective beliefs and are mutually optimistic about their trial prospects, cases may fail to settle. In these cases, high-low agreements can be in the litigants' mutual interest for two reasons. First, they limit the risk of outlier damage awards while still allowing for an optimal degree of speculation. Second, they limit mutually assured destruction when trial expenditures are endogenous and offsetting. Using a unique data set of insurance claims from a large national insurer, we empirically examine the factors that influence whether a high-low agreement occurs and the features of the agreement. Our empirical findings are consistent with the theoretical model.
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