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Exploiting Future Settlements: A Signalling Model of Most-Favored-Nation Clauses In Settlement Bargaining

Author

Listed:
  • Andrew F. Daughety

    (Department of Economics and Law School, Vanderbilt University)

  • Jennifer F. Reinganum

    (Department of Economics and Law School, Vanderbilt University)

Abstract
"Most-favored-nation" (hereafter, MFN) clauses have been used in analyses of international trade, durable goods monopoly pricing, and franchise contracting to address a repeat player's time-inconsistency problem. Recent work by Spier (forthcoming and 2002) has extended this perspective to the settlements of litigation by (for example) one defendant with a collection of plaintiffs. We examine a different motivation for the use of MFNs in settlement bargaining. We argue that a non-repeat player can use an MFN to extend her reach into subsequent bargaining games. That is, an early-bargaining plaintiff can use an MFN to modify the subsequent bargaining game between the defendant and a later-bargaining plaintiff in a manner that improves the early plaintiff's payoff. Moreover, we will identify two routes through which this improvement is achieved. The obvious route is that, if the MFN is triggered by the later settlement, the early plaintiff receives an additional payment. The less obvious route is that the early plaintiff's incentives for information-revelation can be enhanced by the potential for a future payment, so that the defendant can resort to trial on a less-frequent basis. Using a signaling model, we find that the repeat player (the defendant) is indifferent about the MFN, while the later plaintiff is always worse off when an MFN constrains her settlement bargaining with the defendant. Although MFNs can never provide a Pareto improvement in this model, we demonstrate that plausible circumstances exist under which total surplus is increased by an MFN.

Suggested Citation

  • Andrew F. Daughety & Jennifer F. Reinganum, 2002. "Exploiting Future Settlements: A Signalling Model of Most-Favored-Nation Clauses In Settlement Bargaining," Vanderbilt University Department of Economics Working Papers 0221, Vanderbilt University Department of Economics, revised Oct 2002.
    • Handle: RePEc:van:wpaper:0221
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    References listed on IDEAS

    as
    1. Andrew F. Daughety & Jennifer F. Reinganum, 2002. "Informational Externalities in Settlement Bargaining: Confidentiality and Correlated Culpability," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 587-604, Winter.
    2. Choi, Jay Pil, 1995. "Optimal tariffs and the choice of technology Discriminatory tariffs vs. the 'Most Favored Nation' clause," Journal of International Economics, Elsevier, vol. 38(1-2), pages 143-160, February.
    3. Jennifer F. Reinganum & Louise L. Wilde, 1986. "Settlement, Litigation, and the Allocation of Litigation Costs," RAND Journal of Economics, The RAND Corporation, vol. 17(4), pages 557-566, Winter.
    4. Cooper, Thomas E. & Fries, Timothy L., 1991. "The most-favored-nation pricing policy and negotiated prices," International Journal of Industrial Organization, Elsevier, vol. 9(2), pages 209-223, June.
    5. Stephan, Levy, 2004. "Best-price Guarantees as a Quality Signal," MPRA Paper 13466, University Library of Munich, Germany, revised 02 Nov 2004.
    6. Aghion, Philippe & Bolton, Patrick, 1987. "Contracts as a Barrier to Entry," American Economic Review, American Economic Association, vol. 77(3), pages 388-401, June.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Kathryn E. Spier, 2003. "“Tied to the Mast”: Most-Favored-Nation Clauses in Settlement Contracts," The Journal of Legal Studies, University of Chicago Press, vol. 32(1), pages 91-120, January.
    2. Rohan Pitchford & Mark L. J. Wright, 2012. "Holdouts in Sovereign Debt Restructuring: A Theory of Negotiation in a Weak Contractual Environment," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(2), pages 812-837.
    3. Guo, Di & Hua, Xinyu & Jiang, Kun, 2017. "Agency and strategic contracts: Theory and evidence from R&D agreements in the pharmaceutical industry," International Journal of Industrial Organization, Elsevier, vol. 54(C), pages 37-64.
    4. Marco, Alan C. & Walsh, Kieran J., 2006. "Bargaining in the shadow of precedent: the surprising irrelevance of asymmetric stakes," Vassar College Department of Economics Working Paper Series 81, Vassar College Department of Economics.
    5. Yeon-Koo Che & Kathryn E. Spier, 2008. "Exploiting Plaintiffs through Settlement: Divide and Conquer," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 164(1), pages 4-23, March.

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    More about this item

    Keywords

    Settlement bargaining; signalling; most-favored-nation clauses;
    All these keywords.

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • K40 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - General

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