Financing the litigation arms race

Using a dynamic real-option model of litigation, we show that the increasingly popular practice of third-party litigation financing has ambiguous implications for total ex-post liti-gant surplus. A defendant and a plaintiff bargain over a settlement payment. The defendant takes costly actions to avoid deadweight losses associated with large transfers to the plain-tiff. Litigation financing bolsters the plaintiff, leading to larger deadweight losses. How-ever, by endogenously deterring the defendant from taking costly actions, litigation financ-ing can nonetheless improve the joint surplus of the plaintiff and defendant. In contrast to popular opinion, litigation financing does not necessarily encourage high-risk frivolous lawsuits. & COPY; 2023 Elsevier B.V. All rights reserved.