Citation

Langlais, E. (2010). An Analysis of Bounded Rationality in Judicial Litigations: The Case with Loss/Disappointment Averse Plaintiffs. SSRN. https://ssrn.com/abstract=1594706

Research Question

How does plaintiffs’ disappointment (loss) aversion, as a form of bounded rationality, affect pretrial settlement offers and the likelihood of trial in a Bebchuk-style litigation model with asymmetric information?

Key Takeaways

Disappointment/loss aversion is modeled as a structured form of bounded rationality in plaintiffs’ risk preferences; Introducing disappointment aversion into pretrial bargaining makes the effect of “greater risk aversion” on trial versus settlement fundamentally ambiguous; The marginal plaintiff type who goes to trial can become either stronger or weaker depending on behavioral parameters and the distribution of case strengths; Shifts in the underlying strength distribution of cases can have non-monotonic effects on settlement amounts and trial rates under disappointment aversion; Litigation behavior and observed case outcomes may be misread if analysts ignore how plaintiffs psychologically weight losses and disappointment.

Dataset Description

No empirical dataset is used. The paper develops a formal law-and-economics model that extends Bebchuk’s (1984) asymmetric-information settlement framework by incorporating Gul-style disappointment aversion into plaintiffs’ preferences over trial outcomes and settlements.

Methodology

theoretical/model-based (law and economics)

Key Findings

The paper embeds Gul’s theory of disappointment aversion (which entails a form of loss aversion) into Bebchuk’s asymmetric-information model of pretrial bargaining, where the plaintiff privately knows the strength of the case and the defendant makes a take-it-or-leave-it settlement offer. In a benchmark world without settlement, stronger disappointment aversion unambiguously lowers the propensity to litigate because plaintiffs overweight the psychological cost of losing, and some weaker types opt not to file suit. Once settlement bargaining is introduced, however, disappointment aversion changes the plaintiff’s indifference condition between settlement and trial in a non-monotonic way: depending on the level of the disappointment index and the distribution of claim strengths, the marginal plaintiff who is indifferent between settling and trying the case can be either stronger or weaker, relative to the risk-neutral benchmark. Consequently, the defendant’s optimal settlement offer, the equilibrium settlement rate, and the trial rate all become sensitive in a non-trivial, sometimes ambiguous fashion to small changes in behavioral parameters and to shifts in the distribution of case strengths (such as uniform rightward shifts or mean-preserving spreads). The model therefore shows that behavioral risk preferences, even when rationally structured, do not simply make plaintiffs more eager to settle; instead, they can generate counterintuitive comparative statics and richer selection effects than in models based solely on optimism or standard risk aversion. This implies that observed settlement and trial patterns cannot be reliably interpreted without accounting for how disappointment-averse litigants evaluate uncertainty.

Summary

The paper develops a formal law-and-economics model of litigation in which plaintiffs are not fully expected-utility maximizers but instead exhibit disappointment aversion, as developed by Faruk Gul. Plaintiffs care not only about the objective payoffs from trial but also about the psychological cost of ending up with an outcome worse than what they anticipated ex ante. This behavioral structure captures a form of loss aversion and provides a disciplined way to represent bounded rationality in litigation decisions.

The starting point is Bebchuk’s classic asymmetric-information model of pretrial bargaining. In that model, the plaintiff privately observes the probability of success at trial, while the defendant knows only the distribution of these probabilities in the population of potential plaintiffs. The defendant proposes a single take-it-or-leave-it settlement amount, anticipating that plaintiffs with sufficiently strong cases will reject it and proceed to trial, while weaker types accept. Langlais modifies only one key ingredient: the plaintiff’s utility from accepting or rejecting the settlement. Under disappointment aversion, the plaintiff’s evaluation of the risky trial outcome is distorted relative to its expected monetary value, with negative deviations from expectations weighted more heavily than positive ones.

This modification has sharp implications. Without the possibility of settlement, stronger disappointment aversion always depresses the propensity to litigate because plaintiffs fear the psychological impact of an unfavorable outcome. Yet, once settlement is allowed, the same behavioral element alters the plaintiff’s indifference condition between settlement and trial in a more complex way. The threshold type. The plaintiff is just indifferent between settling and litigating. can shift in either direction depending on the strength of disappointment aversion and the distribution of case strengths. As a result, the defendant’s optimal settlement offer and the resulting equilibrium settlement and trial rates are no longer monotone in either the behavioral parameter or in shifts of the merits distribution.

When the distribution of case strengths becomes more favorable to plaintiffs (for example, via a rightward shift or a mean-preserving spread that introduces more very strong and very weak cases), the interaction with disappointment aversion generates ambiguous comparative statics. Trial rates and average settlement amounts may rise or fall in ways that differ from both the standard risk-neutral model and from models that rely on optimism or self-serving bias. Langlais emphasizes that these patterns are systematic, not random: they follow from the precise way disappointment aversion reshapes the perceived value of the trial lottery. The broader message is that understanding litigation behavior and interpreting observed settlement patterns requires explicit attention to how parties process risk and potential disappointment, not just to objective case strength and legal rules.

How the Study Advances Empirical Understanding of Legal Outcomes

The study finds that litigation outcomes in pretrial bargaining settings follow structured, repeatable patterns that arise from how parties evaluate risk and loss within an asymmetric-information framework rather than from random variation across cases. The analysis shows that introducing disappointment aversion into an established economic model systematically alters settlement and trial behavior in non-monotonic ways, demonstrating that observed legal outcomes depend on the interaction between institutional bargaining structures and boundedly rational decision processes. By relying on formal modeling and comparative statics grounded in case-level assumptions about information, incentives, and decision rules, the study’s approach is consistent with Pre/Dicta’s emphasis on empirical, case-based analysis of legal outcomes and decision contexts.