Berkeley Program in Law and Economics

Under an "offer-of-settlement" rule, if a party to a lawsuit makes a formal offer to settle which the other party rejects, the offer nonetheless becomes part of the record, and thus may affect the allocation of litigation costs. If the parties litigate to judgement, the allocation of litigation costs may depend on how the judgement compares with the formal offer. This paper examines the effect that such rules have on the terms of settlement. The analysis first sets forth a general principle that identifies the settlement amount under any such rule. We then apply this principle to derive the settlement terms under the most important of these rules, and we identify a large set of seemingly different rules that produce identical settlements. The analysis has substantial policy implications; in particular, it shows how offer-of-settlement rules can be designed, when deemed desirable, to ensure that settlement terms not deviate from but rather mimic the expected judgement.