Settlement with Multiple Plaintiffs: The Role of Insolvency," mimeo

This paper considers settlement negotiations between one defendant and two plaintiffs when the defendant's wealth is constrained. The acceptance of a settlement offer by one plaintiff may either increase or decrease the other plaintiff's expected payoff at trial. These externalities affect the settlement rate and the allocation of the bargaining surplus. Negotiations fail if and only if the two plaintiffs bargain independently of one another and their payoffs at trial are sufficiently correlated. Settlement is facilitated if the plaintiffs bargain collectively, accepting only offers that are in their mutual interest. Collective bargaining is unambiguously desirable in this case, leading to higher private and social welfare. For intermediate degrees of correlation, collective bargaining shifts bargaining surplus from the plaintiffs to the defendant. In contrast, for low degrees of correlation collective bargaining shifts surplus from the defendant to the plaintiffs. (Risk dominance is used to refine the set of equilibria in this last case.) These results suggest that (1) class actions increase the settlement rate by eliminating externalities, (2) class actions may be either pro plaintiff or prodefendant, depending upon the degree of correlation between the cases, (3) allowing plaintiffs to "opt out " of settlements reduces the overall rate of settlement.