improving litigation decision-making &managing litigation costs byacknowledging risk

34 Coquito Court, Menlo Park • California 94028 • Phone 650.854.1914 • www.litigationriskmanagement.com • [email protected]

LitigationRisk Management

Institute

Bruce Beron, Ph.D., President

Improving Litigation Decision-Making &Managing Litigation Costs byAcknowledging Risk

Risk ManagementLitigation

Institute© Bruce Beron 2014 LRM Brief Intro / Costs

Management–the act, art, or manner of managing, or handling, controlling, directing, etc.

Decisionmaking

Implementation

Most of us are taught implementation (how to take a deposition or write a brief). If we are really good at it, we get promoted to decision-making, which is a different set of skills.

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Strategic decision-making requires a different mind-set / perspective from operational decision-making.

For strategic decision-making, we need to focus on those uncertainties that can change the decision.Most operational/implementation issues are unimportant for strategic decision-making.These operational/implementation “details” may be very important and must be taken into account once the decision has been made and is being implemented.

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Risk — the chance of injury, damage, or loss; dangerous chance

The art of business-like decision-making is the art of balancing risk and reward.Few lawyers or business people understand Risk.It requires a statement of likelihood like:

CouldMightWillOr, most effectively, a probability (quantitative)

And requires a statement of consequence:Hit by a carLose our shirtsOr, most effectively, lose ten million dollars (quantitative)

We define Risk as UncertaintyAnd that doesn’t necessarily imply a chance of lossIt is risky if you get $5M when you might have gotten $100M

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Most attorneys and business people do not think properly about the rewards either.

We almost always focus on the risks, the downside.• There is someone’s name on the check.• The accounting system knows exactly how much was misspent.The potential upsides are never precise or well defined.• Very few people get fired for increasing sales by 30% when they

should have increased them by 40%.• Very few attorneys are criticized for settling a case for $20M

when the expected loss was $10M.The upside too requires a statement of likelihood and a statement of consequence.

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What is Litigation Risk Management?

A way to understand risk

A way to make good decisions

In order to make good decisions, we must understand uncertainty!

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Let's consider a simple litigation example where we are the defendants.

Liability

No Liability

0.3

0.7

Damages$100,000

$0

For simplicity's sake, let's ignore litigation costs.

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The Expected Loss is defined as the sum of all the outcomes times their respective probabilities.

Liability

No Liability

0.3

0.7

Damages$100,000 x .3 = $30,000

$0 x .7 = $0

$30,000

$30,000

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Expected Loss represents the average loss if we could run the litigation many times.

• It is a good starting point for settlement value

•But it doesn't take risk into account.

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What is our maximum settlement value for this litigation?

• The difference between this maximum settlement value and the Expected Loss is our risk premium.

• If our maximum settlement value is $40,000, then our risk premium is $10,000 ($40,000-$30,000).

• This means we are willing to pay an extra $10,000 to avoid the chance of the bad outcome.

This is our reservation price.- If we can settle for less - we will take it .- If we can't - we are willing to take our chances in court.

• There is no right answer, but there is a right way to think about this value. Only three things should be considered:

- Probabilities- Outcomes- Risk Attitude

• Avoid sunk cost thinking!

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Let’s consider the probabilities

Liability

No Liability

0.3

0.7

Damages$100,000

$0

$30,000

Where do they come from and what do they mean?

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A probability is the quantification of judgment, based on knowledge and experience.

• The trial outcome will only happen once, and we will win or lose.

• The question we want answered is• “Will we win or lose?”• The probability reflects our best judgment as to how likely

winning is, to help make decisions.• There is no right answer!

• If the original judgment of win is 95% and we lose, that does not mean that the 95% judgment was wrong!

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A probability is the quantification of judgment, based on knowledge and experience. (continued)

• Do not confuse probability with frequency• Frequency is what is taught in classical statistics• Frequency of heads in a coin toss is 50%.• Frequency is accessible for a coin, not for a unique case.

• Correct probability is an accurate reflection of judgment.• Not always easy to assess.• We all have biases in thinking about probabilities.

• Probabilities change with new knowledge• Quantification does not imply precision

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Would it be a good decision to settle this case for $35,000 if we could?

Yes, because we are settling the case for $5,000 less than the maximum settlement we would be willing to pay.

Expected Loss of $30,000Risk Premium of $10,000

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We should distinguish between decisions and outcomes.

•Good decision-Consistent with knowledge and preferences

•Good outcome-One we want

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We should distinguish between decisions and outcomes.

•Know what you can control and what you can't.

• If you don't analyze decisions, you can only judge on outcomes.

If you judge people by outcomes, they will make those decisions that have the lowest probability of a bad outcome, not the highest expected outcome.

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What tools do we have to manage the trade-off between litigation risk and litigation cost?

•We can calculate the value of imperfect control.-How much would we pay to incrementally decrease the

likelihood of a bad outcome?•How much would we pay to decrease the probability

of liability by 10% back at our simple example?

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Liability

No Liability

0.2

0.6

Damages$100,000 x .2 = $20,000

$0 x .6 = $0

$20,000

$20,000

New Expected Loss is the Value With Imperfect Control -$20,000 - Original Expected Loss -$30,000 Value of Imperfect Control $10,000



We put in the new probability, calculate the Expected Loss, and then subtract the original Expected Loss, to get the incremental value.

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There is always risk in litigation! The best you can do is to minimize those risks in a cost effective manner.

•Acknowledge explicitly the risks/uncertainty in litigation.

• Judge counsel on the quality of their decisions, not on their outcomes.

•Control costs by making explicit trade-offs between litigation risk and litigation cost.

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Litigation Risk Management is a necessary supplement to your intuition.

An effective, efficient decision insurance policy

When intuition doesn't work or you are not quite comfortable with your decisions

When you need to justify or explain your decisions

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Litigation Risk Management is a process for making good decisions.

It is a process, not a product.Characterized by:•Decision focus

•Do enough analysis to make decision

•Balance between:•Paralysis by Analysis•Extinction by Instinct

The real product is not the numbers but a state of satisfice in mind of decision makers.

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If a man will begin with certainties he will end with doubts, but if he will be content to begin with doubts he shall end in certainties.

-Francis Bacon

(1561-1626)

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improving litigation decision-making &managing litigation costs byacknowledging risk

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