Litigation Settlement and Collusion

TLDR: In this paper, the authors show that the threat of litigation and the possibility of settlement can dramatically affect ex ante competition in the relevant market, and that the settlement process provides a legal mechanism for the exchange of side-payments, while the possible of a court decision provides the plaintiff with a credible threat against the defendant so as to avert cheating.

Abstract: Private enforcement of regulatory policy is a significant feature of many government-sponsored contests, such as procurements. Although private enforcement is supposed to promote social welfare, we show that competitors can use it to achieve collusive outcomes. In a noncooperative duopoly setting, we show that the threat of litigation, and the possibility of settlement can dramatically affect ex ante competition in the relevant market. Essentially, the settlement process provides a legal mechanism for the exchange of side-payments, while the possibility of a court decision provides the plaintiff with a credible threat against the defendant so as to avert cheating. The result does not require repeated play, ex ante contracts, or other commitment devices. In the federal procurement context, we show that our results are robust to alterations in the court remedy, bargaining power of the litigants, and many other factors.