Loss Aversion, Framing Effects, and Out of Court Settlement

Imagine you are walking along the street and find £10. Great! You put the money in your pocket. Later, you go to reach for it and it isn’t there any more – you have lost your £10. This feels bad, and, importantly, it likely feels more bad than it felt good when you found it.

This emotional asymmetry is the basis of loss aversion. In prospect theory, loss aversion refers to the tendency for people to strongly prefer avoiding losses than acquiring gains (even when the outcomes of the decision are de facto identical). As demonstrated by Amos Tversky and Daniel Kahneman, losses are on average at least twice as psychologically powerful as gains.

This has a dramatic effect on the way we make choices. If the outcome of a choice is presented as a gain, people will be likely to choose a smaller, but guaranteed, gain, over one that is larger but entails a degree of risk. Conversely, if the outcome is presented as a loss, people will be reluctant to accept a definite loss, and will instead risk losing more for the chance to lose nothing at all. We are, then, very influenced by how a choice is framed.

This is particularly relevant for out-of-court settlement in civil litigation. Settling a legal dispute out of court is typically beneficial for both parties, yet far too few disputes settle when they (mathematically) should, and framing manipulation is one of the many reasons for settlement failure.

In 1996, Law Professor Jeffrey Rachlinski conducted a study in which half of the subjects, the ‘claimants’, could either accept a settlement of $200,000 dollars, or proceed to court where they would stand a 50% chance of being awarded $400,000. The other half, the ‘defendants’, could pay $200,000 to the claimant immediately, or continue to court and risk a 50% chance of being ordered to pay $400,000.

77% of the claimants were happy to take the settlement, but only 31% of defendants were happy to pay it. As predicted, complainants faced with choosing between a definite gain and the chance of a greater gain were risk averse, and defendants were risk seeking when choosing between a guaranteed loss and the chance to pay nothing.

In 2014, Ian Belton and colleagues conducted a study where subjects were presented with a similar scenario, and also examined whether lawyers are as susceptible to framing effects as non-lawyers.

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As predicted, a significant effect of framing was found for both groups, as both non-lawyers and lawyers were much more likely to settle their claim in the gain scenario than in the loss scenario, though the effect for lawyers was less profound.

All parties involved in litigation, then, could benefit from a greater awareness of the biasing effect of framing, and as lawyers we should work to ensure that our clients’ decisions are not influenced by factors that ought to be irrelevant. Litigating in court involves substantial costs, uncertainty, and inconvenience if not stress or distress. If disputes can be settled satisfactorily out of court, then all barriers to mutually beneficial settlement – including framing effects – should be addressed.

References:

Belton, I. K., Thomson, M., & Dhami, M. K. (2014). Lawyer and Nonlawyer Susceptibility to Framing Effects in Out‐of‐Court Civil Litigation Settlement. Journal of Empirical Legal Studies, 11(3), 578-600.

Kahneman, D., & Tversky, A. (1984). Choices, values, and frames. American psychologist, 39(4), 341.

Plous, S. (1993). The psychology of judgment and decision making. Mcgraw-Hill Book Company.

Rachlinski, J. J. (1996). Gains, losses, and the psychology of litigation. S. Cal. L. Rev., 70, 113

 

3 Comments

  1. David Walter

    January 18 at 3:52 pm

    Really enjoying your blog Thanks. Twitter davidat

  2. I have not read Prof. Rachlinski’s study but the asymmetry between claimants and defendants arises,in part, from the ability of insurers to absorb a loss on an individual case. For the plaintiff the trial pools risk in one “bet” . An insurer can spread risk across many “bets” . Your blog on this subject and others is very interesting.

  3. Christine F

    January 28 at 9:56 am

    I really enjoy reading your thought provoking blog. Clear, well-written articles which give food for thought. Thank you

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