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October 6, 2019
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Mediation Lessons from the Talmud: The Endowment Effect and Its Impact on Settlement Negotiations

The Endowment EffectIn this latest post applying Talmudic principles in mediation, we discuss a psychological principle known as the “endowment effect” and its impact on negotiations during mediation (the Talmud being an ancient Jewish legal text compiled around 500 C.E. that is a primary source of Jewish law and philosophy).

Our Psychological Attachment to Objects We Own

There is a ritual law that prohibits carrying objects in a public domain on the Sabbath (readers involved with First Amendment litigation may be familiar with this law from cases addressing the construction of an eruv, or symbolic enclosure, around neighborhoods to enable residents to carry objects outside their homes on the Sabbath; see, e.g., Tenafly Eruv Ass’n, Inc. v. Borough of Tenafly, 309 F.3d 144 (3d Cir. 2002)).

In connection with the above law, the Talmudic Sages developed rules to address situations where individuals carrying an object in a public domain will not have sufficient time to return home with the object before the Sabbath commences at sundown. Interestingly, the relevant rules are more lenient with respect to objects that an individual already owns than with respect to lost objects that an individual has found.

The medieval commentator, Rabbi Shlomo Yitzchaki (more commonly known by his acronym, Rashi) suggests that the greater leniency with respect to owned (versus found) objects is based on human nature. Specifically, a person will be more psychologically attached to an object that he acquired (using money that he earned) than an object that he found fortuitously through a stroke of good fortune. This greater psychological attachment will, in turn, make individuals more inclined to violate the Sabbath to bring an owned object home rather than abandon it in a public domain if they cannot get home in time before the Sabbath commences. Recognizing this, the Talmudic Sages legislated certain leniencies for individuals carrying owned objects that they did not authorize for individuals carrying found objects.

The Endowment Effect

Rashi’s insight that individuals are more psychologically attached to objects that they own finds a modern counterpart in the “endowment effect,” a principle referring to our tendency to overvalue objects that we own.

This psychological phenomenon was demonstrated empirically by Professors Daniel Kahneman, Jack Knetsch and Richard Thaler in their famous “mug” experiment. Half the participants were given a free mug, while the remaining participants were not. The participants who received a mug were then asked how much they would request to sell the mug, while the participants who did not receive a mug were asked how much they would be willing to pay to buy one.

The mug owners placed a significantly higher value on the mugs than the participants who did not own a mug, and were only willing to sell their mugs for a median price of $7.12, while the buyers were only willing to pay a mediation price of $2.87.

In another experiment, participants who received a chocolate bar were generally unwilling to trade it for a coffee mug of equal value, whereas participants given a coffee mug were generally unwilling to trade it for the chocolate bar.

An application of the endowment effect in retail sales is the famous “test drive” offered by many car dealerships. Giving a potential buyer the opportunity to “test drive” a new car creates a feeling of ownership, which makes the potential buyer more willing to buy the car after the “test drive.” Creating a feeling of “ownership” also motivates clothing retailers to allow prospective purchasers to try on outfits that they like in the store.

Endowment Effects in Mediation 

The endowment effect operates in mediations as well. Most obviously, as the “owner” of a claim, the plaintiff will always have built-in tendency to overvalue the claim relative to the defendant who is effectively being asked to “buy” the claim with a payment. A mediator who is not constrained by such biases can serve as an agent of reality by employing a tool such as decision tree analysis to objectively assess the “market” value of the claim.

As decision tree pioneer Marc Victor has suggested, a mediator best fulfills that role when — rather than asking the parties to exchange numbers from which they may be reluctant to move due to endowment effects — he or she instead engages the parties in a discussion of the relevant legal and factual uncertainties in the case, the probabilities of their resolution, and the range of potential damages if liability is found. Such discussions are likely to produce a more objective “market” value for the claim that can then provide the basis for further negotiation (such as with bracketing around a reasonable range).

By analogy, in the coffee mug experiment, a mediator might break the impasse between the sellers and the buyers by referencing the prices of similar coffee mugs online.

The endowment effect also means that, in general, it is always going to be easier for a mediator to persuade a party to abandon a request for something new they want to acquire rather than to surrender something they already own (or “feel” they own). As an example, in estate planning disputes, if there are siblings who have been involved in running a family business, and other siblings who have not been involved, a solution that lets the former acquire full ownership of the business in exchange for surrendering claims to other family assets outside the business is going to be an easier sell.

Similarly, in a divorce mediation, proposing that each spouse keep assets with respect to which they have “feelings” of ownership in exchange for surrendering claims to assets with respect to which they do not, is more likely to succeed than compromises that ask spouses to surrender assets they “feel” they own.

Finally, in the transactional mediation context, Professor Scott Peppet argues that endowment effects make lawyers more resistant to modifying default contractual provisions that they have drafted and reused multiple times even in transactions where those provisions are not a good fit. Mediators not subject to such biases can break contracting impasses in the transactional context by proposing new customized provisions that better address the nuances of the deal at hand.

We invite readers to offer other illustrations of endowment effects at play in mediation.

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