EFFICIENCY OF THE 
COMMON LAW 
HYPOTHESIS

ESNIE – Cargese (Corsica) 2006
Common Law and Theories of Legal Evolution

Selection of Legal Disputes and the Efficiency of the Common Law Hypothesis 

An important premise of law and economics is that the common law (i.e., judge-made law) is the result of an effort – conscious or not – to induce efficient outcomes. 

This is known as the “efficiency of the common law hypothesis.” 

Common law rules are said to enjoy a comparative advantage over legislation in promoting efficiency:

1. 	Judicial lawmaking not affected by “political failures” evidenced by public choice theory.
2. 	“Evolutionary selection” through adjudication and the gradual improvement of legal precedent.
 
Several important contributions provide the foundations for this claim  … but, there is often disagreement as to the conceptual basis of the efficiency hypothesis.

• 	First intimated by Coase (1960) 
•	Later extended by Posner (e.g., Ehrlich and Posner, 1974; Posner 1994).

Rubin (1977)

Rubin (1977) argues that efficiency of the common law is best explained by noting that parties will more likely litigate inefficient rules than efficient ones. 

A key force in Rubin’s paper is the desire of parties to create precedent because they have interest in future similar cases.  

Three basic situations: 

(1) 	Where both parties are interested in creating precedent 

		•	Parties will continue to use the courts until 				the inefficient rule is changed.

(2)	Where only one party is interested in creating precedent

•	The incentive to litigate depends on the allocation of liability.
•	As a result, precedents evolve in the interested party's favor, whether or not the rule is efficient.

(3) 	Where neither party is interested in creating a 	precedent  

•	The legal rule – whether efficient or not – remains in force. 
•	Parties settle out of court because they lack incentive to change the current rule. 

Rubin thus concludes that common law becomes efficient based on the utility maximizing decisions of repeat litigants, rather than on judges’ desires to maximize efficiency.

Priest (1977)

Rubin’s analysis was extended by Priest (1977), who articulated the idea that common law tends to develop efficient rules independent of judicial bias in decision-making. 

Priest asserts that efficient rules develop even in the face of potential judicial hostility toward efficient outcomes. 

• 	He rejects Rubin's conclusion that this tendency occurs only where both parties to a dispute have interest in future similar cases and therefore have incentives to litigate. 

• 	Instead, he asserts that litigation is driven by the costs of inefficient rules, rather than the desire for precedent.

According to Priest's analysis:

•	Inefficient rules impose greater costs on the parties than efficient rules, thereby making the stakes in a dispute greater. 

•	Where the stakes are greater, litigation becomes more likely than settlement. 

•	Consequently, disputes arising under inefficient rules tend to be litigated and re-litigated more often than disputes arising under efficient rules. 

Priest’s “Survival Theory” of Legal Evolution

Efficient rules are less likely to be reviewed and are more likely to survive (even in the face of judges blind to efficiency)

Inefficient rules are reviewed more often: this reduces their “survival rate.” 

•	The review process provides an opportunity for existing inefficient rules to be discarded in favor of more efficient variants. 

•	Once a rule approaches efficiency it becomes less likely to be reviewed and thus more likely to survive. 

•	Thus, the legal system perpetuates selection of efficient legal rules.

Priest and Klein (1984)

An important component of the theories advanced by Rubin and Priest are the criteria for selecting disputes for litigation. 

• 	Only disputes that are actually litigated are capable of generating legal precedents.

•	Disputes that do not lead to a filing or that are settled before a final judgment have no impact on current law. 

Priest and Klein (1984) show that the set of disputes selected for litigation, rather than settlement, constitutes neither a random nor a representative sample of the set of all disputes. 

Selection Hypothesis

When both parties have equal stakes in the litigation, individual maximizing decisions of the parties create a strong bias toward a success rate for plaintiffs at trial (or appellants on appeal), regardless of the substantive law.

Fon and Parisi (2003)

This paper revisits a critical ingredient of legal evolution, the process of selection of legal disputes. 

This model parts from Rubin, Priest, and Priest and Klein in several important respects. 

•	Litigation is exclusively driven by the attempt to maximize returns from the case, rather than by the desire for precedent. 

•	Unlike Rubin, the results do not rely on the parties’ incentives to create precedents. 

•	One-time as well as repeat litigants contribute to the process of legal evolution. 
	 
•	Inefficient rules impose greater costs on the parties and may be litigated more often.

•	But, avoidance of inefficient rules is only a small factor in the parties’ cost-benefit calculation. 

•	The model thus differs from Priest’s analysis.

Important factor

The opportunity to file a case in the first place is predominantly controlled by the plaintiff, creating an opportunity for adverse selection. 

Modified selection hypothesis

If judges have different ideological views plaintiffs will be more likely to litigate “new” or “borderline” cases in “pro-plaintiff” courts. 

Plaintiffs decide whether to litigate or settle based on the likelihood of success in the specific court. 

By doing so, they trigger a bias in the process of legal evolution. 

	Different ideologies imply different propensities to extend the domain of legal remedies and causes of action. 

	Note:  “Ideological” decision-making is not an attribute peculiar to liberal, as opposed to conservative, judges. 

Judges have a uniform distribution of ideological views, but “pro-plaintiff” judges have a greater opportunity to create law because of their greater opportunities to adjudicate new or borderline cases.

Result:	The combined presence of judges’ ideology and plaintiff’s case selection generates an expansionary trend in the evolution of legal rules and remedies.  

Parisi, Fon and Depoorter (2005)

This paper extends the findings of Fon and Parisi (2003) considering the effect of judicial path dependence in the case of asymmetric stake litigation.

In the presence of asymmetric stakes, judicial path dependence may alternatively lead to:

- 	Evolutionary expansion
- 	Evolutionary contraction
- 	Stability of legal rules. 

The paper sets out the conditions and the likelihood of contraction or expansion of legal rules in various litigation and judicial environments. 

Relevant factors: 

-	Degree of asymmetry in the litigation stakes, 
-	Existence and nature of positive litigation costs,  
-	Weight of past precedents on the ongoing process of legal evolution.

Main intuitions:

1. 	An increase in the degree of asymmetry in the litigation stakes may lead to an increase in evolutionary contraction. (i.e., it renders smaller probability cases worthy of pursuit)

2. 	The presence of positive litigation costs may lead to an increase of the region with evolutionary expansion (i.e., it increases the probability of success necessary to justify litigation). 

3. 	The combined effect of asymmetric stakes and positive litigation costs is of particular interest at this point. 

Positive (and non recoverable) litigation costs offset the impact of litigation asymmetries. 

4. 	Finally, a change in the institutional weight of precedents may have a substantial impact on the (i) domain of stability, and (ii) direction that the process of legal evolution may take. 

1. 	Common Law and Legal Evolution: An Economic Model 

We formulate a simple model of path dependence in the law in which the rate of recognition of legal claims brought by plaintiffs in past cases affects the state of the law in the future. 

The evolution of the law is thus affected by the rate of production (or probability) of negative and affirmative judgments. 

We consider a model of civil litigation. 

•  	Litigants are faced with a dispute where the probability of success for plaintiff is p. 

• 	We assume that potential litigants form rational estimates of the probability of success. 

• 	When a plaintiff verdict is obtained the judicial award is W. In the case of a verdict in favor of defendant, the plaintiff pays an amount L to the defendant. 

•	Symmetric stakes would imply W = L. 

•	Plaintiffs face litigation cost C which will not be recovered even in case of successful filing. 

•	Cases are filed whenever the expected net return from the case is positive.  

		 ,				

We define the win-loss ratio  and concentrate on the normalized expected return function by rewriting equation:
		
.				

We proceed in our analysis by considering the relevance of litigation costs and symmetry of litigation stakes on the process of legal evolution. 
1.	Benchmark Case:  Symmetric Stakes (W/L = 1) and Costless Litigation (C = 0)

In Figure 1a we show the expected return as a function of the probability of winning, , given 

1. 	symmetric stakes  and 
2. 	costless litigation .  

For cases with a probability of success  less than half, , the expected return is negative, and the plaintiff would rationally choose not to file suit.  

Path dependence and legal evolution:

Given p > ½, if there is a prevailing rate of positive judgments, the recognition of similar claims in future disputes will be facilitated.

Note:	Different doctrines of precedent may use a different threshold such that past precedents become persuasive only if the consistency of such precedents falls above p* > ½.  

2.	Asymmetric Stakes (W  L, W > L) and Costless Litigation (C = 0)

Asymmetric stakes are likely to be expected in most litigation scenarios (e.g., torts, etc.).

Our model with asymmetric stakes allows for both forms of asymmetry, but the discussion concentrates on the more realistic case of W > L. 

Symmetric results would obtain in the complementary case of W < L. 

Here we continue to assume costless litigation C = 0. 

As we can see from Figure 2a, the expected return line for the asymmetric stakes case is steeper than the equal stakes case considered above.

Point in Figure 2a and point  in Figure 2b correspond to zero expected return with .  

For all cases corresponding to , the expected return from litigation is negative, and the plaintiff would rationally avoid filing suit.  

For all cases corresponding to , the plaintiff would file suit since the expected return from litigation is positive.  

With asymmetries in litigation a case may be rationally filed even when the probability of success is less than 50 percent. 

Although privately rational, the filing of suits in such low probability cases may have a negative impact on the likelihood of success of future similar cases. 

If the flow of positive precedents falls below the evolutionary threshold, p*, the process of legal evolution may generate a gradual contraction in the scope of remedies.  

To the extent that the evolutionary threshold is set at p* = ½, no such contraction could obtain in the case of symmetric stakes.
3	Asymmetric Stakes and (W  L, W > L) and Costly Litigation (C > 0)
 
In Figure 3, we consider the effect of positive litigation costs in both symmetric and asymmetric litigation.  

For any given win-loss ratio, all points to the right of the zero expected return curve correspond to cases filed. 

In the “filing region”, if the probability of winning is greater than the critical evolutionary threshold, p* (in our example, p* > ), evolutionary expansion may obtain. 

Meanwhile, for all suits with probability  falling to the right of the zero expected return curve but to the left of the critical evolutionary threshold, p < p* (in our example, p < ½), cases would be filed but lead to an evolutionary contraction of remedies.  

4.	Litigation and the Evolutionary Expansion of Legal Systems

In Figure 4 we bring together our findings for:

1. 	Different levels of asymmetry in the litigation stakes

2. 	Different litigation cost  and a fixed loss .  

The no-filing region is given by .  

With asymmetric litigation, cases can be rationally filed even when the probability of success is small. 

Filing Region:	

Northeast of the zero-expected-return curve.

Contraction Region (Subset of filing region):	

Northeast of the zero-expected-return curve and to the left of p = p*.

This is given by . 

In this area we could possibly observe an evolutionary contraction. 

Expansion Region (Subset of filing region):

Northeast of the zero-expected-return curve and to the right of the critical threshold p = p*. 

This is given by .  

In this area, we could conversely observe an evolutionary expansion. 

Stability Region (Subset of filing region):

This region can be found when p* > ½

Past precedents play no role in decision-making unless they reach a “supermajority” proportion (e.g., jurisprudence constante doctrines in Louisiana and Quebec)  

Conclusions

Main intuitions:

1. An increase in the degree of asymmetry in the litigation stakes may lead to an increase in evolutionary contraction. (i.e., it renders smaller probability cases worthy of pursuit)

2. The presence of positive litigation costs may lead to an increase of the region with evolutionary expansion (i.e., it increases the probability of success necessary to justify litigation). 

3. The combined effect of asymmetric stakes and positive litigation costs is of particular interest. 

Positive (and non recoverable) litigation costs offset the impact of litigation asymmetries. 

4. Finally, the relative size of the regions with evolutionary expansion, contraction or stability critically depends on the institutional choice of p*. 

A change in the institutional weight of past precedents may have a substantial impact on the (i) domain of stability, and (ii) direction that the process of legal evolution may take. 

Recent extensions have considered the effects of adverse selection and judicial path-dependence in conjunction with different procedural systems, different doctrines of precedent, and alternative fee-shifting arrangements.

SSRN Author's Page:

http://papers.ssrn.com/author=227722