CSIO working paper / Northwestern University, Center for the Study of Industrial Organization 0044
The information that is created and disseminated through the litigation process can have social value. When economic agents learn about risks, they can fine-tune their future behaviors to mitigate these risks. Specifically, suppose that an injured plaintiff sues a defendant for damages sustained in an accident. In the future, the plaintiff may be harmed in similar accidents involving different defendants. The first lawsuit creates valuable information that the future defendants can use to fine-tune their investments in accident prevention. If the plaintiff and the first defendant are symmetrically uninformed about the true damages, their private incentive to litigate the first case is too small. If the plaintiff and the first defendant are asymmetrically informed, then the incentive to litigate the first case may be too large. The optimal liability rule trades off the need to provide defendants with incentives to take precautions and to provide the plaintiff with incentives to create valuable public information through litigation.