It’s after lunch, and Fred’s feeling pretty good as he sorts through today’s mail.  Ah! There it is, Tom Smith’s response to Fred’s settlement offer in Ajax Accounting v. Johnston. It’s a solid offer, and Fred smiles as he thinks about the vacation he’s going to take during what are now the two weeks set for trial. He eagerly rips open the envelope, reading quickly.  WHAT?! Tom turned it down? How could he? The offer made perfect economic sense! Fred slumps in his chair, frustrated and bewildered.

What just happened here? Assuming that Fred is right and his offer to defendant was a model of economic rationality, he’s just been reminded that negotiators are not purely rational beings. Their choices are affected by a set of cognitive biases that color the decision-making process. Awareness of these biases and how to counter them can make us more successful negotiators. Several of these biases are discussed below:

Reactive devaluation is distrust of an offer simply because it comes from our opponent. This bias comes from the idea that life is a zero-sum game, so that what is good for you must be bad for me. In fact, mutually beneficial outcomes are possible. The easiest counter to this bias is to change the source of the offer – to have a mediator present it, or talk things over with your opponent in an effort to give a sense that the proposal was jointly achieved. Further, maintaining a straightforward and cordial relationship throughout the case will build a sense of trust that weakens the bias. (Richard Birke and Craig Fox, PSYCHOLOGICAL PRINCIPLES IN NEGOTIATING CIVIL SETTLEMENTS, Spring 1999 4 Harv. Neg. L. R. 1, 48-50.)

The endowment effect is the finding in behavioral economics that owners would demand more to sell what they already own than they would pay to buy the same item on the open market. So Tom and his client value their case more highly as plaintiffs than other observers would. Since a direct challenge to the skewed valuation wouldn’t be believed (because of reactive devaluation, above), and might insult the plaintiffs, Fred’s best bet is to present an independent (and therefore credible) valuation, or perhaps demonstrate value with jury verdicts of other cases closely on point (Craver, ‘THE IMPACT OF PSYCHOLOGICAL FACTORS ON BARGAINING INTERACTIONS,’ 29 Alt. High Cost Lit. 113 (June, 2011))

Optimistic Overconfidence leads humans “to discount small probabilities, assume luck runs in their favor, and distort unattractive consequences.” See Donald R. Philbin, Jr., The One Minute Manager Prepares for Mediation: A Multidisciplinary Approach to Negotiation Preparation, 13 Harv. Negot. L. Rev., 249, 282 (2008). Partly this is the result of the “confirmation bias,” which states that people are more likely to seek information that supports their viewpoint than they are to seek information that supports their opponents’ cases.  They construe new information to confirm their pre-existing beliefs about their odds of prevailing. (Birke and Fox, supra at 16)

Professionals like Tom and Fred have been shown to be overconfident in their own fields. In one study that presented “plaintiffs” and “defendants” and presented them with identical evidence, plaintiffs estimated the chance of success at 75% while a median defense estimate was 55%. Both sides were overconfident, but plaintiffs were more so. Why? Another cognitive bias is at work. The difference in outcome is caused by “loss aversion.” People prefer avoiding losses to achieving gains, so defendants are more conservative than plaintiffs. See Don Peters, IT TAKES TWO TO TANGO, AND TO MEDIATE: LEGAL CULTURAL AND OTHER FACTORS INFLUENCING UNITED STATES AND LATIN AMERICAN LAWYERS’ RESISTANCE TO MEDIATING COMMERCIAL DISPUTES, 9 Rich. J. Glob. L. Bus. 381, 402.  Birke and Fox suggest, at p 20,supra  that the remedy for overconfidence and related issues is consciously seeking objective data such as statistics to help evaluate cases.

The “sunk costs” fallacy: Another bias that can impede settlement is the “fallacy of sunk costs” –  the “greater tendency to continue an endeavor once an investment in money, effort, or time has been made,” (Arkes, Hal R., Peter Ayton, “The Sunk Cost and Concorde Effects: Are Humans Less Rational Than Lower Animals?”  Psychological Bulletin 1999, Vol. 125, No. 5, 591-600).

In other words, past expenditures become a reason to continue litigation, though they can have no effect on the outcome.  Arkes and Ayton suggest a two-fold reason for this effect. First, we have a general dislike of waste.  Second, the negotiator may feel a need to preserve the deal in order to save face.

Dr. Lee Merkhofer, an expert in decision analysis, recommends focusing on what you would do if you were presented with the situation today, without knowledge of past work. How would you advise a client? Another tactic is to seek the opinions of disinterested observers. (See http://www.prioritysystem.com/reasons1.html)

Naïve realism and the false consensus effect: “Naïve realism” is the idea that one’s perceptions are especially accurate. The “false consensus effect” causes us to believe that others have the same beliefs, perceptions, and attitudes that we do.(Richard Birke, Neuroscience and Settlement: An Examination of Scientific Innovations and Practical Applications, 25 OHIO ST. J. ON DISP. RESOL. 477 (2010)). If Fred’s perceptions of his case are accurate, and Tom shares those perceptions, then Tom’s failure to settle is inexplicable and frustrating.  If Fred realizes that Tom and his client see things differently, he will be more able to understand differing needs and interests that could form the basis for an acceptable compromise. The remedy for these biases is the same as for many others – resort to objective information or intervention of an independent neutral.

Successful dispute resolution often requires more than a strong case or a reasonable offer.  It requires an in-depth knowledge of negotiators’ perceptual biases and of the decision-making process that a seasoned mediator can provide.

by Scott Van Soye

Scott Van Soye is the managing editor of ADR Times. He is also a full-time mediator and arbitrator working with the Agency for Dispute Resolution with offices in Irvine, Beverly Hills and nationwide. He is a member of the California Bar, and practiced real estate, civil rights, and employment law for over twenty years. He holds an LL.M. in Dispute Resolution from Pepperdine University, where he is an adjunct professor of law. He welcomes your inquiries, and can be reached at scott.vansoye@agencydr.com or (800) 616-1202, Ext. 721. www.scottvansoye.agencydr.com