Bargaining (Sindac, Fancis Loyd C.

Introduction to Bargaining

Under this chapter, first here are two introductory examples:

First is the story about Bearn Stearns. In March of 2007, Bear Stearns (on the verge of
bankruptcy and under pressure from the Treasury Dept.) accepted an acquisition offer from JP
Morgan: to sell at just $2 per share. Bear’s shareholders were unhappy with the deal, and
threatened to declare bankruptcy instead.
In following two days Bear’s stock was up to $6 per share.
Bargaining ended when JP Morgan offered to pay $10 per share and Bear shareholders accepted
the offer.

Second is a story is about Texaco. In 1985, Texaco was found guilty by a Texas jury for
interfering with Pennzoil’s attempt to buy Getty Oil.
Texaco was fined $10.5 billion, but appealed the verdict and began negotiating with Pennzoil.
In 1987, Texaco filed for bankruptcy. Pennzoil was then unable to seize control of Texaco’s
assets. Texaco was also freed from the responsibility to pay interest and dividends.
One year later Texaco and Pennzoil settled the case, with Texaco having to pay only $3 billion.
Texaco successfully used bankruptcy to reduce its liability by over 70%

This chapter will be assessing bargaining, and strategies to improve your bargaining position,
like those used by Bear Stearns and Texaco.

There are two approaches of bargaining that are complementary:

The strategic perspective examines bargaining using game theory tools (Game theory is the
study of the ways in which interacting choices of economic agents produce outcomes with
respect to the preferences (or utilities) of those agents, where the outcomes in question might
have been intended by none of the agents.). Bargaining can be considered as a sequential-move
game with two equilibria or a simultaneous-move game with two equilibria, where one player
obtains an advantage by committing to a position.

The non-strategic view recognizes that real-life negotiations do not follow the same set of rules
as formal games. This viewpoint holds that, regardless of the rules of the negotiation game, the
alternatives to agreement define the terms of agreement.

If you can increase your opponent’s relative gain, or decrease your own, you can gain a bigger
share of the “pie”. By declaring (or threatening) bankruptcy, Bear Stearns and Texaco were able
to improve their bargaining “position”, i.e., by changing the alternatives to agreement; they
changed the terms of agreement. By improving their outside option by declaring bankruptcy,
Bear Stearns and Texaco both reduced their own gain to reaching agreement and this allowed
them to get a bigger share of the proverbial “pie” In Texaco’s case, bankruptcy also increased
Pennzoil’s relative gain because they could suspend paying dividends.

Strategic view of Bargaining

Bargaining: a simultaneous-move game

Negotiations over wages, for example:

A set sum of $200 million is being negotiated between management and labor.
Each player can choose between two strategies: "bargain hard" or "accommodate."
If neither party is willing to compromise, no agreement will be reached. Neither party benefits.
If both parties agree, they will divide the profits from trade.
If one person bargains aggressively while the other accommodates, the player who bargains
aggressively receives 75 percent of the "pie."
There are two equilibria for this game. Management prefers the lower-left equilibrium
Labor prefers the upper-right. This bargaining game has the same structure as a game of
“chicken”. Each party can gain by committing to a position, which turns it into a sequential
game.

Bargaining: a sequential-move game

The first "player" makes an offer that the second "player" can accept or reject in sequential-move
bargaining. Look ahead and back to evaluate a sequential-move game once again.
To figure out how her opponent would react to each possible move, the first mover "looks ahead
and reasons back." The first-mover can then look at the effect of each possible move.
In this scenario, sequential-move games provide a "first-mover advantage," which means that a
player can obtain an advantage by moving first. We may look at sequential-move bargaining and
first-mover advantage using the same wage negotiation case.

First-mover advantage:

Management “wins” by moving first and making a low offer

Union can change the outcome by credibly committing to strike if a low offer is made

Because management has the first-mover advantage, making a low offer is in their best interests,
and accepting that offer is in the best interests of the union. However, despite management's
first-mover advantage, if the union can successfully threaten to strike (in such a way that
management believes them); they can change the game's outcome. Threats that are credible are
difficult to make because they require the union to act against its own interests.
If management does not believe the threat, the union may have little choice but to carry it out.
So, once again, the ideal threat is one that you'll never need to employ.

Non-strategic View of Bargaining

The outcome of strategic bargaining "games" is determined by the rules of the game, which are
not always evident in real life. Any reasonable outcome to a bargain, according to John Nash,
maximizes the product of the bargainers' surplus. This is referred to as an "axiomatic" or "non-
strategic" bargaining strategy. According to this viewpoint, the terms of any bargain are
determined by the advantages from bargaining in comparison to the alternatives to bargaining.

This point of view also implies that if you want to strengthen your bargaining power, you can
increase your opponent’s gain from reaching agreement or decrease your own.
If your rival has more to gain by agreeing, he becomes more eager to reach agreement, and
accepts a smaller share of the surplus.

Nash’s axiomatic approach:

[ S1(z) – D1 ] x [ (S2(z) – D2 ] , where:

z is the agreement
S1(z) is the value of the agreement to player 1 (sub 2 for player two)
D1 is “disagreement value,” or pay-off if no agreement is reached, for player 1 (sub 2 for player
two)
So player 1’s gain from agreement is (S1(z) – D1)

For example:
Two brothers are bargaining over a dollar. If no agreement is reached, neither participant gains.
If they reach an agreement (z)
Player one, the older brother, has a surplus of z
Player two, the younger brother, has a surplus of 1 – z
Nash’s solution is for them to “split” the gains from trade, i.e., {½, ½} is the axiomatic solution.
But, now the older brother receives a $0.50 bonus for “sharing nicely,” and the total gain rises
from $1.00 to $1.50. The Nash bargaining outcome is for the brothers to split to total gains –
each receiving $0.75, meaning the older brother effectively shares half of his bonus.
By increasing the first player’s gain to reaching agreement, he becomes more eager to reach
agreement, and “shares” his gain with his brother.

Bonuses for agreement

Giving a bonus for reaching agreement is similar to incentive compensation

schemes used by many companies. When salespeople are offered bonuses it increases
their eagerness to reach agreement and this induces them to accept “weaker” agreements.
So giving salespeople such a bonus driven incentive will lead to lower prices when they
negotiate with customers.

Alternatives to agreement

Nash’s bargaining solution incorporates the effect of alternatives to agreement on

the agreement itself. This creates some sound bargaining advice:
To improve your own bargaining position, increase your opponent’s gain from
reaching agreement, S2(z) – D2, or reduce your own gain from reaching agreement, S1(z)
– D1.
When you increase your opponent’s gain in agreement, you make him more
willing to agree. Reducing your own gain makes you less willing to compromise and
helps to improve your position.

How Nash’s view differs from strategic

When it comes to influencing the game's result, the strategic view of bargaining places a
larger focus on timing and commitment. In the case of labor and management, the union's
decision to strike, or management's first move, changes the game's equilibrium.
However, neither action changes the agreement’s gains, nor so neither would influence
the Nash bargaining outcome. The Nash bargaining outcome is based on the premise that
lowering your own gain to agreement makes you a better bargainer.

Summary (Bargaining)

 Strategic view of bargaining: model as either a simultaneous-move or sequential-move

game.
A player can gain bigger share of the \“pie” by
1) Changing a simultaneous-move game into a sequential- move game with a first-mover
advantage; or by
2) Committing to a position.
Credible commitments (threats) are difficult to make because they require players to commit to a
course of action against their self-interest. Thus, the best threat is one you never have to use.

 The strategic view of bargaining focuses on how the outcome of bargaining games
depends on who moves first and who can commit to a bargaining position, as well as
whether the other player can make a counteroffer.

 The non-strategic view of bargaining focuses on the gains and alternatives to

agreement to determine the outcome of bargaining.
Main insight: The gains from agreement relative to the alternatives to agreement
determine the terms of any agreement. Anything you can do to increase your opponent’s
relative gains from reaching agreement or to decrease your own will improve your
bargaining position.
Froeb, L. M., & McCann, B. T. (2008). Managerial Economics: A Problem Solving Appraoch

(2nd Edition). Thomson South-Western.

Game Theory (Stanford Encyclopedia of Philosophy). (2019, March 8). Plato.Stanford.Edu.

https://plato.stanford.edu/entries/game-theory/#:%7E:text=Game%20theory%20is%20the

%20study,by%20none%20of%20the%20agents.