Third-Party Involvement in Litigation: An Economic Analysis

Abstract

This paper provides an economic analysis of how different forms of third-party litigation funding arrangements affect the incentives to engage in litigation. Alternative funding schemes can take the form of equity, debt, or donations, which may be fixed-sum or create marginal cost reduction. Each alternative has divergent effects on litigants' expected value calculations and marginal costs/benefits when deciding whether to file suit, invest in their case, or settle. The analysis shows third-party funding can address underinvestment due to budget constraints, but can also lead to overinvestment and distorted settlement incentives depending on the funding structure. From an organizational perspective, third-party funding often misaligns investor and litigant interests, leading to principal-agent problems. However, incentives can realign when both parties’ returns are tied to the lawsuit’s outcome. The paper concludes that some forms of litigation funding can expand access to courts and properly align incentives. Still, regulators should consider incentive distortions created by concealed forms of funding more accessible to corporate litigants. Overall, this economic analysis enriches our understanding of how third-party funding arrangements affect organizational behavior in the legal process.