The valuation of a dynamic litigation process: the lawsuit as a (real) option on an option

Abstract We solve a multi-stage real options model of litigation that embeds extant frameworks from the literature. The characterization of filing a lawsuit as a compound option permits a novel analysis of real-world phenomena. Heightened pleading standards, with the front-loading of litigation costs and potentially earlier trial payoff predictability, are analyzed in terms of their impact on the marginal propensity to sue. Court delays, despite concomitant cost increases, may lead to a destructive positive feedback loop in which delays inspire more filings. An equilibrium settlement solution is derived, implying efficiency gains, but more frequent low expected value lawsuits.