Contingent Fees, Signaling and Settlement Authority

Conventional wisdom suggests that under contingent fee contracts, attorneys have an excessive incentive to settle the case; therefore, a plaintiff should retain the authority over settlement decisions. We show, by contrast, that when the plaintiff possesses private information about the outcome of a trial and makes a take-it-or-leave-it settlement demand, delegating settlement authority to an attorney under a contingent fee contract increases the probability of settlement and the plaintiff’s equilibrium payoff. We also show that contingent fee contracts with attorney control over settlement are more efficient than hourly fee contracts, as the former involve a higher probability of settlement. The intuition behind these results is that the attorney’s greater reluctance to go to trial allows him to more effectively signal the plaintiff’s type through the settlement demand.