Credible Discovery, Settlement, and Negative Expected Value Suits

This paper introduces the option to conduct discovery into a model of settlement bargaining and negative expected value (NEV) suits under asymmetric information. We find that the option to conduct discovery has important effects on the standard model of settlement under asymmetric information for several reasons. First, because discovery is typically cheaper than litigation, it reduces the defendant’s incentive to settle under conditions of asymmetric information. Second, discovery only matters if it is credible. Because discovery is more valuable the greater the uncertainty that it can resolve, this introduces a credibility constraint on the feasible pre-discovery settlement offers. This can further reduce the probability and size of a defendant’s pre-discovery settlement offer. Lastly, both of these factors tend to reduce the ability of NEV plaintiffs to use asymmetric information to extract significant settlements from defendants. Discovery sometimes reduces the probability of NEV suits being filed and it always reduces the expected settlement a NEV plaintiff can obtain, thereby mitigating the incentive effects of NEV suits on defendants’ behavior.