Pretrial Bargaining with Asymmetric Information: Unilateral versus Bilateral Payoff Relevance

[Author Affiliation]Amy Farmer, , , , amyf@walton.uark.eduPaul Pecorino, , , , ppecorin@cba.ua.edu[Acknowledgment]We would like to thank Akram Temimi and two anonymous referees for providing helpful comments on the article.1. IntroductionAsymmetric information is a leading explanation for bargaining failure, and the role of asymmetric information has been extensively analyzed in the civil litigation literature.1 Most of this literature concerns information that has bilateral payoff relevance in the sense that the information in question affects the expected payoff at trial of both the plaintiff and defendant. When there is bilateral payoff relevance, trials may be predicted in the equilibrium of the bargaining game, regardless of whether the informed or uninformed party makes the offer. In this article, we analyze information that has unilateral payoff relevance, meaning that it affects the expected payoff of one of the two parties to the dispute, but not the other. As an example, suppose the plaintiff has private information on her risk preferences. This affects her expected payoff at trial but not the defendant's. When there is unilateral payoff relevance, there are never inefficient trials in the equilibrium of the game where the informed party makes the offer.2 However, there may still be costly disputes in the equilibrium of the game in which the uninformed party makes the offer.Examples of information with bilateral payoff relevance include information on the probability that the plaintiff will prevail at trial, and information on the amount of the judgment to be awarded at trial in the event the plaintiff is victorious. In both cases, the information clearly affects the expected payoff of both the plaintiff and defendant at trial, and these are the types of informational asymmetry considered most often in the literature. What type of information has only unilateral payoff relevance? One example, mentioned above, is information on risk preferences. Farmer and Pecorino (1994), Swanson and Mason (1998), and Heyes, Rickman, and Tzavara (2004) all examine asymmetric information on risk preferences within the context of the screening model in which the uninformed party makes the offer.3 In each case, trials are predicted in the equilibrium of these models, as long as trials are not too costly for the participants. However, other types of information also have only unilateral payoff relevance. A large literature on the ultimatum game has provided convincing evidence that under certain circumstances individuals will express a preference for being treated fairly.4 This preference may be expressed specifically by the percentage of her own court costs a player is willing to concede to her opponent via his settlement offer.5 Since this preference is not observable and presumably differs across individuals, the proposer in a screening game must decide how much of the joint surplus of settlement he will attempt to extract without knowledge of how low he can go before triggering a rejection.Suppose the judgment is $100,000 and the plaintiff's court costs are $30,000. A plaintiff without a taste for fairness will accept an offer of $70,000 rather than proceed to trial. A plaintiff with a taste for fairness might (as an example) accept no less than $90,000. The defendant then must choose between an offer of $90,000 and $70,000 without knowledge of whether the other party has a taste for fairness or not. The defendant will make the low offer if he believes it will be accepted with a sufficiently high probability; if the plaintiff does indeed have a taste for fairness, she will reject the low offer and a trial will result. Presumably a mechanism along these lines explains the persistence of disputes in ultimatum game experiments.Another example of information with unilateral payoff relevance is the degree of litigiousness, which can be modeled as differences in perceived court costs on the part of the plaintiff (Eisenberg and Farber 1997). …