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If Only Humans Were Rational

July 29, 2013 at 2:32 PM

Nigel Dunlop looks at how people behave in negotiation and what to do about it

Negotiation can be an exasperating business. Too often, people will not make sensible decisions. They act in a way which defies logic.

We like to think of ourselves as rational beings. But we are not. The way we negotiate is distorted by our psychological make-up.

I outline below a variety of psychological phenomena which get in the way of quick and sensible negotiation outcomes. By understanding these psychological traits, lawyers who represent parties in negotiation are more likely to achieve better outcomes for their clients.

Loss aversion and risk tolerance

Generally, people attach greater weight to prospective losses than prospective gains. We are more concerned about losing something than gaining something. This is why defendants may have greater difficulty than plaintiffs in reaching a settlement.

Those contemplating a possible gain are risk averse. They prefer certain gains over larger but riskier gains. A plaintiff considers that a bird in the hand is worth two in the bush. By contrast, those facing a possible loss tend to be risk tolerant. They prefer the risk of a bad outcome to the certainty of lesser loss. A defendant is more inclined to run their chances in court because they find the prospect of paying out so unpalatable.

The phenomenon of loss aversion/risk tolerance, links to that of framing. A solution to loss aversion is reframing, referred to below.

Framing

We are powerfully influenced by the way we frame possible outcomes. If we perceive a possible outcome as a loss we are inclined to reject it, but if we are able to perceive the same possible outcome as a gain, we are inclined to accept it.

For example, employees are typically reluctant to give up established benefits in exchange for an equivalent wage rise because they frame the outcome in terms of loss. They do so, because people are more concerned about losses (in this case of benefits) than attracted to gains (in this case of wages).

Framing can result from an unhelpful or misleading point of reference. A vendor in a depressed market may decline a good offer, because they are comparing the price offered with their original purchase price. If they frame the offer differently, by reference to current values, the offer may appear attractive. Similarly, a plaintiff may frame a settlement offer as a loss because their reference point is the full amount they are claiming. If on the other hand, their point of reference is more realistic, then the same settlement offer could be viewed as an attractive one.

A solution to adverse framing by a party is to explain and demonstrate why a proposed settlement is in their interests, so that they come to see it in positive rather than negative terms. In short, the solution is reframing.

Anchoring

People have an automatic, unconscious tendency to 'anchor' on the first number they encounter when estimating a value. The anchor is their point of reference.

In negotiation, a party might unwisely use the anchor of a first offer to estimate the value at which they should settle. They might decide that a figure 50 - 70 per cent from the opening offer is worth settling for. The initial offer, however, may be a preposterously unrealistic figure. Such a party is open to exploitation by a savvy opponent who pitches the opening demand accordingly. A settlement of $200,000 in a $500,000 claim may appear attractive to a plaintiff when the defendant's initial offer was $30,000. Conversely, a plaintiff's first offer in a $500,000 claim to settle for $485,000 may result in a later offer to settle for $375,000 appearing attractive to the defendant.

Such is the power of anchoring, that even when negotiators have a clear view of the value of their cases, and know about anchoring, they may still be subconsciously influenced by an opening offer. The challenge for the targeted party is to remove the case analysis away from the anchor so that it ceases to be a reference point.

It might seem that such is the power of this phenomenon that all negotiators (whether for plaintiff or defendant) should play the game of unrealistic first offers in order to exploit it. However, that can be a dangerous game to play for at least the following reasons:

  • The offer may inject unhelpful negativity into the negotiations, even to the extent of the offeree abandoning the negotiations out of despondency, frustration, or anger;
  • An unrealistic first offer is likely to create a long, fraught, and exhausting (and thereby risky) process of incremental bargaining whereby the amount on offer is progressively raised by small degrees;
  • The offeror loses credibility and the ability to later argue that a much improved offer is reasonable – it can hardly be contended at one moment that $30,000 is fair and then later that $200,000 is fair.

The endowment effect

People ascribe greater value to something they own than do people who do not own that thing. House owners, for example, typically consider their home to be worth more than non-owners consider them to be worth.

This phenomenon is related to the loss-aversion phenomenon previously described. We are reluctant to part with (lose) anything we own, and therefore expect a premium to be paid for it.

In any negotiation involving the sale and purchase of an asset, therefore, there will be a genuine mismatch between vendor and purchaser perceptions of the true value of the asset concerned. Likewise, in a non-personal injury case, the plaintiff owner will typically attribute greater pre-injury value to the asset concerned, than the defendant.

Obtaining authoritative evaluations is an obvious solution, but sympathetic acknowledgement of the emotional value of the asset to the opponent will be helpful: "You have a lovely home of which you can be proud, but the fact of the matter is that it has been valued at only $950,000 and is not worth the $1,300,000 you say it is worth."

Certainty attraction

People place a premium on certainty. We will spend more to reduce uncertainty of outcome from say 15 per cent to zero than from 30 per cent to 15 per cent, even though the movement in both cases is 15 per cent.

Parties in negotiation will therefore pay extra to achieve a full or final settlement, in contrast to a partial or interim settlement.

For example, a respondent builder in a 'leaky home' case will prefer to pay $250,000 to settle the claim once and for all, than pay $200,000 on the basis that if further existing problems are identified in the future, he will rectify them, even though he knows that the chance of further problems being detected is remote.

The canny negotiator who knows that finality is more important to the opponent than themselves, should therefore be able to extract a premium in settlement.

Risk familiarity

People are prepared to take greater familiar risks, than smaller unfamiliar risks. We are more concerned about the unfamiliar than the familiar, even though the latter might hold greater risk than the former.

Therefore, in negotiation, it is better to seek outcomes that might carry a known risk rather than an unknown risk. It is better for example to agree to a solution that involves recognised processes than those which are untested. We prefer tried and true solutions to newfangled solutions, even if all the evidence points to the latter being more effective.

Selective perception

People dislike cognitive dissonance, that is to say, a clash of information. We prefer a consistent picture of the world. Therefore, we unconsciously screen out data that contradicts our existing view.

Thus, there is a tendency for parties in negotiation to have genuine difficulty 'hearing' the alternative picture which is being painted by their opponent. Subconsciously, they filter out conflicting evidence because it is psychologically uncomfortable to contend with the consequent contradiction and uncertainty.

The solution is to present the conflicting evidence with clarity and perseverance, and to do so in a manner and tone which does not cause offence.

Reactive devaluation

People tend to react negatively to information and proposals provided by an adversary. We automatically discount what our opponents say. We believe, for example, that if a proposal comes from the other side, then ipso facto it cannot be worthwhile.

As a result, concessions or proposals made early in a negotiation will be discounted and devalued more by the opponent than if they are made later, when a degree of trust and goodwill may have been established.

That is why it is of importance in negotiation to establish goodwill and trust before engaging in hard bargaining. For this reason 'cutting to the chase' (so beloved by some lawyers) can be counterproductive.

Winner's curse

This is closely related to reactive devaluation. When a deal is done, a party may feel they have let themselves down. They surmise that the other party only agreed to a settlement because it favoured that other party.

In negotiation, parties often anticipate winner's curse. They are reluctant to make an offer in case the other side accepts it, thereby demonstrating that the offer was unduly favourable to the other side; in which case, they should not have made the offer! There are echoes here of loss aversion and framing. A party views the opponent's acceptance of their offer as tantamount to a loss ("I could have got another $10,000 out of them").

The solution to winner's curse is for the parties to stay focused on their own needs and interests, and realise that it is impossible to quantify them with arithmetical precision. It is no bad thing that a good outcome for the client happens to be a good outcome for the other party as well.

Attribution error

People attribute blame to others rather than themselves. We typically believe that our successes are due to our own industry and talent, but that our failures are caused by others.

When we accuse others of doing things to us, we believe those things were within the control of those other persons. By contrast, when we are accused of doing things to others, we believe those things were beyond our control.

Thus, in negotiation, parties seek to avoid blame and liability by attributing their conduct to external circumstances beyond their control. On the other hand, the parties doing the blaming attribute internalised (deliberate) conduct to the blamed parties.

Solutions are to explore the evidence rather than the perceptions of causation, avoid moralistic judgement, and overcome personal defensiveness.

Judgemental over-confidence

People place unwarranted confidence in their own predictions about future events. We have an unjustified cockiness. We believe on average that we are more intelligent, insightful, and capable than others.

Typically, therefore, people overestimate their chances of winning at trial.

The solution to this problem is for the negotiation to include a thorough and objective examination of the facts, including possible or likely scenarios should the case not settle.

Initial course commitment

People have a tendency to stick to their guns. Once we have adopted a course of action, we like to stay with it even where that is no longer sensible. This partly explains the stubbornness often observed in negotiation.

A type of initial course commitment is commitment to sunk costs. Parties tend to frame settling for less than they have already spent in legal expenses as a loss. Although self-defeating, a weak case might be pursued with mounting transaction costs in the forlorn hope of recovering those costs.

The solution is reframing: "It is best that I cut my losses now and get out of this mess while I can" compared with "I won't feel good unless I have recouped every cent I have spent on this case".

Persuasion principles

Negotiation, like litigation, involves the art of persuasion. Here are six principles of persuasion to which people psychologically respond.

Liking
People will bargain more favourably with those they like than don't like. We prefer to say yes to the requests of people we like. That is why it is seldom an advantage to their clients for lawyers engaged in negotiation to be unpleasant towards the opposition.

Reciprocity
People are more inclined to offer concessions if concessions are offered to them. As marketers who offer free knick-knacks know, people like to give something back, even if it is of much greater value. Making a concession in a negotiation, far from being a sign of weakness, can be a smart move, inducing a greater concession from the other side.

Social proof
People bargain in accordance with what they believe their peers would do. We determine what is correct by finding out what other people think is correct. It is a smart move therefore to reassure the opponent that the settlement proposed is what like-minded people would have agreed to.

Consistency
People desire to be, and to appear to be, consistent with what they have already done. By extracting commitment from a party, they will thereafter act consistently with that commitment, to the advantage of the other party. If you get the opposition to agree to explore a mutually acceptable outcome, they will usually find one. In negotiation, therefore, discuss commitment to settle before discussing possible settlement outcomes.

Authority
People generally respect authority. They are more likely to subscribe to outcomes which are sanctioned or encouraged by judges and respected others. Therefore, the likely views of those respected persons should be highlighted. Similarly, people respond favourably to the authority of experts, and so they should be used.

Scarcity
People want more of what they can have less. They will agree to an outcome which seems elusive. Make the opposition feel that they are on to a good thing and they should therefore grab the settlement whilst it is on offer.

Conclusion

Lawyers representing parties in my mediations often tell me that the negotiation process throws up many surprises and is invariably fascinating. I believe that the reason largely relates to the psychological phenomena discussed above. In the early to mid phases of a negotiation/mediation, these psychological phenomena dominate, but gradually with the knowledge, perseverance, and skill of all concerned, the 'irrationality' dissipates in the closing phases. How often I have heard it said: "I never thought they would settle!"

Nigel Dunlop is a barrister and mediator in Auckland.

The sources for this article are: D R Philbin, "The One Minute Manager Prepares for Mediation: A Multidisciplinary Approach to Negotiation Preparation", Harvard Negotiation Law Review, Vol 13: Winter 2008 at 249; Mnookin, Peppett, and Tulumello, Beyond Winning: Negotiating to Create Values in Deals and Disputes (Harvard University Press, 2000); Bazerman and Neale, Negotiating Rationally (The Free Press, 1992); Lewicki, Barry, and Saunders, Negotiation (McGraw-Hill/Irwin, 2007); Golann, Mediating Legal Disputes (Wolters Kluwer Law & Business 1996); Peter Spiller (ed), Dispute Resolution in New Zealand, second edition (Oxford University Press, 2007).

NZLawyer Extra, 7 May 2010, Edition 1



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