London School of Economics

OR 304.1 
Behavioural Decision Theory

Rational Behaviour in Risky Negotiations

by

Martin Schilling (pg)

12.12.2002

1. Summary

Rational behaviour in risky negotiations is the core topic of this essay. At first, negotiation conduct in deterministic and non-deterministic (risky) settings is analysed descriptively: how do people, differently framed, behave in this kind of negotiations? Second, these results are compared with the normative findings of two game theoretical models, the one -shot and the repeated negotiator’s dilemma. Third, on the basis of these results a prescriptive advice is developed, how to improve negotiation results, when the negotiator faces risky choices.

 

2. Concept of risk & rationality applied to negotiations

2.1 Field negotiations as risky negotiations

Most negotiation experiments in the laboratory involve deterministic outcomes. As soon as the negotiators settle on a certain option of one dimension, the monetary impact for each negotiator is known. In these settings a negotiator can quantify exactly his costs or his profits when settling for example on option A of dimension A. However, negotiations in practice are different. Settling for certain options often involves a high amount of risk or uncertainty. How did the negotiation team of the British telecommunication company Vodafone value the potential German competitor Mannesman, when submitting their take-over offers in 1999 and 2000? How did the Israeli government calculate the costs and benefits of their approval in Camp David 1972 to the retreat from Egyptian land? In both settings the negotiators had to deal with risk and uncertainty. The values of the relevant options to them were unknown. For each possible settlement each party had to estimate the expected value of the different options. Baron (2000)¹ distinguishes between “risk” as a set of outcomes with known probabilities and “uncertainty” as a set of outcomes with unknown probabilities of occurrence. As the probabilities of occurrence of certain options often have to be estimated in practice this distinction is somehow artificial. A negotiation setting, where certain options occur with an unknown probability is difficult to treat. Therefore the following chapters focus on risky negotiation settings.

2.2 Rational behaviour in negotiations

The definition of rationality “as the kind of thinking, we would all want to do, if we were aware of our best interests, in order to achieve our goals“ of Baron (2000) ² will be used as the basic assumption to analyze negotiation conduct. Bounded rationality, as the fact that people have time constraints and limited cognitive computational power shall not be discussed in this essay. Especially for the normative analysis and the prescriptive conclusions to improve performance in risky negotiations (see chapter 4 and 5), I assume negotiators to behave as expected utility maximizers. Rational behavior in negotiation depends on the primary objective of the negotiation. If achieving the best deal is most important, utility can be increased by applying value maximizing strategies. If clinching the deal is crucial, utility is maximized by applying strategies to come to a settlement. For more details see chapter 5.

3. Descriptive negotiation behaviour in risky negotiation settings

The following considerations are, due to limited space, restricted to two persons multi-issue negotiations.

3.1 Possible strategy choices in distributive and integrative negotiation settings

Which strategy choices do negotiators face in different negotiation settings? The applicable strategies are limited when the negotiation is distributive. In these kind of negotiations the parties bargain over a “fixed pie”. Concessions made by one party are gains of the other party and vice versa, the negotiators play a constant-sum game. For example the negotiation between employer and employee over salary, without consideration of any other compensation dimension like bonuses, company car or IT equipment is a typical case of a distributive bargaining situation. In distributive bargaining situations the negotiator can be either apply a “soft” or a “tough” strategy. “Soft” negotiation implies co-operative behaviour, like generous concession making and friendly behaviour towards the other party. The “tough” negotiator is generally less willing to make concessions, starting with higher aspiration levels, and behaves less generously towards the other party.

In integrative bargaining settings the choices amongst possible strategies is of a greater variety. In general, negotiators have to decide between pure value claiming (distributive) strategies, pure value creating strategies or a mixture of both. Claiming (integrative) strategies refer to non-co-operative “tough” behaviour, whereas creating strategies describe the active search for possibilities to “expand the pie”. The successful application of integrative strategies maximises joint profits. This includes the search for exploitable differences in preferences on different negotiation dimensions, differences in forecasts of events, differences in risk attitudes or differences in time preferences. Most difficult in integrative bargaining settings is to slice and expand the pie at the same time.

3.2 Framing of negotiator options in negotiation settings

The choice between co-operative and non-co-operative strategies in negotiations can be manipulated. Depending on the framing of the outcomes negotiators tend to apply different strategies. The idea to frame negotiation outcomes, according to a reference point, is based on the Prospect Theory (Kahneman & Tversky, 1979). Kahneman and Tversky showed that people tend to decide risk-averse in the domain of gains and risk-seeking in the area of losses. Applied to bargaining, gain-framed negotiators should be more co-operative (risk-averse to fail to reach an agreement) and more concession-averse when loss-framed. A risk-seeking negotiator should be more willing to threaten the other party with breaking off the negotiations. These “strategic moves” named by Dixit & Nalebuff (1991) include moves to claim resources at the cost of the other party with tactics such as making commitments or strategic misinterpretations of preferences.

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1 p. 246

2 p. 5