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Superstars, Lawsuits, and the Public Interest

April 12, 2006 4:51 PM

Alex,

My intention today was to get fully into my critique of your article with Eric Helland, but after your most recent post, I again wanted to clarify some theoretical issues. To keep this entry at a readable length, I'm posting it first. I'll follow up tonight or in the morning with an analysis of your empirical findings.

In your most recent post, you draw an analogy between contingency fee arrangements and arrangements in which "superstar" actors and actresses -- like Julia Roberts -- get a piece of the eventual revenues from their movies. You then suggest that such forms of actor compensation are a major reason why we have bad, dumbed down "blockbuster" movies -- and argue that nevertheless we shouldn't regulate actors' movie contracts (that's an easy point of agreement!).

I don't think your analogy works on a number of levels. Studios, not actors, are the main drivers behind the "blockbuster" business model. They may be coming into question of late, but summer blockbusters have been the industry's staple since Jaws and Star Wars hit it big some 30 years ago. The blockbuster movie model predated actors' ability to get a slice of movie revenues, not the other way around.

Now, a limited group of actors has proven its ability to "draw" audiences based on reputation alone, and has thus gathered a piece of the pie (not on a true "contingency" basis but rather on top of a multimillion dollar guaranteed fee). But this group is a very limited one, and includes only the "top draw" actors like Tom Cruise, Julia Roberts, Reese Witherspoon, Will Smith, and a handful or two others. These artists get a stake in blockbuster movies' outcomes because they have negotiating leverage based on their unique human capital, a proven brand name that virtually guarantees ticket sales. But the run-of-the-mill actor doesn't get a percentage of the movie's profit. The "superstar actor" model, then, is very different from what we observe with contingency fee arrangements for lawyers, in which the vast majority of plaintiffs' lawyers in personal injury/ products liability/ medical malpractice cases work on a contingency fee -- at essentially the same standard 33% level.

Studios, unlike the vast majority of contingency fee plaintiffs, have no liquidity constraints when it comes to paying actors. They may get some improved performance out of superstar actors when they give them a piece of the pie, by inducing them to be more enthusiastic about promotional movie junkets. But that incentive effect is much more analogous to incentives offered to top corporate executives in the form of stock options than lawyer contingency fees; and with the exception of employers trying to wring union concessions via ESOP plans, stock options only go to key personnel.

So when it comes to clever but misleading rhetorical devices, I think the "actor superstar" analogy fits the bill. And, most importantly, it conveniently sidesteps the crucial difference between employee incentive arrangements in the free market and contingency fee arrangements in the legal market: litigation involves using government force to redistribute wealth, whereas movie sales involve willing consumers. If I pay for a movie, then I presumably value the experience more than the ticket price. I may sometimes be disappointed, ex post, just as I might be for a meal, a bottle of wine, or a basketball game. But going in, I expect to prefer the experience to the cash. The social planning instinct that underlies wanting "better movies" through contract regulations is of course silly to those of us with libertarian instincts -- and after all, in this day and age we can watch classic movies via Netflix or AMC; visit art house cinemas; or take in opera, theater, and the like.

But litigation is a different beast entirely. What the plaintiff and lawyer are contracting for is to take money from someone else. While it isn't quite the same as Tony Soprano paying a henchman to shake down a local business owner for "protection," it isn't always so different. Yes, in an ideal world, our legal system would be the perfect black box that only spit out awards to deserving plaintiffs, quickly and at low cost. But it isn't.

There are a couple key points that bear emphasis:

First, litigation costs society. Lawsuits are not just market transactions in which two parties both benefit, helping society apart from any negative externalities. Plaintiffs may be perfectly happy to give up one-third of their ultimate winnings to obtain financing and reduce attorney-client agency costs. But let's not forget that defendants and companies insuring defendants end up paying over one-third of all litigation costs. Moreover, market incentives are significantly distorted by the prospects of litigation. If you believe, a la Calabresi, that the courts are on average creating distortions that drive decision makers in the economy to reduce true "accidents" or social costs, at an efficient level, you're just fine with that (as long as the social costs reduced exceed the dead weight loss of the system). But if you agree with Peter Huber that such distortions are actually welfare and safety reducing (as the recent study by Paul Rubin and Joanna Shepherd tends to suggest), you've got an even bigger reason to worry about litigation's effects on our society.

Second, contingency fees increase the quantity and decrease the quality of litigation. I've suggested a couple of mechanisms through which this effect happens, which you consider to be in "real tension." Well, let's see. First of all, most contingency fee plaintiffs are unsophisticated, creating a market failure because there's no price competition over the fee. Apart from the Brickman studies previously cited, I think that the fact that fee percentages are not varied based on case risk (or in most instances attorney quality) is extremely evident to anyone with much familiarity with the legal system. As Walter Olson pointed out on Overlawyered yesterday, David Giacolone recently wrote extensively about this market failure on his blog, in much more detail than I have here. (I don't agree with everything he says, but it's very interesting.) In my view, the fact that there are a lot of cases in which attorneys on a contingency fee get high returns for little risk leads a lot more attorneys -- filing a lot more lawsuits, often dubious -- to enter the field. The latter attorneys do worse than their hourly fee brethren, but the end result is more lawyering, and more money for lawyers on both sides.

The second mechanism I suggest to explain how contingency fees drive up the quantity and reduce the quality of litigation is the very fact that contingency fee lawyers have a big incentive to file low probability, high value cases because they have a stake in the outcome. In your initial post you attacked this line of thinking in a couple of ways. First, you note that "the lawyer's client has exactly the same incentives (indeed, given a contingent fee of 1/3rd, twice as strong incentives!)." But that isn't really very compelling to me: remember, the plaintiff, just like Tony Soprano, may have lots of incentive to shake down a business, but that doesn't mean that society is better off if he does. It doesn't really trouble me that some plaintiffs who aren't liquidity constrained (and who are capable of assessing and monitoring their cases) might still find ways to file low probability cases. To begin with, the contingency fee from the outset was a mechanism for giving the poor access to the legal system. That the non-liquidity-constrained might prefer it, too -- because it reduces monitoring costs but also because it gives attorneys incentives to cut ethical corners -- doesn't in my view add much to the debate. And it isn't really in tension with the fact that some plaintiffs are abused, either: the corporations and rich folks who want contingency fee lawyers are almost certainly better able to protect themselves from their own attorneys' potential abuse.

Your second argument against my point that contingency fees encourage "low probability, high value" lawsuits is that "[n]ot all low-probability, high damages cases lack merit." Well, sometimes that's true (though I'd say that on average we witness the opposite effect -- that cases that really lack merit are high probability due to bad laws or rules, or judges' or juries' prejudices). But you wouldn't really argue that in our legal system good cases are on average very unlikely to win, would you? Even accounting for selection bias, that's hard to believe when over 50 percent of civil jury trials result in a plaintiff verdict. In reality, most low probability cases are low probability for a reason: the plaintiff shouldn't win (but might given a bad judge or jury). Recognizing that litigation costs society due to huge administrative costs and substantial distorting effects, as I explained in point 1, we really don't want those cases in court.

Finally, the fact that contingency fees create a direct and very powerful incentive for attorneys to bend the rules is a crucial point. Attorneys having a stake in the outcome gives them a strong inducement to generate fraudulent claims, fabricate evidence, and suborn perjury. Hourly fee attorneys are zealous advocates, for sure, but without a stake in the outcome of the case, their advocacy typically has real limits. If you don't believe that the contingency fee has an extremely powerful effect on attorneys trolling for clients, consider what Ted Frank reported on Overlawyered a couple weeks back: "Six of the eight most expensive Google AdSense search terms are for attorneys (the other two are for mortgage and loan refinancing), with 'mesothelioma lawyers' topping the charts at $54.33." And if you don't think that contingency fee lawyers haven't been manufacturing false claims on a grand scale, take a look at Janis Graham Jack's findings in the silicosis litigation (along with our commentaries), or what Judge Harvey Bartle found in the fen-phen litigation (summarized nicely in a recent Forbes article). I haven't heard of any silicosis or fen-phen lawyers working on hourly fees. But one thing's for sure: these cases are extremely costly to society.

In sum, I think the contingency fee is a primary cause of the litigation explosion. The contingency fee caps you and Eric study are a crude mechanism to be sure, but their problem isn't that they infringe on the right to contract but that they don't go far enough. Your empirical analysis, as you interpret it, directly undermines the arguments I've made above: you conclude that contingency fees on average improve case quality and lower the time it takes cases to settle -- presumably increasing the social welfare. I think you misinterpret your data, though, as I'll explain in full later tonight or in the morning.

 

 

 

Rafael Mangual
Project Manager,
Legal Policy
rmangual@manhattan-institute.org

Communications
Manhattan Institute
communications@manhattan-institute.org

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.