As I noted in the last post, the ‘active managers’ accounted for by the real options approach want the flexibility to calibrate their investments in litigation to developments in the case at hand and the portfolio as a whole. Fully staged financing, as reflected in the model, provides that flexibility. However one of the underlying features of claim value that drives that desire for flexibility and makes staged financing so useful deserves more explicit examination: the nonmonotonic trajectory of claim value.
We have argued in our essay on staging litigation funding that claims have a fundamental valuation difference from the start up companies at the heart of the venture capital analogy. That is, claim value doesn’t generally grow organically in value by orders of magnitude over time as the claim develops (although the value of both start ups and claims is similar in that it can prove to be zero.) But in that essay we didn’t sufficiently emphasize the fact that claim value goes up and down over time, unpredictably. Indeed, a claim’s value may go up, then down, then up again.
These nonmonotonic valuation changes are primarily a result of the institutional context of litigation, namely, procedural variables, the emotional/cognitive biases of decisionmakers such as judges and jurors, and the fact of appeals. As a result of a litigation value’s tendency to go up and down unpredictably, the flexibility to actively manage investments in cases becomes even more valuable to the repeat-playing portfolio holders at the heart of the real options approach.
Given this need for tailoring, full staged financing that keys the ability to increase or reduce (or end) investment to developments that reveal the current trajectory of the nonmonotonic value–milestones–is far more useful than the sequencing that ex ante negotiates lump sum tranches of capital to be released or withheld whenever the litigators finish burning through the prior tranche.