OK, at long last I want to start getting at the substantive meat of your article with Eric Helland. Your article makes two key findings that lead you to conclude that in states with contingency fee caps, plaintiffs' lawyers switch to hourly fees and exploit their clients:
- You observe that in states with contingency fee caps, lawyers are more likely to drop cases they've filed; you interpret this finding as evidence that in those states more plaintiffs are suing using hourly fees, and -- being unsophisticated -- are duped by their lawyers into filing bad cases.
- You observe that in states with contingency fee caps the average time it takes a case to settle is longer; again, you interpret that finding as evidence that those states have more suits filed using an hourly fee, in which lawyers are stretching out their cases to rack up bills on their unwitting clients.
In this post, I'll set out my initial objection to your theory itself and offer an alternative explanation for your first result. I'll get to your second finding in my next posting.
In my view, your results are consistent with your theory that contingency fee caps cause lawyers to switch to more hourly work and thereby rip off their clients; but your theory is not the only -- or the most persuasive -- explanation of your results. The big problem I have with your theory (and its application to your empirical results) is that it doesn't match reality. Yes, some contingency fee litigation involves businesses that would switch to hourly rates on the margin when fee caps are imposed. But the overwhelming majority of contingency fee plaintiff cases exist in the American system solely due to the contingency fee itself; by definition, the clients lack sufficient liquidity and sophistication to hire hourly lawyers. Lester Brickman raised this essential critique in an AEI conference on your paper in 2004:
Alex Tabarrok's paper has several false assumptions. His assumption that contingency fee caps are a surrogate for hourly rates does not reflect the real world. Attorneys do not combine hourly rates with contingency fees -- they do in commercial litigation, but not in tort cases. Instead, caps are a practical way of lowering the effective hourly rate of return to attorneys, thereby reducing the overall volume of litigation.
Contrary to Tabarrok's assertion that there is no reason to think fee caps will decrease effective hourly compensation, there is no reason not to think that caps will decrease effective hourly compensation. Fee caps will move the threshold of risk such that attorneys working on contingency fees will take lower-risk, lower-return cases and pass on the higher risk cases of questionable merit.
In reaching his conclusions, Tabarrok assumes that a variety of fee agreements are available to plaintiffs, including agreements that waive fees. Empirically, the market for legal fees is not competitive, and so the kinds of flexible agreements which the paper presumes possible simply are not observed.
Tabbarok's critique of fee caps rests heavily on unwarranted assumptions. If society deems it a worthy goal, fee caps will reduce the volume of litigation by reducing the effective compensation to attorneys.
I think Lester's right here. You basically pooh-pooh the point, arguing that it's "trivial economics": "Imagine that tips for waiters were banned. What would happen to wages? They would increase. No big surprise but apply the same idea to lawyer contingent fees and we get lots of objections."
But I think what you're going after here is a straw man. Of course substitution effects exist. Of course contingency fee lawyers would shift on the margin to hourly work if caps were imposed. The real question, though, is whether that hourly work would involve the same type of work the lawyers performed with the contingent fee. And on that question, I'd say no; rather, I'd say that on the margin you'd have fewer of the products liability, medical malpractice, and personal injury cases the contingency fee reform was designed to reduce. Lawyers couldn't afford to pursue as many of those cases, of the shoot-the-moon variety, with contingency fee caps. Nor would they have those very same plaintiffs lining up to pay them hourly rates for the same types of cases. I think what you'd see is lawyers substituting hourly work of a different variety -- trusts and estates, family law, real estate, transactional. The increase in labor supply in those fields of law would push hourly rates down over time, and ultimately on the margin induce some lawyers to substitute nonlegal for legal work, in essence giving up the sunk cost that was their legal education and experience.
If you can come up with contrary evidence here -- even anecdotal -- I'd love to hear it. Can you show that there are a lot of medical malpractice cases being filed using hourly fees in states with contingency fee caps, like New York, Illinois, and California? Since that supposition is the linchpin of your theory, it would be nice to see even a quantum of evidence that lawyers are behaving consistent with your theory in the real world.
With that said, I'll move on to interpret your analysis of case drops.
Dropping the Ball: An Alternative Interpretation of Higher Case Drop Rates in States with Contingency Fee Caps
Chapter 5 of Judge and Jury, and the AEI paper on which it's based, are laymen's versions of a 2003 article you and Eric published in the Journal of Law, Economics, and Organization, available at 19 J.L. Econ. & Org. 517 ($). Your first major observation is that among medical malpractice cases filed in states in which contingency fees are capped, "18.3% of medical malpractice cases are dropped, but only 4.9% are dropped" in states without contingency fee caps. 19 J.L. Econ. & Org. at 531. You also look at what happened in the state of Florida before and after contingency fee caps were imposed and observe "a 15% increase in drops" after the caps were put in place.
I should note to our readers that your technical paper includes much more sophisticated analyses than the laymen's version in Judge and Jury. Specifically, you and Eric run two more sophisticated tests -- econometric regressions -- to see if the observed increase in drop rates still holds once you control for other factors. (Your methodology for analyzing your data across states is quite ingenious, I might add: you control for variation across states by observing differences between medical malpractice cases, in which fees are capped, and auto accident cases, in which they're not.) On one of your two cross-state tests, and on your Florida test, you find again that drop rates are significantly higher when contingency fee caps are in place.
Well, at first blush, this doesn't look too good for Copland's theory, does it? I mean, I hypothesized that by reducing the effective rate of return for attorneys who file low probability, high dollar claims, you'd improve overall case quality. On the surface, then, it doesn't make much sense that you'd see more dropped cases when states had caps on fees.
But let's step back a minute. As I noted in my first post, a rational plaintiffs' lawyer (risk neutral, with a diversified portfolio of cases) will accept a contingency fee case if and only if:
F*Pr*D > C
F = contingency fee ratio,
Pr = probability of success at trial,
D = expected damages at trial, and
C = cost of pursuing and trying case.
As I noted then, however, it's crucial to realize that the probability of success at trial and expected damages at trial are best viewed as ranges, not certainties, and that in any event they are not constant over time. Herein, I think, lies the most plausible explanation of your findings.
Why is that? Well, the probability of a case's success, from the perspective of the plaintiff's lawyer, varies over time. Litigation involves various stages:
- Pleading. In the United States today, the dominant rule is "notice pleading," in which "the plaintiff is required to state in their initial complaint only a short and plain statement of their cause of action. The idea is that a plaintiff and their attorney who have a reasonable but not perfect case can file a complaint first, put the other side on notice of the lawsuit, and then strengthen their case by compelling the defendant to produce evidence during the discovery phase."
- Discovery. Here the parties exchange information in "the pre-trial phase in a lawsuit in which each party through the law of civil procedure can request documents and other evidence from other parties or can compel the production of evidence by using a subpoena or through other discovery devices, such as requests for production and depositions. In American law, discovery is wide-ranging and can involve any material which is relevant to the case excepting information which is privileged or information which is the work product of the other side."
- Summary Judgment, Settlement, or Trial. The parties look for the judge to rule for one side or the other as a matter of law, they try to settle the case, and if all else fails they go to trial.
Viewing cases in this light -- how they actually occur in practice -- helps us to see what I think is actually going on here. Notice pleading is very, very cheap for the plaintiffs' lawyer. All a plaintiffs' lawyer has to do is pull up his template on Microsoft Word, alter a few names, dates, and phrases, and -- voila! -- notice is served. The plaintiffs' lawyer can then demand that the defendant produce documents, attend depositions, and the like.
And herein lies our answer. When a plaintiff first walks into the lawyers' office -- having seen that ad telling him he only need pay if he wins -- all the lawyer can observe is the plaintiff's level of injury. He cannot determine with any certainty whatsoever how likely he is to win at trial: that involves proving causation, i.e., that the plaintiff's injuries were caused by the doctor or hospital; and fault, i.e., that the doctor or hospital was negligent in causing those injuries. At the outset, when he signs up the plaintiff and assumes the minimal expense of filing the case, he only has his perception of the plaintiff's credibility to go on.
But once the defendant files a reply and discovery starts, it's a whole new game. Now the plaintiffs' lawyer starts to get a lot more information about what went on from the defendant's point of view. He starts to figure out just what the defense is probably going to look like at trial. So he readjusts his probability range, upwards or downwards, in a narrower band, based upon the information he has received.
Once we view the problem this way, it should come as little surprise that we see higher drop rates in cases in which we have contingency fee caps. At the outset, whether a state has contingency fee caps or not, lawyers sign up cases if the damages are sufficient that it might be worth their while to go to trial. Once the lawyers get more information as the legal process continues, they have a better estimate of the cases' real value. For any case, if the new expected value based on better information is below the expected cost to try the case, the lawyer drops the case. If the damages are really great, some low probability cases might still survive -- consistent with your strong empirical finding using the Florida data that cases with "permanent and grave" injuries were much less likely to be dropped. But for a significant subset of low probability cases, the expected value, once you have good information, is too low to justify pursuing when you have a cap on contingency fees but still worth taking a shot at if you have unlimited contingency fees. So you have more dropped cases in states with contingency fee caps precisely because the caps work as expected: once information emerges that refines the probability assessment for the plaintiffs' lawyer, he's more likely to drop the weaker cases.
In my interpretation of your results, then, contingency fee caps do work to eliminate bad claims. Because my interpretation is much more consistent with what we actually observe on the ground -- namely, that the relative merits of a case only emerge with any precision for the plaintiffs' lawyer after the claim is filed, and that we simply don't see lawyers pursuing med-mal cases on an hourly basis in states with contingency fee caps -- I think it's far more compelling than the explanation you give.
The legal profession is necessarily detail-oriented, and lawyers quite regularly miss the forest for the trees. But economics is necessarily a simplifying profession, and we must be vigilant to ensure that those simplifications make sense. When the assumptions of our economic models don't match reality, we can reach bad results.