Analytic Methods for Lawyers: Spring 2006

 

Final Exam

 

 

I. You are  defending a lawsuit for Imperial Mining & Petroleum (IMP).  Paula Plaintiff's settlement demand is a nonnegotiable $900,000--she will not consider any other offer.

 

The plaintiff has only a 50-50 chance of prevailing on liability; if she prevails, her damages are $1 million. Your trial costs would be $100,000. If she prevails there is a slight chance — only 10% — that a jury would award punitive damages, for a total recovery (compensatory plus punitive damages) of $9 million; since she has only a 50% chance of prevailing, that is only a one in twenty risk.

 

Draw the decision theory diagram for this situation. Should you settle or go to trial? Explain.

                                                                                                                                                                                                                    (5 points)

 

II. Further research adds the following information, modifying the situation described above:

 

1. Going to trial will cost Paula $100,000--but with that investment, her chance of getting punitive damages if she wins the suit is only 5%. By spending an additional $200,000 on much more extensive legal and factual research, she can raise that to 10%. 

 

2. Paula is risk averse.

 

Draw the appropriate diagram and use the concept of subgame perfect equilibrium to decide:

 

If the case goes to trial, how much will Paula spend?

 

Should the firm settle for $900,000 or go to trial?                                                                                          (10 points)

 

III. Briefly explain what a Nash Equilibrium is. Give an example. Is the equilibrium unique--can a game have more than one equilibrium? If so, give an example.                                                                                                                                                                           (5 points)

 

IV. Teachers on Tape (TOT) offers a catalog of taped lecture series featuring famous professors expounding their favorite theories.  Customers who purchase one series by a professor often return to buy additional sets of lectures by other professors and also recommend the series to their friends.

 

You have been asked to begin developing the prototype contract that TOT will use with new professors hired to produce new courses. Advise TOT on the compensation scheme that should be used in the new standard contract. Should professors be paid by how many hours of lectures they produce, how much time they spend producing them, or on some other basis? Some professors only have to tape their lectures once, others use up many hours of (expensive) studio time for each hour of tape produced—how, if at all, should the contract take account of that? Explain.                                                                                                                                                                                                                 (10 points)

 

V. According to this course, what is the central objective when designing a contract? Briefly discuss how to achieve it. (5 points)

 

VI. After passing the bar with flying colors you fail to receive a partnership offer from any of the stateÕs top law firms and decide on a new career—teaching other students how to pass the bar. Starting with a $50,000 interest free loan from your father, received on January 1st 2007, you set up a firm: Flying Colors Inc.

 

Write the initial balance sheet for Flying Colors, showing assets and liabilities.

 

You spend $2000 for a new computer, $500 for a color laser printer. Show the T diagrams for the transactions.

 

During the first year, you hire two third year students part time for $5,000 each as tutors. You pay $2000 to rent the room where you do your tutoring and $500 for advertising for this year and an additional $500 at the end of the year for advertising to appear early next year. You have forty customers who pay you $500 each. Write an income statement for the firm.

 

Write a balance sheet for the end of the year.

 

At the beginning of the second year you receive an offer from a prestigious IP firm and decide to go out of the tutoring business. You discover, to your pleased surprise, that your color laser printer is actually worth more than you paid for it, so you sell it for $600. Your computer, however, sells for only $1000. You pay back the loan. Those are the only transactions that year. Show the T-statements, the income statement and the balance sheet for the end of the year.

                                                                                                                                                                                                                 (10 points)

 

VII. How do accountants deal with intangibles, such as goodwill? How do they value assets? How do they deal with uncertain events, such as the possibility of paying out damages in a law suit? Explain why things are done this way.      (5 points)

 

VIII. Briefly explain one of the following three theoretical ideas:                                                          (5 points)

 

CoaseÕs explanation of why firms exist

 

The Berle/Means view of large corporations with dispersed stock ownership

 

The Miller/Modigliani theorem

 

IX. A firm you have sued makes two alternative settlement offers: $5,000,000 today or $3,000,000 today and another $3,000,000 ten years from now.

 

Discuss the problem of deciding what interest rate you should use in choosing between them.

 

If you conclude that the right interest rate is 10%, which offer should you prefer?           (10 points)

 

X. What is a demand curve? How do the demand and supply curves for a good determine the price and quantity? If the good is umbrellas and a very rainy year makes them more popular, how does that affect the supply curve, demand curve, price and quantity?      (10 points)

 

XI. What is an externality? Why are externalities a problem? Briefly discuss alternative ways of dealing with the problem.            (5 points)

 

XII. What is the Òoptimal level of auto accidents,Ó economically speaking?

 

Suppose drivers are strictly liable for damage to pedestrians. How does that affect the incentives of drivers to avoid accidents? Of pedestrians to avoid being the victim of accidents? Compare to the result under a negligence rule.

 

What does ÒnegligenceÓ mean in the context of the economic analysis of law?                     (10 points)

 

XIII. I steal $100 from you, making me $100 richer, you $100 poorer. Why, economically speaking, is this a bad thing? WhatÕs wrong with theft and robbery anyway?                                                                                                                                                                (5 points)

 

XIV. You have been keeping track of what grade of gasoline you buy and what mileage you get and have used the data to calculate the correlation between octane rating and miles per gallon. The correlation coefficient is .8. What does this tell you about the relation between octane rating and mileage? You observe that 80 octane gasoline costs $2/gallon, 90 octane costs $2.10. Does that plus the correlation coefficient tell you which you should buy? Explain. Are there other ways of analyzing the data that would help? Explain.      (10 points)

 

XV. A few years from now, a study of student records and bar results reveals that students who took this course have a substantially higher bar passage rate than students who did not. Do you conclude that we could raise our bar passage rate by making this course a required one? Discuss. What additional information might you want to use in answering the question, and how would you include it in your analysis?                  (5 points)

 

XVI. What does it mean to describe a result as Òstatistically significant?Ó                                     (5 points)

 

XVII. A statistician employed by the Law School analyses bar passage rates using a multiple regression. The dependent variable is whether a student passed the bar on his first try, the independent variables are his LSAT,  GPA from college, first semester grades and first year grades. The regression has an R2 of .9, yet none of the independent variables has a t value large enough to be statistically significant. What do you think is happening?                                                                                                                                                                                   (5 points)