Wednesday, December 23, 2015

Improving Results in Mediation: Should Lawyers Make Extreme Demands To Take Advantage of the Anchoring Effect?

I wrote recently about the impact of the anchoring effect on mediation. Improving Results in Mediation: Should the Defense Request a Pre-Mediation Demand? I wrote that human beings tend to rely too heavily on the first piece of information they receive when making decisions. This is known as the anchoring effect, and that first piece of information is known as the anchor. For example, a high initial sales price for a used car serves as the anchor for the rest of the negotiations, dragging the final sales price higher than a more reasonable initial demand would. Numerous experiments have shown that the anchoring effect exerts a powerful pull, even on experienced professionals. In one study, a simple roll of the dice had an astonishingly strong influence on the sentencing decisions of highly experienced criminal judges. Finally, I explained that because of the anchoring effect, the defendant should not ask the plaintiff for a demand until the defendant sets its own anchors by determining its "walk-away" and "go-for" numbers.

Since I published the article, I've received numerous questions along these lines: "Are you saying that the plaintiff should make a very high demand early in every case? If my demand can anchor the negotiations, shouldn't I make an exceptionally high demand every time, even if the case does not have a high value?"

The answer is no. Despite the impact of anchoring on negotiations, plaintiffs' lawyers should avoid making unreasonably high demands, and the reason is credibility. Credibility is critical in every ongoing relationship, and the prosecution or defense of a law suit is very much an ongoing relationship, one that often lasts for years. This all sounds obvious, I know, but it is very important. While demands can anchor settlement negotiations, extreme numbers damage counsel's credibility, and this loss of credibility can more than offset any gain realized as a result of the anchoring effect.

In order to understand the importance of credibility in negotiation, one first must understand this: Parties derive power in negotiation from their alternatives. "What happens next if I don't get this deal done?" Mediators like to talk about this in terms of a party's best alternative to a negotiated agreement (BATNA) or worst alternative to a negotiated agreement (WATNA). The better a party's alternatives, the more comfortable she will feel walking away, the harder she will press the other side to meet her conditions, and the greater her power at the bargaining table.

Think of a well-informed consumer shopping for a car. He knows that he can get a good price from Dealer A, and this gives him power in his negotiation with Dealer B. He feels comfortable pressing Dealer B to meet his terms, and if Dealer B won't do the deal, he has no problem getting up and walking away. And of course once the dealer knows that the buyer is willing to walk away, he becomes more flexible.

This operates in litigation as well. If a party has a high level of confidence that it is going to win the case, then its alternatives to a negotiated agreement look positive, it feels powerful in the negotiation, and it will have no problem walking away if its conditions of satisfaction are not met.

Back to credibility. Counsel's credibility has a strong impact on how the opposing side sees its alternatives. For example, attorneys frequently tell each other that if a case does not settle, they will litigate aggressively, leave no stone unturned, and take the case to trial. Where opposing counsel has a low level of credibility, the threat of a tough road ahead is minimized, the party's alternatives to a negotiated agreement look better, and the party feels more powerful at the negotiating table. Of course, the threat of hard-fought litigation and trial sounds very different when it comes from an attorney with a high level of credibility.

As another example, plaintiff's counsel in a recent mediation gave me a witness statement to show to the defendants (with the witness's name redacted), and asked me to tell them that she had two more witnesses prepared to give similar testimony. Plaintiff's counsel had credibility with the defense, and she had not damaged that credibility by making outrageous demands in mediation. Although defendants did not take the witness statement or counsel's representation at face value, they did take them into account, and they did increase the settlement value at the end of the day. The witness statement would not have had the same effect if plaintiff's counsel did not have credibility in the other room. 

Plaintiff's attorneys must step carefully in crafting their opening demands. Though they know that their numbers will have an anchoring effect on the negotiation, counsel should consider carefully the effect that overly aggressive demands will have on their credibility -- and the importance of credibility in closing the deal. 

Thursday, October 15, 2015

Improving Results in Mediation: Should the Defense Request a Pre-Mediation Demand?

The study of human decision-making holds important lessons for people involved in all types of negotiations, including mediation. Learning the ropes will help the attorneys and their clients achieve better results in mediation.

Employee E sues her former employer, Company C, alleging harassment, discrimination, and retaliation. Company C answers, and the parties conduct discovery and take the depositions of Employee E and other key witnesses. The court orders the parties to mediate, and they select their mediator and set a date.

In order to get a better idea of the plaintiff’s expectations and the likelihood of resolution, defense counsel asks plaintiff’s counsel for a pre-mediation demand. Plaintiff’s counsel says that she will discuss the issue with her client and call defense counsel back if they decide to convey a number. Defense counsel asks again two weeks later, with the same response. The day of mediation arrives, and defense counsel tells the mediator that he still does not have a demand. When Employee E makes her demand an hour into the process, the demand is far more than Company C had anticipated or prepared for. Defense counsel expresses his frustration to the mediator, stating that he has been sandbagged, and that the delay decreases the probability of resolving the case.

It is easy to understand why defense counsel would have wanted a pre-mediation demand, and easy to understand his frustration, but the underlying question is this: Is a pre-mediation demand good for the defendant? The field of behavioral economics, which studies the way that humans make economic decisions, suggests strongly that a pre-mediation demand helps the plaintiff move the final settlement number to his or her favor, and the defendant should avoid a pre-mediation demand at all costs.

Scientists have found that a cognitive bias -- a tendency to think in a certain way -- known as the anchoring effect has a surprisingly strong impact on our decisions. Simply put, human beings tend to rely too heavily on the first piece of information they receive when making decisions. This is known as the anchoring effect, and that first piece of information is known as the anchor. For example, a high initial sales price for a used car anchors the rest of the negotiations, dragging the final sales price higher than a more reasonable initial demand would.

A number of studies demonstrate just how strong the anchoring effect is. In one study, researchers asked two groups of students to estimate how old Mahatma Gandhi was when he died. (Strack and Mussweiler, 1999). The researchers asked the first group whether he was older or younger than nine when he died. Of course, the students knew that he was older than nine. When researches then asked his actual age, the first group, on average, said 50. Researchers asked the second group whether he was older or younger than 144. These students answered correctly and then gave an average answer of 67. The only difference between the two groups was the obviously inaccurate number in the initial question. Yet this seemingly irrelevant difference actually moved the students’ answers by more than 33%.

Back to the question at hand: Should the defendant request a pre-mediation demand? The Gandhi study and many others suggest that obtaining the plaintiff’s demand in advance will anchor the negotiations, dragging the settlement figure higher than it otherwise would be. This obviously is a bad idea for the defense.

“But I have years of experience in litigation and mediation,” you say. “I know the reasonable settlement range and the likely outcomes on summary judgment and at trial. Just getting the plaintiff’s number isn’t going to affect me.”

Yet other studies suggest that the anchoring effect exerts a powerful force even on experienced professionals. In one study, researches asked a number of very experienced judges (averaging more than 15 years on the bench) to read a description of a woman who had been caught shoplifting and then asked them to roll a pair of dice. Yes, a pair of dice. Once they rolled the dice, the judges were asked to sentence the woman. Unbeknownst to the judges, the dice were loaded to land on either three or nine. Shockingly, those who rolled a three gave an average sentence of five months; those who rolled a nine gave an average sentence of eight months. (Kahneman, 2011.) The mere roll of the dice impacted these sentences by more than 50%. Other studies have shown similar results.

So how does a defendant avoid the anchoring effect of the plaintiff’s initial demand? After all, even if the plaintiff does not make the demand in advance, it typically will be the first number on the table at the mediation.

The answer is this: Defendants must create their own anchors before they hear the plaintiff’s opening number. Fortunately for the defense, they frequently do exactly that through early evaluation, reporting to clients and carriers, and the setting of reserves and settlement authority. All of these numbers, developed before the defense hears the plaintiff’s demand, serve to anchor the negotiations for the defense. Armed with their own anchors before they hear the plaintiff’s demand, defendants are in a much better position to weather the storm and keep the final settlement figure closer to their own evaluation of the case’s reasonable settlement value.

In sum, the last thing that a defendant wants to do is to hear the plaintiff’s demand in advance of mediation, allowing that number to anchor the negotiations before the defendant has set its own anchor firmly in the sand.

Thursday, October 24, 2013

Mediation and the Science of Decision Making: Conclusion

Daniel Kahneman and Amos Tversky revolutionized economics by changing the focus from hypothetical “rational actors” to real people, who frequently make bad decisions as a result of behavioral patterns and cognitive errors of which they are not aware. Learning to recognize these patterns and errors will help you be more successful in all decision-making processes and in all negotiations. And a mediator who understands these patterns and errors and how to deal with them will do a better job helping the parties resolve their cases.

Here are the links to all eleven installments of this series: 
Part I: Introduction 
Part II: People Act Rationally, Don’t They? 
Part III: People Avoid Risk When They Stand to Gain and Seek Risk When They Stand to Lose 
Part IV: People Evaluate Gains and Losses Relative to Their Reference Points 
Part V: The Greater the Loss or Gain, the Less Any Incremental Change Matters 
Part VI: People Hate Losing More Than They Love Winning. Losses Loom Larger Than Gains. 
Part VII: States of Change -- The Possibility and Certainty Effects 
Part VIII: Set Your Reference Points Before You Begin Negotiating 
Part IX: Think Like A Trader 
Part X: Shift Reference Points And Use The Endowment Effect To Close The Deal. 
Part XI: Do The Math, With Pencil And Paper.

Tuesday, September 17, 2013

Mediation and the Science of Decision Making Part XI: Do The Math, With Pencil And Paper.

We talked last time about using the endowment effect and shifting reference points to help close deals.  But how do you actually do that?  One good way is by showing the parties the numbers: "What will you gain by resolving the case?  What will you lose if you don't?" 

Some people are very good at math and can run numbers in their heads. Others require a calculator or adding machine. In any case, all of us are subject to the cognitive errors identified by Kahneman, and it can be very difficult to identify and compensate for these errors when called upon to make important decisions. 

One of the best ways to help people avoid these errors is to work through the numbers with them as they make their decisions. And because most people are not great at doing math in their heads, it helps to work through the numbers on paper, or on a white board, which is particularly good for this purpose. Putting the numbers on paper makes them more concrete, increases the likelihood that the parties will adopt them as reference points – even if they differ from their original reference points – and helps the parties evaluate them rationally, rather than emotionally. 

For example, while a party typically will evaluate a $50,000 settlement intuitively as a loss or gain relative to his existing reference points, he typically will not evaluate its expected value relative to a 50% chance of a $100,000 judgment at trial. Explaining and walking through this type of calculation makes the settlement more real, increases the likelihood that the party will adopt it as a reference point, and helps the party accept or reject it on rational, rather than emotional, grounds.  

Thursday, August 15, 2013

Mediation and the Science of Decision Making Part X: Shift Reference Points And Use The Endowment Effect To Close The Deal.

Very frequently, the parties to a negotiation will set reference points that do not overlap or allow for easy resolution. The plaintiff may have a bottom line of $200,000, while the defendant has a top dollar of $100,000. The likelihood of mutually exclusive reference points is greater in employment lawsuits, which frequently are zero-sum-games. A zero-sum-game is a situation in which the only issue to be resolved is how to allocate a limited resource, in this case money. (Some employment actions are not zero-sum-games, as where the parties will continue to be involved with each other in the future, and there may ways to “grow the pie,” rather than just dividing it.)  

In a zero-sum-game, where the parties’ reference points do not overlap, resolution is possible only if a party accepts a loss relative to his or her reference point. This "loss" may be the plaintiff accepting less than her bottom line or the defendant paying more than her top dollar. Frequently, both parties must accept such losses in order to get a deal done. As we have seen, people have a very hard time doing this. (See People Hate Losing More Than They Love Winning. Losses Loom Larger Than Gains.)  

A skilled mediator can help the parties move toward resolution by helping them shift their reference points. Shifting reference points involves what behavioral psychologist Richard Thaler dubbed the “endowment effect.” Thaler, a collaborator of Kahneman and Tversky, found that, contrary to rational choice economic theory, people frequently like to keep what they have, even when offered a fair price in exchange. This is particularly true for the things that people hold for their own use or enjoyment, things like nice bottles of wine, tickets to a sold out concert, or a coffee mug with one’s college logo on it.  

In mediation, the endowment effect comes into play when the parties begin to see themselves as already enjoying the benefits of a settlement. For the plaintiff, the benefits of settlement may include the peace of mind of not having to testify at deposition or trial or being able to pay off credit cards used for living expenses after a termination. For the defendant, the benefits may include cutting litigation expenses and being able to focus on running the business, rather than defending the litigation. 

The trick for the mediator is to help the parties see the benefits offered by resolution and then adopt those benefits as their new reference points. Once the parties accept the new reference points, they will be reluctant to give them up, making resolution more likely.  

Next time, another useful tool for closing deals: Do The Math, With Pencil And Paper.

Tuesday, July 30, 2013

Mediation and the Science of Decision Making Part IX: Think Like A Trader

Last time, we looked at one way to use behavioral economics to help our clients make better decisions in mediation by setting reference points before we begin negotiating.  Today we discuss another way to do better in any negotiation: thinking like a trader.  

Most attorneys have a great deal of experience with negotiation and may even consider themselves to be professional negotiators. (Interestingly, Kahneman and Tversky found that even professionals make the same cognitive errors as the rest of us, but we will put that aside for the moment.) 

Most parties do not have the same level of negotiation experience as their lawyers. And even if they do, the stress of litigation and mediation leaves them less capable of making rational economic decisions. Although there are benefits to long days of mediation, experienced negotiators know that 12 or 14 hours of mediation can reduce one’s ability to think clearly and make good business decisions. Especially at the end of a long day, parties need to understand the impact that cognitive errors have on them.  

Kahneman and Tversky tested ways to help people be less sensitive to these cognitive errors. They found first that professional traders in the financial markets – people who make decisions on gambles for a living – are more tolerant of losses and as a result suffer from fewer cognitive errors when making financial decisions. 

Amazingly, one simple way to help people make better decisions is to tell them to “think like a trader.” Participants in experiments become less risk averse, and their emotional reaction to loss (as measured physiologically) decreases when given this simple advice. In other words, simply asking people to “think like a trader” gives them a better framework for analyzing their choices and helps them make better, more rational decisions.   

A simple yet powerful tool that works well when it's time to close the deal. Next time, another tool for closing deals: Shifting Reference Points And Using The Endowment Effect. 

Tuesday, June 11, 2013

Mediation and the Science of Decision Making Part VIII: Set Your Reference Points Before You Begin Negotiating

We have seen that behavioral economics holds valuable insights into the way that people make decisions. Specifically, behavioral economics teaches that behavioral patterns and cognitive errors play a tremendously important, if seldom recognized, role in decision-making. 

Now we get to the fun part: learning to use behavioral economics to help our clients and ourselves make better decisions, not just in mediation, but in every negotiation.  

Lesson One: Set Your Reference Points Before You Begin Negotiating. 

Reference points are extremely important in every negotiation. They can be the key to an effective negotiation strategy, but they also can stand as an obstacle to a good settlement. Effective negotiators know how to use them to drive negotiations and to help close deals. 

In Thinking, Fast and Slow, Nobel Prize winner Daniel Kahneman explains that people frequently adopt their goals as reference points. In golf, for example, par is a reference point. A birdie (one shot under par) represents a gain, and a bogey (one shot over par) represents a loss relative to the reference point, par. 

We have seen that people dislike losing more than they like winning, and they work harder to avoid a loss than to make a gain. Economists who have studied golf (yes, there are such people) have found that professional golfers prove this point: they do far better when putting for par (avoiding a bogey, which is a loss relative to par) than when putting for birdie (making a gain over par). Whether the putt is easy or hard, at every distance from the hole, professional golfers are 3.6% more successful when putting for par than when putting for birdie. Over the course of a 72-hole tournament, this easily can be the difference between winning and losing. 

Like golfers, parties frequently set reference points prior to a negotiation. Plaintiffs in mediation frequently know the “bottom line” number below which they will not move, and defendants frequently know their “top dollar. These “walk-away” numbers become the parties reference points. A settlement that improves upon one’s reference point creates a gain; one that does not creates a loss. (It may seem strange to refer to a defendant who pays less than its top dollar as experiencing a gain, but remember that we are speaking of results relative to reference points, and even cold water can feel warm to a hand that has been sitting in a bowl of ice water.) 

Because people work harder to avoid losses than to make gains relative to their reference points, all parties should establish their reference points before they start negotiating. Plaintiffs should know their bottom line, and defendants should know their top dollar before the mediation starts. Surprisingly, many parties walk into mediation with no reference points, thinking only that they want to do “the best they can.” 

Experienced negotiators will set not only the walk-away numbers beyond which they will not move, but also goals that are better than those walk-away numbers. Parties who set “shoot-for” numbers as their reference points typically do better than those who only formulate walk-away numbers. 

For example, a defendant who decides that it will not pay more than $100,000 but has the goal of settling for $80,000 will settle for closer to $80,000 than one who only sets its top dollar number. The same goes for plaintiffs: one who establishes a shoot-for that is higher than her bottom line will recover more than one who does not. The reason for this is simple: once the party sets a shoot-for number as her reference point, she will work very hard to defend it, as anything that falls short will be seen as a loss.  

Setting one's reference points before the negotiations start is a simple strategy that will produce demonstrable results in your next mediation. 

Next time: Think Like A Trader.