Judgment Contingent Settlements

Abstract: Asymmetric information is widely considered a major obstacle to settlements. In this paper, we argue that litigants facing asymmetric information can use a simple add-on to the settlement o¤er to alleviate the information barriers to settlements. In particular, we show that informed parties can promise to pay an additional sum should they lose at trial (if the settlement proposal is rejected and trial occurs). We refer to the general class of these provisions as “Judgment-Contingent Clauses ”(JCC). We show that JCC’s enable informed parties to signal their type to the uninformed party costlessly, and accordingly decrease litigation rate and at the limit eliminate it altogether. JCC’s manage to reduce litigation because they are costly to a party who misrepresents herself, but they can be costless to a party who presents herself truthfully through the settlement o¤er. We discuss possible limitations to such settlements clauses including wealth-constraints; loser-pays rules; and endogenous litigation costs.