Albert H. Choi and Kathryn E. Spier (University of Virginia School of Law and Harvard University – Law School – Faculty) have posted Taking a Financial Position in Your Opponent in Litigation on SSRN. Here is the abstract:
We explore a model of litigation where the party bringing the lawsuit, the plaintiff, can acquire a financial position in the target firm, the defendant. The plaintiff gains a strategic advantage by taking a short financial position in the defendant’s stock. First, the plaintiff can turn what would otherwise be a negative expected value claim (including a frivolous one) into a positive expected value one. Second, the short financial position raises the minimum amount the plaintiff is willing to accept in settlement, thereby increasing the settlement amount. Conversely, taking a long position in the defendant’s stock puts the plaintiff at a strategic disadvantage. When the firm’s market value reflects all publicly available information, the plaintiff does not systematically profit from its financial position. When the defendant is privately informed of the merit of the case, the plaintiff balances the strategic benefits of short position against the costs of bargaining failure and trial. Short selling by the plaintiff can, under certain circumstances, benefit both the plaintiff and the defendant and also reduce the rate of litigation.