As trial lawyers we pretend that all our decisions — including if, when and how to settle a case — are rooted in logic.  We create decision trees, we research jury awards, we plumb the depths of our hard-won experience – and as a result we simply set emotion aside and give our clients the “right” advice.  Our clients in turn weigh our advice dispassionately and reach a sensible decision based upon even-handed balancing of pros and cons, risks and rewards. 

      Well, the human brain isn’t so simple.  It turns out that the emotional part of our brain has a simple, powerful flaw known as loss aversion.  As demonstrated by psychologists Kahneman and Tversky, and as described in Jonah Lehrer’s How We Decide, the pain of loss is twice as powerful as the pleasure of a gain.  Accordingly, low-yield bonds are popular because they seem a safe bet, even though over time stocks outperform bonds by a large margin.  “The fear of losses makes investors more willing to accept a measly rate of return.”  Similarly, investors are quicker to sell stocks that have increased in value, while stubbornly hanging on to those that are losers:  “selling shares that have decreased in value makes the loss tangible.  We try to postpone the pain for as long as possible; the result is only more losses.” 

            It turns out that loss aversion is part of a phenomenon known as negativity bias:  “bad is stronger than good.”  (see, eg., the current deluge of political campaign ads).   This proves out in experiments in which participants are presented with two mathematically identical risks, but their decisions change markedly depending on whether the alternatives are framed as possible gains versus possible losses

            For example, in part 1 you are given $50 and offered two choices: either you can take a gamble that gives you a 40% chance of keeping the $50 and a 60% chance of losing everything, or you can forego the gamble and automatically keep $20. 

            Now you play the game again, and while the first option is the same – taking a gamble with a 40% chance of keeping $50 and a 60% chance of losing everything.  The alternative option, the sure thing, changes only in its description from getting to keep $20 to having to lose $30.  (Yep, read it again – having to lose $30 out of $50 is precisely the same as getting to keep $20 out of $50). 

            So guess what our mind does to us?  Even though the two parts of the experiment present identical options from a mathematical perspective, when the choice is framed as gaining $20, 58% take the money and 42% pass on the 40% chance of keeping $50.  But when the choice is framed in terms of losing $30 (again, the same thing), now only 32% take the sure thing and 68% roll the dice!  How We Decide, 105-06. 

            Thus, in settlement negotiations, the clever bargainer will frame the other side’s choices in terms of what they will lose if they go forward versus what they can gain by settling now.  Those who don’t understand how their excited amygdala can mislead them will focus on the surge of emotion they feel when they anticipate the pain of loss, and then either pay more or take less than their reason would say they should. 

            How to avoid this trap?  See the next post.