Moral hazard and agency relationship in sequential litigation

The aim of this paper is to determine the optimal fee contract between a plaintiff and his lawyer in a trial process where liability and damages are treated sequentially: the court determines liability at the first stage and chooses damages at the second one. The plaintiff-lawyer relationship is embedded in a dynamic principal-agent setup where the lawyer's effort is unobservable by her client. It is shown that such a sequential process induces an interesting spillover effect for the plaintiff: the prospect of payment at the second period acts as carrot for the first period by inciting the lawyer to make effort in the liability stage in order to enjoy the reward in case of winning when damages are litigated. This effect implies a particular contractual design where the lawyer gets no transfer from the plaintiff at the first period. (C) 2014 Elsevier Inc. All rights reserved.