Transaction Costs

Transaction costs, or, What matters more: your brain or your wallet?

Image of John Lennon's mind. "Mind Games" by Derek Davalos.

Mind Games” by Derek Davalos / CC 3.0

What motivates people to settle their lawsuits once a case is open?

Courts across the United States are experimenting with different models to nudge parties toward resolving disputes short of trial. One model mandates that parties attend a “settlement day” prior to their scheduled trial date. Unlike other mandatory court-affiliated settlement, however, there is no prescribed mediation or conference before the judge or other judicial officer. The only difference between settling in court and settling out of court is just that: the court.

The economic theory of transaction costs posits that a variety of obstacles (e.g., time, finances, reputation) can impede mutually beneficial agreements. One of its main lessons is that two parties will always reach an agreement—regardless of who holds a legal right—when transaction costs are zero. In courts and other public policy decisions, the goal is often to minimize transaction costs to facilitate negotiation. By extension, under this line of thinking, raising transaction costs would make an agreement less likely.

The mandatory settlement day effectively represents one of those transaction costs to the parties, who are otherwise free to negotiate and settle without taking the time off work to travel to court and spend the day in the courthouse. This is particularly true in eviction cases, where both parties clearly are familiar with one another and at least one party quite literally knows where the other party lives.

Refining the theory of transaction costs is the deadline effect: cases are generally more likely to settle as they approach their trial date. Perhaps the combination of: (1) the deadline effect; (2) the ex ante costs of preparing for settlement day as mandated by the court; and (3) and physically coming to court, all make parties more likely to settle.

The idea that negotiation is an intrinsic part of litigation is not new. In fact, it has its own name: litigotiation. But what role does the court play when it requires parties to appear in a courthouse and negotiate?

  • By increasing some transaction costs (e.g., time, opportunity cost, cost of preparation and travel to appear in court), is the court dramatically reducing others (particularly psychological and emotional cost)? Or simply increasing transaction costs overall?
  • By the simple act of bringing parties together and requiring them to have a conversation about their dispute (with or without formal participation of a mediator or judicial officer), is the court
    • removing psychological barriers to a negotiated settlement?
    • moving the “deadline” earlier?
    • providing a more level playing field to reduce the influence of asymmetric information?

The Access to Justice Lab is looking for opportunities to study the effects of mandatory settlements and mediation more closely, through randomized studies that can test these hypotheses. We also want to hear from you: what are your experiences with court-led settlement conferences and other forms of dispute resolution? What effects are you seeing?

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