Why negotiations fail

Strategic uncertainty, a career focus for associate economics professor Amanda Friedenberg, occurs when the parties in a negotiation don’t know how the others will behave, perhaps because they’ve never negotiated before. This scenario plays out every day on the world stage, creating often significant economic inefficiencies. Freedenberg’s research suggests that a smart mediator may find ways to help the parties overcome fears of putting ‘good’ offers on the table, speeding up positive outcomes for all.

First featured in the Spring 2014 W. P. Carey magazine

There are many reasons why John F. Kennedy beat Richard Nixon. Why Ronald Reagan ousted Jimmy Carter. Why Bill Clinton unseated George H.W. Bush. No doubt one of those reasons is charisma. In fact, charisma is often a significant factor in the election of politicians at all levels.

But why? Why do voters prefer charismatic politicians over non-charismatic ones?

That's a question Amanda Friedenberg, now associate professor of economics at the W. P.  Carey School of Business, wondered about in graduate school. "A classmate conjectured that voters believe the candidate with charisma will be better able to bargain with other politicians," Friedenberg recounts. "At some level, that explanation struck me as correct, but why should a charismatic politician be better able to negotiate? If politicians understand each other's preferences — i.e., what the others want, and what they're willing to accept — they know what they have to give in order to make the negotiation succeed. Then charisma shouldn't matter."

"Perhaps," Friedenberg recalls thinking at the time, "politicians themselves have different beliefs about how charismatic politicians 'play the game.' Perhaps charismatic politicians are believed to be more able to sway their counterparties in negotiation — and it is that belief about them, not their actual ability, that matters."

That was the first insight into what has become a career focus for Friedenberg, studying strategic uncertainty. Strategic uncertainty occurs when the parties in a negotiation don't know how the others will behave, perhaps because they've never negotiated before. In this case, each party behaves according to a preconceived set of beliefs about the other. As Friedenberg explains, "For whatever reason, Person A may get stuck with a set of beliefs about Person B and those beliefs influence how Person A behaves."

Strategic uncertainty plays out every day on the world stage, creating often significant economic inefficiencies. In her most recent working paper Bargaining Under Strategic Uncertainty, Friedenberg explains, "Strikes and holdouts are detrimental to both workers and firms. Legislative stalemates have caused government shutdowns. Delays in renegotiating debt contracts can have negative macroeconomic consequences. And so on. A first step to moving past these inefficiencies is a better understanding of their cause."

Negotiators rely on preconceived beliefs

Strategic uncertainty is part of what's known as game theory, which Friedenberg describes as "a language that allows us to analyze situations where the actions of one party affect the payoff to the other party." In game theory, it is generally assumed that each party knows how the other will play the game — that is Nash equilibrium.

Although a part of game theory, strategic uncertainty does not assume the Nash equilibrium, and that is, in fact, what makes it so powerful. More like real life, strategic uncertainty assumes that the parties to a negotiation don't know the other party's strategy. Furthermore, their thinking about how the others will behave is influenced by their preconceived beliefs. Friedenberg explains, "Think about firms setting prices, for example. If the firms interact a lot, they may actually have a good idea of how the other will price. But that's a very special case. If the two parties have never interacted then the equilibrium assumption may not hold; players may face strategic uncertainty."

It's difficult to rationalize behavior that is not in line with preconceived beliefs

To understand strategic uncertainty, an example is helpful: "Think about territorial negotiations," Friedenberg says. "One reason that leaders have thus far failed to agree is that both sides are afraid to make concessions because they're uncertain about how the other party will react. Imagine that Side A is willing to give up more land or release certain prisoners. But they're afraid that if they make those concessions, Side B will say, 'Wow, that's more than I expected Side A to concede. Maybe if I stick with my hard line, I'll get even more concessions.' That may or may not be the actual reaction of Side B. But if Side A believes that reaction is possible, they'll be reluctant to make the concessions, and will instead continue to make the same poor offers."

How Side A and Side B come to their beliefs about what the other might do is an important facet of Friedenberg's work. "After the offer, Side B updates their beliefs about Side A," Friedenberg explains. Ideally, Side B would rationalize Side A's offer, thinking of it in its own isolated context and responding accordingly. "But if because of their past history — because Side A has only ever made unreasonable offers, for example — Side B is incapable of rationalizing Side A's behavior, then Side B will not be able to take the truly reasonable offer at face value."

As Friedenberg explains, strategic uncertainty makes negotiations tricky because:

1. Each party's reasoning is influenced by prior history and other experience that leads to a preconceived set of beliefs
2. Parties update their beliefs about their counterparties not only based on past offers but on how those offers fit within the preconceived set of beliefs
3. Each party makes their offer based in part on how they think their counterparty will react — how the offer may lead the counterparty to update their beliefs

When beliefs about the other party are based on that party's peer history, negotiation is even more difficult

When individual negotiators are part of a larger group — politicians and their political parties, for example, — negotiations are even trickier. Then, each side's beliefs are based not only on past history with the individual counterparty but on beliefs about and history with their whole group. The problem is that beliefs based on "peer histories" are beliefs the individual may or may not actually subscribe to; furthermore, the actions of one individual affect the peer history for the whole group.

"Imagine, for example, that two counterparties in a negotiation — Side B and Side C — went to the same business school," Friedenberg explains. "Research demonstrates that graduates of the same business school have similar ways of reasoning. Side A doesn't know which business school Sides B and C went to, so A doesn't know how they'll reason, only that their reasoning will be the same. In this world, when Side B makes an offer, Side A uses that offer to make inferences about Side C's beliefs."

Furthermore, being tied into a peer history makes individuals worry that their offers will influence beliefs about their entire group. "When Side A makes an offer she worries that now anytime Sides B or C negotiate with someone from her group, they'll have preconceived beliefs about the groups' strategy based on A's offer," Friedenberg says.

"Smart" mediation can help overcome "bad" beliefs

Friedenberg says it is good news that breakdowns in negotiation are often due to strategic uncertainty, rather than, say, asymmetric information (where one side has fundamental knowledge that the other does not). Strategic uncertainty, she says, might be easier to overcome. "The problem is that parties are stuck with bad beliefs that prevent them from making or accepting, 'good' offers. To resolve the stalemate, then, we have to find some way for the parties to overcome their beliefs."

Mediation, Friedenberg says, can help. She explains in her working paper Bargaining Under Strategic Uncertainty, "Consider the case where Bargainers are trapped in a situation with a 'bad' set of beliefs. There are mutually beneficial outcomes. Indeed, if the Bargainers had a different set of beliefs, they would be able to obtain such mutually beneficial outcomes. But, with their actual beliefs, they each fear making such a mutually beneficial offer, uncertain how the other will react to the unexpected. One might conjecture that a mediator can be particularly effective in such a situation — helping the parties to overcome fears based on strategic uncertainty."

"But it has to be smart mediation," Friedenberg cautions. "A smart mediator must find ways to help the parties overcome fears of putting 'good' offers on the table. An environment in which the parties in the negotiation can't use other parties' offers to update their beliefs may be helpful. So maybe the mediator goes behind closed doors with each party and gets a signed agreement that if the other's offer is within a given range they'll accept." For that to be successful, both parties must trust the mediator.

If an understanding of strategic uncertainty can help us learn how to get people to change their beliefs, so they can agree, then it is key to solving heretofore intractable problems. Mandatory finishing school for all is probably not the answer, but understanding why charisma is a valuable asset in politics — because it positively shapes others' beliefs — might be key to figuring out how counterparties can come to an agreement more quickly and less painfully.

Bottom line

• Strategic uncertainty is the concept that when the parties in a negotiation don't know how the other parties will behave, each party behaves according to a preconceived set of beliefs about the other. Strategic uncertainty plays out every day on the world stage, creating often significant economic inefficiencies.
• As Amanda Friedenberg, associate professor of economics at the W. P.  Carey School of Business explains, strategic uncertainty makes negotiations tricky because each party's reasoning is influenced by prior history and other experience that leads to a preconceived set of beliefs.
• Parties update their beliefs about their counterparties not only based on past offers, but on how those offers fit within the preconceived set of beliefs.
• Each party makes their offer based in part on how they think their counterparty will react — how the offer may lead the counterparty to update their beliefs.
• Strategic uncertainty may be overcome. Friedenberg says, "The problem is that parties are stuck with bad beliefs that prevent them from making, or accepting, 'good' offers. To resolve the stalemate, then, we have to find some way for the parties to overcome their beliefs."