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Economic Tools for Improving Negotiation OutcomesRead Time: 5 mins
For deal lawyers, no matter the stripe, negotiations can sometimes feel rote. Clients may have a list of “must-haves,” stock provisions approved by committee, or regulatory imperatives, on the one hand, and almost everyone knows—depending upon the type of deal—the flashpoints in a given transaction, on the other. This can lead to sub-optimal outcomes—measured in terms of excessive expense or unwieldy implementation, particularly in an environment where clients sometimes view “success” as a signed-up deal, regardless of terms that made it into the transaction documents.
While not all deals need the same amount of preparation and rigor—as one of my former partners liked to say, “You don’t always have to drive a Cadillac; sometimes a Buick is fine”— there are a few steps negotiators can take in every deal to improve outcomes. Some are proactive, some reactive, and most have little to do with “law.” As noted in Rule 2.1, however, clients may benefit from a lawyer’s reference “not only to law but to other considerations such as moral, economic, social and political factors.” See Model Rules of Prof’l Conduct R. 2.1. Each tool discussed below falls into the “other considerations” category and can enhance the quality of the negotiation experience and client outcomes.
Tool No. 1—Prepare
It may sound so simple as to be meaningless, but preparing for negotiation means more than looking over a term sheet, collecting deal points from a client or reviewing a counterparty’s draft agreement. Negotiation preparation requires, among other things, an understanding of the client’s and counterparty’s goals; the legal framework in which the parties are operating and constraints the framework imposes on the parties; the relative bargaining power of the parties; the client’s alternatives to the deal; the client’s particular sensitivities to and risk around certain topics (e.g., confidentiality, deal timing, price sensitivity, performance risk). Most negotiations have multiple outcomes, and each falls along a spectrum of acceptability for the client. Understanding the parties’ goals and the client-counterparty dynamic can be just as important to a successful negotiation as understanding the applicable legal framework, and can help in mapping out likely outcomes.
Tool No. 2—Make a Decision Tree
Two-party negotiations generally unfold as what economists call “sequential games.” That is, one party starts, the other responds, the original party replies, etc., and the cycle continues until a deal is reached or the negotiation abandoned. The primary strategy for solving sequential games is backward induction. That is, “reason forward and look back.” See Luke Froeb a, Brian T. McCann, Michael Shor and Michael R. Ward, “Managerial Economics: A Problem Solving Approach 170″ (3rd ed. 2014). This approach involves visualizing an outcome and working backward through the decision sequence to map out what must occur to achieve the outcome. The resulting diagram is a decision tree, with the branches representing choices to be made or avoided in order to achieve the sought-after outcome. By working backward, you can anticipate responses and counter-offers from your counterparty and visualize the path toward your preferred outcome.
Each move has associated with it a payoff, whether positive or negative. The goal of the decision tree is to maximize your payoff. Where your counterparty’s payoff is also positive, there is a higher likelihood of reaching an agreement. Mapping out payoffs and the path toward them functions as a roadmap for the negotiation and, thus, increases the chance of a successful outcome.
Consider, for example, a negotiation involving the retention of a management team post-acquisition. Current management is important to the acquirer, but it does not want to overpay. Members of management want to remain, however, so everyone benefits from making the contract. Likewise, failing to reach an agreement hurts everyone. Under these circumstances, the decision tree may look something like this:
As noted, Acquiror wants to keep management but not over-pay (here, “overpay” means the management’s payoffs exceed Acquiror’s). Similarly, management wants a deal, but not an abusive one (here, “abusive” means all of the gains of trade accrue to one party of the other). Because it is in everyone’s interest to reach an agreement (i.e., there are some baseline benefits to each side regardless of the type of agreement), only payoffs above the “baseline payoff” are considered in calculating “gains.” Similarly, because it is in everyone’s interest to reach an agreement, only “contract” outcomes are considered for mapping outcomes.
Taking all of this into consideration, Acquiror should “reason forward” to “contract” outcome No. 2. In this outcome, Acquiror does not overpay and realizes most—but not all—gains of trade. To reach this goal, Acquiror should open with a “hard offer” and stick with that approach throughout the negotiations, understanding that management, not wanting to feel abused, is likely to reject the initial offer and counter.
Tool No. 3—Check Your Bias
Each of us suffers from bias. In the negotiation context, think of bias as rules of thumb that help us to make decisions quickly based on experience. See, e.g., Daniel Kahneman, “Thinking Fast and Slow” (2011). In a repeatable process like negotiation, however, “good decisions” are not those that yield positive outcomes; rather, they are the product of processes that reliably produce the desired outcomes. See, e.g., Jim Paul & Brendan Moynihan, “What I Learned Losing a Million Dollars” (Columbia Business School Publishing 2013). Good decisions come from objective and rigorous processes designed to accommodate and adapt to new information. Good decisions are objective and replicable (regardless of outcome), not the product of intuition or “gut feeling.” Bias, then, is the opposite of good decision making, even though the results in many instances may be similar. Bias distorts decisions and makes desired outcomes in any particular negotiation less certain. In the negotiation context, the following biases are common and should be realized (and guarded against):
|Anchoring||Over-reliance / fixation on the first piece of information introduced in a discussion.||Introduce a second piece of information contrary to the first to break the fixation and create room for open discussion (e.g., reframing a stock-for-stock deal as an all-cash deal).|
|Availability||Over-emphasis of information that is readily available or most easily recalled.||Broaden your information / experience set; consciously review earlier deals to reduce likelihood of missing a best practice.|
|Confirmation||Over-reliance on information that supports your position||Actively seek information that contradicts your views and assumptions.|
|Conservatism||Tendency to under-adjust one’s position sufficiently in the face of new information.||Review principles rather than current/previous positions to evaluate how best to process or respond.|
|Distinction||Over-reliance on differences when evaluating terms simultaneously than when evaluating them separately||Consciously evaluate options separately.|
|Expectation||Discounting information that contradicts expectations||Involve neutral third parties in evaluating new information.|
|Hostile Attribution||Tendency to impute ill motive on ambiguous actions of others.||Ask clarifying questions.|
|Recency (Selective Attention)||Over-reliance on information most recently noticed.||Introduce evidence that the idea is tried and true (or tried and found wanting) in order to dispel the novelty and create room for discussion (e.g., relevant regulatory or industry guidance)|
As should be apparent from the above, one of the most important elements of any successful negotiation is the recognition it is a deliberate process. So viewed, it is easy to see that preparation, anticipation, and awareness are critical to success and—when practiced over time—will consistently improve client outcomes.
Reprinted with permission from the June 9, 2020 issue of The Legal Intelligencer. © 2020 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.