Exploiting Future Settlements: A Signalling Model of Most-Favored-Nation Clauses in Settlement Bargaining

Andrew Daughety and Jennifer Reinganum ()

RAND Journal of Economics, 2004, vol. 35, issue 3, 467-485

Abstract: Most-favored-nation (MFN) clauses have been used to address a repeat player's time-inconsistency problem in international trade, durable-goods monopoly pricing, franchise contracting, and settlement bargaining. We argue that a nonrepeat player (an early-bargaining plaintiff) can use an MFN to profitably modify the subsequent bargaining game between the defendant and a later-bargaining plaintiff. If an MFN is triggered (which can happen in equilibrium), the early plaintiff receives an additional payment. Less obviously, the early plaintiff's incentives for information revelation are enhanced by this potential payment, so the defendant can resort to trial less frequently. Conditions exist such that an MFN increases total surplus.

Date: 2004
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