Prospect Theory, Fairness, and the Escalation of Conflict at Negotiation Impasse

58 Pages Posted: 19 Aug 2018

See all articles by Topi Miettinen

Topi Miettinen

Hanken School of Economics - Helsinki Graduate School of Economics

Olli Tapani Ropponen

Government of the Republic of Finland - VATT Institute for Economic Research; University of Helsinki - Department of Political and Economic Studies

Pekka Sääskilahti

Compass Lexecon

Date Written: June 2018

Abstract

We study a bilateral negotiation conflict setup where at bargaining impasse the disadvantaged party chooses whether to escalate conflict or not. Escalation is costly for both parties and it results in a random draw of the winner of the escalated conflict. We derive the behavioral predictions of a simple social utility function which is convex in disadvantageous inequality thus connecting the utility specifications of two celebrated behavioral models: inequity aversion and prospect theory. The model predicts that more equality and more variance in escalation outcomes increases the escalation rate, thus predicting that escalation rates are highest when escalation outcomes are riskier and more equal and lowest when they are certain and unequal. We embed the social utility model into a logit quantal response equilibrium framework. Our causal laboratory evidence is to a large extent consistent with the predicted comparative statics effects, and the maximum likelihood parameters of the QRE-model are consistent with these comparative statics. In particular, the inequity-as-loss model and QRE jointly predict that the disagreement rate is lower when the cost of escalating the conflict (to both parties) is exogenously increased. The subgame perfect equilibrium fails to organize the effects, both under self-interested and other-regarding preferences.

Keywords: bargaining, fairness, escalation, inequity aversion, loss aversion, quantal response equilibrium, settlement

JEL Classification: C72, C91, D03

Suggested Citation

Miettinen, Topi and Ropponen, Olli Tapani and Sääskilahti, Pekka, Prospect Theory, Fairness, and the Escalation of Conflict at Negotiation Impasse (June 2018). Available at SSRN: https://ssrn.com/abstract=3222620 or http://dx.doi.org/10.2139/ssrn.3222620

Topi Miettinen (Contact Author)

Hanken School of Economics - Helsinki Graduate School of Economics ( email )

Helsinki
Finland

Olli Tapani Ropponen

Government of the Republic of Finland - VATT Institute for Economic Research ( email )

Arkadiankatu 7
P.O Box 1279
Helsinki, FIN-00531
Finland

University of Helsinki - Department of Political and Economic Studies ( email )

P.O. Box 54
FIN-00014 Helsinki
Finland

Pekka Sääskilahti

Compass Lexecon ( email )

Helsinki
Finland

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