We (will) discuss in class how a plaintiff can pre-commit to going to trial when the defendant does not accept its settlement offer. Such a strategic move can be interpreted as a commitment action to make its threat credible, thereby effectively manipulating the defendants choice.

Below is a detailed description of the nuisance suit model we discussed in class.

You are the manager of a large firm considering introducing a new product. All financial and economic analysis suggests the product will be very successful. However, a counsel from your law firm expresses great concern. She argues that large firms in this industry are subject to nuisance suits (for an environmental issue or a safety concern etc), which could make the product unprofitable. Somewhat surprised by this possibility you go back to your strategic planners who had received A+ in their MBA Game Theory courses. You all sit down and are considering the following possible scenario:

Some plaintiff decides whether to bring suit against you (the defendant) at cost $C (to the plaintiff). If the plaintiff decides not to, then the story is all over. If the plaintiff decides to bring suit, he then makes a take-it-or-leave-it settlement offer -request, in fact - $S. You (the defendant) can then decide whether to accept or reject the settlement offer. If you accept the offer, then the game is over again. But if you reject the offer, the plaintiff decides whether to give up or go to trial. When the case is brought to trial, it additionally costs $P to the plaintiff and $D to you (for lawyers service etc). If the case goes to trial, the plaintiff wins (and you lose) a compensation amount $X with probability w (0

(Case 1) Now suppose that the plaintiff is contemplating upon paying his lawyer the amount $P, in advance, as he chose to bring suit, with no refund if the case settles. For this case, we in class have configured the conditions under which the plaintiff would take this pre-commitment action, bring suit and the defendant would accept the plaintiff's settlement offer without going to trial: the condition was S = wX+D > C+P.

(1) (Case 2) Suppose now that not only the plaintiff but you (the defendant) also had hired a lawyer in advance at the fixed fee of $D as you initiate the suit. The lawyer you hired is ready to work for you in case a nuisance suit like the one above emerges, regardless of whether the plaintiff accept or reject your offer and also regardless of whether you go to trial of not. Under which conditions of $S would it be in your interest to bring the suit and request a settlement request $S which is to be accepted by the plaintiff? Construct a new game tree with actions and payoff well specified and solve for the subgame perfect Nash equilibrium to answer the question.

(2) Compare your answer to Case 2 in (1) with the condition under Case 1. What practical/strategic implications would you derive from this example? Briefly discuss.