Negotiation 101 Fairness and the importance of looking ahead.

Bilateral Bargaining Two parties are bargaining over how to divide $100. We focus on how negotiated outcomes are affected by: –Threats; –Psychological Considerations; –The “rules” of the negotiation.

Key Lessons Look forward and reason back. Pay attention to psychological as well as monetary payoffs. Threats need to be credible to impact negotiated outcomes.

A Simple Bargaining Game 1 makes a take-it-or-leave-it offer to 2. 2 can accept or reject this offer. If 2 accepts, each receives 1’s proposed settlement. If 2 rejects, each earns zero.

A Diagram It is useful to show the structure of negotiations in a diagram. 0,0 100-x,x 100,0 0, x,x Accepts Rejects 12

Understanding the Diagram Initially, 1 offers 2 an amount x of the $100 and keeps the rest. 2, after hearing 1’s offer, must then either accept it or reject it. If 2 accepts, 1 receives 100-x and 2 receives x. Otherwise, negotiations break down and both receive zero. 0,0 100-x,x 100,0 0, x,x Accepts Rejects 1 2

What is the Outcome? Suppose 2 threatens to block any settlement less than If 1 believes this threat. –Then if 1 offers 60-40, 2 will reject and 1 will earn zero. –Whereas offers yield 1 a payoff of 50. –And is the best 1 can do. Should 1 believe 2’s threat?

Credible Threats Suppose 1 ignores 2’s threat and offers anyway. –If 2 rejects, she earns zero. –If she accepts, she earns 40. –So 2 would be crazy to reject such an offer. So 2’s threat was not credible. Effective negotiation means that non- credible threats be discounted.

Now what is the outcome? For any x > 0, 2 is better off accepting than rejecting. Thus, no threat by 2 to block a settlement is credible. Conclusion: –1 should offer –2 should accept.

Diagrammatic Analysis Begin at the end of the game. –Prune away all branches that lead to lower payoffs for 2. –In this case, Rejects is always worse than Accepts for 2. 0,0 100-x,x 100,0 0, x,x Accepts Rejects 1 2

Pruned Tree 1 faces the pruned tree when choosing his strategy. Removing 1’s branches with lower payoffs Leads to the conclusion that 99-1 is best for x,x 0,100 99,1 1

Tentative Conclusions Threats must be credible for them to induce changes in strategy. Look to the endgame and reason back in assessing negotiating situations. Player 1’s agenda control gave a big advantage in the negotiation.

Reality Check The 99-1 prediction is only valid if only economic payoffs matter. Fairness and other not-easily - mapped-into- “rationality” factors also play a role. What might they be?

Fairness. You think it would be wrong to offer $0.01 You are determined to do “what is right.” Evidence for this thought –If you are the offerer, and gain that role by coin flip, you offer relatively more to other –If you gain role by e.g. winning a trivial pursuit contest, you offer less Conclusion. You may be motivated by thoughts of what your position entitles you to.

Wait. You may be motivated by thoughts of not making an offer that the other will reject Why would the other reject a 99-1 offer? –Public reputation. If he were known publicly as a “pushover,” he would suffer many 99-1 offers in the future –Thus, better and perfectly rational for him to reject your 99-1 offer for the sake of his future credibility

More “why will he rejects” Because he is angry at the demeaning message conveyed by the offer –The postulated evolutionary utility of anger. “Homo Reciprocands” –Anger as a conditioned emotion –An internalized prohibition against being “a sap”

Publicity: why you might not want to offer an “unfair” arrangement In a world in which people voluntarily enter into deals with one another, having a reputation of taking “maximal advantage” is a disadvantage. Evidence –Anonymity from other increases the share you keep –Anonymity from experimenter increases it more

Getting clarity: The dictator game Offerer makes offer. Recipient has no choice but to take it. Results. In a repeated game, with guarantees of anonymity –The offerer (dictator) initially gives other better that 0.01% –Over time, as dictator’s conviction of anonymity increases, offer approaches 0.01

Conclusions We generally have a socialized value of “fairness.” As we discover we are in situations in which the standard mechanisms for cuing or enforcing fairness considerations decrease, we increase our proportion of the takings

Psychological Considerations: Modeling what we have said Suppose that the perceived fairness of outcomes also matters to player 2, the receiver Payoff = Economic + Psychological Suppose x = 50 is perceived to be fair. If 2 accepts: Payoff = x + (x – 50) If 2 rejects: Payoff = – (x – 50)

Negotiated Outcomes What does this do to negotiated outcomes? If player 1 knew 2’s preferences, then choose x such that 2 would just prefer to accept rather than reject. –If accept, 2 earns 2x – 50 –If reject, 2 earns 50 – x –Hence x = 34, leads to acceptance.

Conclusions Incorporating psychological considerations, such as fairness, can lead to less extreme predictions..34 is not a bad approximation to the empirically offered and taken outcome. Different cultures should have different weights on fairness. In Israel, lower offers are made and taken

Counteroffers Suppose that if 2 rejects, 2 can refuse the offer and then come back with a counteroffer. 1 must then accept or reject the counteroffer. This resembles a “strike” by 2 Game rule. The strike costs half of the surplus. Now what happens?

Diagramatically The following diagram describes the situation y,.5y 0, 0 Accepts Rejects Accepts Rejects 100 – x, x 50 –.5y,.5y

Look Forward Reason Back In the last stage, 1 will accept any offer that leaves him more than zero Hence 2 should offer 2,98. –Due to losses from the strike, this translates into payoffs of 1, 49. Thus, if 2 rejects 1’s initial offer and strikes, this yields a payoff of 49 to player 2.

Pruning the Game Tree With this observation, 1’s initial offer problem becomes: 12 Accepts Rejects 100 – x, x 1, 49

Disagreement Options Notice how 2’s threat to strike and counteroffer, improves her payoffs to rejecting 1’s initial offer. This dramatically improves her negotiating position. –Any very extreme offer by 1 will be (credibly) met with a strike by 2. –Strikes are very harmful to 1’s payoffs, so a conciliatory stance is required.

1’s Offer To give 2 an incentive to accept, 1 must do better than what 2 obtains in a strike, 49. Thus, 1 must offer 50 or more to avoid a strike. Hence, 1 optimally makes a offer initially, and 2 accepts.

Conclusions Assess the credibility of threats by placing yourself in the other person’s shoes. Non-credible threats should not deter aggressive offers. Look forward and reason back in determining what to offer. Strengthening your disagreement option (even if not exercised) improves your bargaining position.

Your disagreement option Your batna (best alternative to a negotiated agreement) is one form of a disagreement option Thus improving your batna radically improves your bargaining position Example. If in the ultimatum game, 2 can decline 1’s offer and get 49 from another source...