Loss Aversion
Negotiating with a Full Deck
As we all know, negotiating isn't like gambling, negotiating is gambling. All negotiations require the bargainers to evaluate the potential risks and likely benefits of any offered deal -- whether it be a million dollar demand to settle a lawsuit or a $20 offer to try out a new internet service. Since we can can never truly know the mind of another nor predict the future, we should, at a minimum, know our own propensities in regard to risk as well as our best alternatives to a negotiated agreement ("BATNA").
Recent Research on Loss Aversion
Fellow legal blogger, law professor and commercial litigator Michael Webster reports on the most recent research on loss aversion as follows:
Over at the Neuroeconomics blog, they ask are we bad forecasters of loss? In the economic literature, loss aversion is described as turning down risks or gambles with large chance of loss, but with a positive expected value. For example, consider wagering $50 on a bet that returns $200 30% of the time and 70% of the time nothing. Even though the bet has an expected value of $60, which is greater than $50, most people will not play this bet. What is the basis for risk aversion?
Here is Neuroeconomics' conclusion:
Predications of emotional impact weigh heavily on decisions. In fact, people avoid risk even when faced with the prospect of large gain, predicting loss will hurt them much more than an equal gain will please them. If that is true, this phenomenon (termed loss aversion) is simply a rational product of accurate affective forecasting. Currently, research seems split on this question. Studies have indicated that loss induces more intense neural activity, indicating that our forecasting may be valid. However, behavioral economics generally proposes that we are bad forecasters, and studies show that we consistently overestimate the intensity of emotion from life tragedy.
In a new study, participants effectively minimized impact of loss after a game of luck using various coping mechanisms, such as dissonance reduction,self-affirmation, motivated reasoning, and positive illusions. Researchers found that "there was no evidence that losing actually had a greater emotional impact than winning," showing we are indeed poor loss forecasters".
Improving Your Negotiation Position by Understanding Loss Aversion
Understanding loss aversion adds a couple of aces to your negotiation deck. The first ace is knowing your own propensity for avoiding loss and the second is knowing that of your negotiation partner. Knowing that potential losses appear to be more fearsome than we would experience them in fact should give us the confidence to take greater negotiation risks. Knowing our opponent's attitudes toward loss should give us an even greater advantage, particularly when we understand the effects of negative framing and characterize all of our bargaining partners' options as potential losses.
So what should you do when the settlement judge lays out the parade of horribles attendant to a jury trial? First, evaluate a potential loss against objective criteria such as the present value of the potential loss today and the ease or difficulty the plaintiff might have in collecting a judgment. Second, conduct a dispassionate risk-benefit analysis to off-set the effects of any tendency toward an irrational risk aversion.
If the plaintiff is seeking $100,000 in damages; the attorneys prognosticate a 50-50 chance of winning or losing; and, it will cost each side $25,000 to proceed through trial, is the settlement value to both parties the same? Not to the risk averse.
Although both parties must pony up $25,000 in attorneys' fees to play the game, the Plaintiff is wagering he will achieve a net gain of $75,000 while the defendant is wagering he will sustain a net loss of $25,000. Loss aversion theory tells us that the plaintiff will always be willing to risk more today for a potential future gain even where both have an equal chance of prevailing. This remains true even though the present value of a future $100,000 loss is far less than the loss of $100,000 today.
Understanding your own and your opponent's attitudes toward loss and capitalizing on your negotiation partner's presumed loss aversion should permit you to bluff just a little bit longer than an opponent who understands neither his own nor your cognitive biases.
Remember Your BATNA and Stick to Your Game Plan
Understanding negotiation psychology is never, however, a substitute for homework and adherence to a reasonable game plan. If you have analyzed your best alternatives to a negotiated agreement, you should never be in a position where the other side can "psych you out" and into an ill-advised settlement. Know your bottom line and stick to it.
