Taking a case to trial always involves some level of risk and a sense of gambling. To better manage and understand that risk, it is critical to understand the “expected value” of your case. For the purposes of litigation, the expected value is a function of your chances of success at trial and the financial exposure in the case. For example, if you were litigating a $1 million case, and your chances of winning at trial were 50%, the expected value of the case is $500,000 (EV = (.5 x $1,000,000) + (.5 *$0) = $500,000).
To the extent that counsel is able to determine the expected value of their case, they are in a position of power when it comes to settlement negotiations. Consider an example which is not as even handed as the example above, one in which defense counsel determines that they have a 75% chance to win at trial in a case where $1.5 million is at stake. Here, the expected value of the case is $375,000 (EV = (.25 x $1,500,000) + .(.75 x $0) = $375,000). If plaintiff’s counsel makes a $650,000 settlement demand, that demand should be rejected, because it represents a value that is much higher (and presumably higher than the costs to continue with the litigation) than the expected value of the case. Conversely, it should be considered a “win” if defense counsel is able to effectively negotiate a settlement agreement for less than $375,000 plus the anticipated costs of continuing with the litigation.
One can observe how expected values are used in real financial decisions by simply watching a broadcast of poker on television. In poker, whether one bets or folds is determined by assessing the odds that your hand (which is known) is better than your opponent’s hand (which is not known). A skilled player may make substantial bets even if they think they don’t have the best hand, because the expected value of those bets is positive. That is, they have enough chance to win the hand and the amount of money they can win is large enough to justify a substantial bet. It’s probably not surprising that some of the best poker players in the world are highly skilled at mathematics and probability theory, as these decisions must be made rather quickly with very high personal stakes.
Although similarities exist between poker players and litigators and their assessment of risk, important differences exist as well:
- In poker, the psychological hurdle is determining what cards your opponent holds, and then betting and reacting to bets that are appropriate in terms of expected values. The easy part is knowing who has the best hand when all the cards are on a table. A flush will always beat a straight, and there is nothing subjective about the assessment of the two hands.
- In litigation, the problem is a bit different. Here, everyone knows each others “hand” while the game is being played. The difficulty is in terms of assessing the strengths and weaknesses in each hand, which are inherently subjective and determined by a third party (i.e., a jury, judge, arbitration panel, etc.).
Thus, the challenge for litigators is to accurately determine the financial exposure of their case, as well as their chance of success at trial. To the extent that this information can be reliably determined, counsel will be in a position to better manage their litigation risk.
In our next blog, we’ll discuss factors that contribute to both financial exposure and probability of success at the jury level.
View the orginial posting here: