Loss Aversion in Negotiation

Civil Negotiation and Mediation by Nancy Hudgins

One last word on Sway, the Brafman brothers’ book on irrational forces that move us.

The Brafmans identify loss aversion as an irrational force. Simply put, we will do almost anything to avert a loss. The word itself is emotionally charged. The Brafmans point out, “losses loom larger than gains.” Also, the more meaningful a loss is, the more loss averse we become. This is why new stock market investors tend to sell when the market goes down. They start playing not to lose.

How does loss aversion interact with commitment to sway us into irrational behavior?

The Brafmans recount the experience of Professor Max Bazerman at the Harvard Business School. Every year in his negotiation classes, Bazerman auctions off a $20 bill to his students. The auction’s rules are simple: The winner pays the amount of the bid and “wins” the $20. The loser pays the amount of the losing bid.

In his auction, generally, most students drop out at about $16 or $17. They see a bargain if they win, but if they come in second, they’re willing to pay a nominal amount. There are always a couple of students, however, who are swayed by commitment—they continue on the path they started , they don’t want to deviate from it, and they become loss averse: to drop out would mean that they have to pay their last bid. The bidding always continues after $20 is bid, the point where the winner will pay more to win the auction than the winning prize is worth. The leading bidder keeps bidding, held in the thrall of the sway of commitment. The subsequent bidder raises the bid because, as the Brafmans point out, losing is a “deeply unattractive option.” Therefore the option of continuing to bid is relatively attractive.

Over the many years Bazerman has conducted this auction, what do you think the highest winning bid for the $20 bill has been? $30? $50? $100?

Higher.

I’ll reveal the record high bid to the first person who posts a comment.

                       

Nancy Hudgins

Nancy Hudgins, a San Francisco mediator and lawyer, began specializing in civil litigation in the 1970's. She has represented both plaintiffs and defendants, chiefly in personal injury, medical malpractice, elder abuse and product liability lawsuits, but also in a wide variety of complex litigation, including civil rights, fraud and class… MORE >