The Optimality of Contingent Fees in the Agency Problem of Litigation

Abstract

Linear contracts are of particular interest to economists. They have a simple structure, yet they are very popular in practice. In this regard, plaintiff-lawyer contractual relationships are of particular interest. Lawyers' fees are mostly paid by a sharing rule and they are typically a fixed proportion of the recovery across all lawsuits of the same type and this fixed proportion typically stays constant for many years. Such a simple and stable form of contract is puzzling to contract theorists. This paper presents a simple agency model with a risk-averse principal and a risk-neutral agent. We show that the observed puzzling features of contracts in litigation are in fact optimal behaviors if a lawyer's effort has a constant marginal cost.

Keywords: Litigation, Contingent Fees, Agency Problem

JEL Classification: K00, K13