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.

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