The Psychology of Settlements – loss aversion theory and “beyond winning”


Beyond Winning” is another thoughtful article from barrister Josh McBride.  I recommend Josh’s posts to readers, if you haven’t already visited.

In Beyond Winning, Mnookin analyses the dynamics of negotiations against the particular incentives at play in dispute resolution.  Can we really trust lawyers to encourage settlement, if they are being paid by the hour?  Are there tensions between in-house counsel and senior management?  Is settlement possible where the clients are still motivated by revenge and telling each other the case is a “matter of principle”?

The tension between the litigation side of the law and the commercial side has always been present, at least where I have worked.  Dare I say it, there are more solution focused, and litigation averse, lawyers on the commercial side, because those that enjoy the adversial contest are inevitably drawn to the courts.  In deciding whether to pursue litigation or accept an offered settlement, it may not be the thought of an  hourly rate that drives them so much as the job enjoyment and satisfaction of winning a contest.

Loss aversion is one topic in the book that I find fascinating.  Mnookin references Kahneman and Tvesky’s “prospect theory“, showing that decision-makers tend to attach greater weight to prospective losses than to prospective gains, even when what is the gain or loss may depend on how the outcome is framed in relation to an arbitrary reference point.  He notes that people do not always behave rationally in the face of uncertainty and risk.  When it comes to assessing our chances of winning, most people prefer to taken the sure money on offer, rather than a punt.  However, when it comes to assessing our chance of losing, most of us will do almost anything to avoid crystallising a loss, even if that means a huge gamble.

Loss aversion usually makes it more difficult to settle disputes.  While knowing how to accurately assess the risk that your client – and your opponent – is facing is a fundamental skill for litigators, understanding how your client and your opponent are likely to perceive that risk is even more important.

I was talking with a litigation partner last week about a dispute our clients were embroiled in, and I identified a point of dispute.  “Oh good!” he said, quite clearly enthused, “perhaps we’re going to have a fight after all!”

We talked a little further, and it was clear that this, if it went to court, would be precedent setting stuff.  “Not that setting a precedent is any comfort to the clients paying the bill, of course”, I said at one point.  “Ivan”, he replied, “the Law is never about the clients.”

Well, actually, to me it is.  He was however absolutely genuine, and (as much as it is possible to evaluate someone on a short telephone call) it was in his nature to seek the combative approach, without personal rancour.

To me, that is the type of personality that might benefit from some reading in the prospect theory area (although, to give him his due, he did express the reasonable view that litigation pressure was in his opinion far more likely to induce a settlement than mediation or other non-adversarial dispute resolution tactics).   For opposite reasons, so might the more commercial and litigation averse lawyers like myself…to make sure, or at least be aware of, any tendency toward forfeiting the potential gains to avoid crystalising a loss.

I’m going to clarify slightly here: Josh in his article is talking about loss aversion as delaying settlement. However I am using it in my last paragraph in a slightly different context: that of a client and/or their lawyer being reluctant to enter into litigation at all because to do so, with the requirement often for substantial retainers and court fees with no certainty of return, is a form of “crystalizing loss” right from the start, that can then only be mitigated by a favourable settlement or a litigation win.

Once committed to the litigation path the instinctive tendency is to “double-down” to avoid facing those costs as losses, as Josh’s article notes, and professionals aware of this tendency may become over-reluctant to engage in litigation even though on the probabilities their clients might be better served by doing so.

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About Ivan McIntosh

I am a partner of Carter Atmore Law...residing in City Road just off the busy thoroughfare of Symonds Street, Auckland, New Zealand....where we are specialist business & property development lawyers, working for both local and international clients. Proud husband to Joanna, and dad to two sons. Passionate rugby supporter. Email: imcintosh@calaw.co.nz Ph: 64 9 921 5026
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