Dispute Rates and Contingency Fees: An Analysis from the Signaling Model

We analyze contingency fees in the Reinganum and Wilde (1986) signaling model of litigation. The effect of contingency fees on settlement depends on the details of the contingency fee contract and the nature of the informational asymmetry assumed in the model. Introducing bifurcated fee contracts where the contingency percentage is higher at trial changes the selection of disputes at trial but has ambiguous effects on the overall dispute rate when an informed plaintiff makes the offer. For reasonable parameter values, it increases settlement in the model where the informed defendant makes the offer. Introduction of a unitary contingency fee in which the contingency percentage is the same in a pretrial settlement as at trial unambiguously increases the incidence of trial in both variations of the signaling model. The interaction of fee shifting with contingency fees is also analyzed.