Are Settlement Decisions “Predictably Irrational”?

Posted By Cliff Tuttle | September 6, 2008

Posted by Cliff Tuttle

On August 8, PLBT posted a story about a study which concludes that 61% of plaintiffs who passed up a settlement offer and went to trial ended up getting less money than if they had taken the offer. Although defendants made the wrong decision far less often, when they did, the costs were much higher.

One of the study authors suggested that one explanation lies in the fact that taking a risk by turning down the offer and going to trial costs the contingent fee plaintiff nothing, while the defendant usually pays more counsel fees and takes more risk by going to trial. Plaintiffs would be more willing to take a risk when faced with a choice between small gain and potential large gain than would the defendant faced with the choice of small loss and risk of large loss.

A comment to the PLBT post suggested that one answer might be found in a book released earlier this year called “Predictably Irrational: the Hidden Forces that Shape our Decisions” by Dan Ariely, a professor at MIT’s Sloan School of Management. Ariely’s work is part of a growing trend to apply social science methods to the study of economic behavior.

Ariely does not deal directly with the issue of why plaintiffs appear to want to try cases that should be settled, but he does discuss the power of zero cost in biasing economic decision making. For example, Amazon.com sells a lot of extra books by offering free shipping for multiple orders. The cost of the extra books usually exceeds the value of the shipping and there is evidence that the extras wouldn’t even be sold. Ariely reports that when Amazon began this practice it had a big increase in sales. However, in France, where shipping had been offered at the price of one Franc, sales remained the same. When the one Franc offer was replaced with the multi-book free shipping offer, sales in France jumped to match increases in other parts of the world. In reality, one Franc for one book was a better deal, but the “power of free” was too strong. Ariely says:

“What is it about zero cost that we find so irresistible? Why does free! make us so happy? After all, free! can lead us into trouble: things that we would never consider purchasing become incredibly appealing as soon as they are free! For instance, have you ever gathered up free pencils, key chains, and note pads at a conference, even though you’d have to carry them home and would only throw most of them away? Have you ever stood in line for a very long time (too long), just to get a free cone of Ben and Jerry’s ice cream? Or have you bought two of a product that you wouldn’t have chosen in the first place, just to get the third one for free?
What is it about free! that’s so enticing? Why do we have an irrational urge to jump for a free! item, even when it’s not what we really want?
I believe the answer is this. Most transactions have an upside and a downside, but when something is free! we forget the downside. Free! gives us such an emotional charge
that we perceive what is being offered as immensely more valuable than it really is. Why? I think it’s because humans are intrinsically afraid of loss. The real allure of free! is tied to this fear. There’s no visible possibility of loss when we choose a free! item (it’s free). But suppose we choose the item that’s not free. Uh- oh, now there’s a risk of having made a poor decision—the possibility of a loss. And so, given the choice, we go for what is free.”

Defense counsel in personal injury suits have long argued that many cases would never be filed if the plaintiffs had to pay the fees. Perhaps the same observation applies to pretrial settlement. Ariely cites experimental evidence that we all tend to overvalue what we own, which would presumably include a cause of action.

How do you overcome that bias? Ariely suggests getting feedback from neutral parties.

Going beyond the covers of the book let me suggest a thought. When the arbitration limit was raised, many cases that would have gone to trial before a judge began to be argued before arbitrators. After the arbitrators decision, many of those cases settled. Many others were dropped and never appealed. Although reasons vary, in some cases the losing party accepts the arbitrator’s decision as the probable outcome on appeal and simply quits. This was one of the reasons for the institution or pre-trial arbitration in our U.S. District Court. Also, courts which hold mini-trials as a prelude to big cases, like medical malpractice suits, report a high rate of settlement after the verdict of the mock jurors is heard.

If you wish to read a comprehensive review of “Predictably Irrational, click here.

Welcome

CLIFF TUTTLE has been a Pennsylvania lawyer for over 45 years and (inter alia) is a real estate litigator and legal writer. The posts in this blog are intended to provide general information about legal topics of interest to lawyers and consumers with a Pittsburgh and Western Pennsylvania focus. However, this information does not constitute legal advice and there is no lawyer-client relationship created when you read this blog. You are encouraged to leave comments but be aware that posted comments can be read by others. If you wish to contact me in privacy, please use the Contact Form located immediately below this message. I will reply promptly and in strict confidence.

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