Psychological Principles Applicable to Settlement Negotiations

by David Pomeroy

It is the rare legal dispute that at some point does not engender settlement discussions. And the vehicle of settlement is usually fueled by filthy lucre – dollars and cents. So it may be helpful to think about some basic psychological principles which can be at work in such discussions. Awareness of these principles can serve as both and sword and a shield – use them to obtain better settlements and be aware of the potential effects when used on you.

Offers: Should I go first? If so, what should it be?

Two psychological phenomena may be relevant to these questions: “anchoring bias” and “reciprocity”. Anchoring bias is the tendency to anchor on a particular number and fail to make reasonable adjustments no matter what new information is presented. By making the first offer, one may draw the offeree into an order of magnitude that is more favorable to the offeror.

Negotiating behavior is also governed by the phenomena of reciprocity, according to which one should reciprocate concessions made by others. It seems to be a fact that negotiations often settle roughly midway between opening offers to the extent that the midpoint is feasible for both sides. Therefore, by making the second offer, the negotiator can define where the midpoint lies. In general, whether one makes the first offer in order to exploit anchoring, or makes the second offer in order to leave room for concessions and exploit reciprocity, it is good strategy to make as extreme an opening offer as can be gotten away with, but not so extreme that the offeror appears to be negotiating in bad faith – in other words the “highest reasonable offer” versus the “lowest reasonable offer”. Unfortunately, this leads to the conclusion that “starting reasonably” is not good negotiation strategy.

An adversary who has no clear notion of the value of the claim will be more susceptible to anchoring bias. Let’s assume we have a wrongful death claim for a woman who was working as a waitress while she attended law school. She could have finished law school, entered private practice and done very well. Or she could have graduated and gone into public service law and done not quite so well financially (there are other rewards). OR, she could have dropped out of law school and pursued her career as a waitress. In such a case, a high first offer might draw the opponent into a debate about how successful a law career the deceased would have had rather than a discussion whether she would have finished law school at all.

On the other hand, where the opponent has an idea as tot he reasonable value of the claim, the best approach may be to have that person make the first offer so that your counter offer can establish a favorable midpoint. For example, if our deceased waitress/law student had been an established attorney with stable income, it might make sense to let the opponent make the first offer. If the offer is $4,000,000 and you want to settle at $8,000,000, the counter will be $12,000,000.

How to protect oneself against being exploited by these principles? Gather as much information as possible to help assess the value of the claim in question. The more information one has the less likely she is to b susceptible to anchoring bias. Use the information to establish a value in advance based on an estimate of what is the likely outcome of a trial. Adjust this value only if relevant new information is presented.

Use the principle of reciprocity to your advantage by insisting that any concessions made by you be followed by concessions from the other side. Parties seems to be more sensitive to the rate of concessions than they are to the magnitude of those concessions.

Offers: How should I frame it?

In a perfect world, parties should be sensitive to the economic impact of settlement offers and the particulars of how the offers are communicated should not matter. But it has been shown that this standard economic assumption does not always hold true. Studies show that framing an offer in terms of gains versus losses will affect the acceptability of the offer. So, how should one frame an offer so that it is most likely to be accepted?

There is diminishing sensitivity to increasing gains and losses, and the willingness to take risks differs for losses versus gains. For example, increasing an award from 0 to $1,000 is more pleasurable than increasing an award from $1,000 to $2,000; increasing an award from $2,000 to $3,000 is even less pleasurable, and so forth. Similarly, increasing a payment from 0 to $1,000 is more painful than increasing a payment from $1,000 to $2,000, and so on. The implication of these patterns is that people’s willingness to take risks differs for looses versus gains. Because $1,000 is more than half as attractive as $2,000, people typically prefer to receive $1,000 for sure than face a 50-50 chance of losing $2,000 or losing nothing to losing $1,000 for sure.

Losses have more impact on choices than do equivalent gains. Most people do not think a 50% chance of gaining $100 is sufficient to compensate a 50% chance to losing $100. People typically require a 50% chance of gaining as much as $200 or $300 to offset a 50% chance of losing $100. From an evolutionary perspective: The Neanderthal exposed to the elements finds a cave that can provide shelter. He goes in and is bitten by a snake and it hurts. He will risk the cold rather than go in the cave again with the snake. The threat of loss outweighs the potential for gain.

The way in which an offer is framed in terms of losses or gains can impact behavior in negotiations in two ways. First, loss aversion creates a bias in favor of the status quo because disadvantages of alternative outcomes are perceived as greater than the relative advantages. Therefore negotiators are reluctant to make tradeoffs necessary to joint gains. Let’s assume to partners in a failing consulting firm. The joint office space and secretarial support costs are unduly burdensome, and divide their territory and agree not to compete, each could have a profitable career. But each would have to agree to give up half of the firm’s client base. Each partner may view the territory they retain as a gain that doesn’t compensate adequately for the territory they must relinquish. Yet failure to make such a split consigns them to continuation in a losing venture.

The way that gains or losses are described can affect the attractiveness of offers. A negotiator can increase the attractiveness of an offer by integrating each aspect of it on which the recipient stands to lose (thereby exploiting the principle of diminishing sensitivity to each additional loss and separate each aspect of which the recipient stands to gain (thereby avoiding the tendency of people to experience diminishing sensitivity to each additional loss) and separate each aspect of which the recipient stands to gain (thereby avoiding the tendency of people to experience diminishing sensitivity to each additional gain). For the failing consulting firm, it would be most effective to describe the territory forgone as a single unit (“everything north of 63rd is mine”) and the territory obtained in component parts (“you will have Midtown, Downtown, Bricktown, and everything in Core to Shore”). It is least effective to describe the foregone territory in component parts and the territory obtained as a single unit (“I keep Nichols Hills, the Village, Chesapeake campus, and Belle Isle; you get everything south of 63rd”).

Knowledge of these psychological principles can help a negotiator frame offers in ways that make them more attractive to the recipient and, conversely, look past such efforts by his opponent to the actual merits of the offers.

 


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