42: Aim for the best deal, not the easiest

In a negotiation, there is an inherent asymmetry of knowledge between the two parties. While there is an economic dimension—such as what constitutes a fair distribution of the deal, offer, or the economic value created—personal incentives can also drive the buyer or seller towards suboptimal outcomes. Although this analysis is from a buyer’s perspective, it is equally relevant to sellers.

The dilemma for a corporate bidder purchasing an asset is that what benefits the company most (securing the lowest purchase price) may not align with the employee's personal interests. If they take a risk and fail, they may face unpopularity, but if they overpay and win, they receive praise. This highlights a critical principal-agent issue[1].

Imagine you are representing your company in a bid to win a piece of business, lease, or a new customer. You have three options: (1) Bidding 100 guarantees victory with a 100% chance, (2) bidding 90 reduces the chance of winning to 70%, and (3) bidding 80 lowers the chance to below 40%. Assume that the profit margins are 1, 11, and 21 for these three scenarios. What would you choose?

An ‘easy winner,’ focused on maintaining their personal profile, might even bid 102. This would secure the win, but it wouldn’t be the best economic outcome for the company—there’s a reason why the win was so easy. Congratulatory emails will follow, and the year-end performance review will highlight the victory. But was this the best economic decision for the company?

The ‘risk-taker’ employee would bid 80. Despite only a 40/60 chance of success, the high potential value makes the risk worthwhile. These individuals are opportunistic, capable of creating significant value, and dislike being overcharged. However, they will sometimes miss good opportunities.

The ‘optimal’ employee would bid 90. They might lose the bid and risk looking like a disappointment, but if they win (and there’s a good chance they will), they’ll have created meaningful value for their company. Most of the time, their strategy pays off. The win will be recognized, but due to the asymmetry of information about optimal value, they’ll receive the same congratulatory email as the over-payer.

This is why, when selling an asset, it’s preferable to engage with ‘trophy buyers’ who want to make a splash with a big press release or LinkedIn announcement, showcasing their ‘success’ despite the poor economics. Their company might fall victim to the winner’s curse, but that’s another issue[2].

Even in negotiations where your money isn’t at stake, it’s crucial not to be an ‘easy winner.’ Stand firm, act in the best interests of your company, and don’t fear losing occasionally: winning too often may be a sign that you are overpaying or overbidding.

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[1] A good, long, excellent book on the principal-agent problem is “The Theory of Incentives: The Principal-Agent Model” by Jean-Jacques Laffont and David Martimort. It explores the dynamics of incentives, information asymmetry and contractual relationships. At the heart of the book is the principal-agent problem, which arises when one party (the principal, such as a company or shareholder) delegates work to another party (the agent, such as an employee or manager) who has different goals and access to different information. This relationship can lead to conflicts of interest, especially when the agent’s actions are not fully observable by the principal, or cannot be easily assessed. These misalignments can lead to suboptimal outcomes, such as agents exerting less effort than desired, making decisions that favour their own interests over those of the principal, or engaging in opportunistic behaviour. This is for another post...

[2] For a good book on the subject check “The Winner’s Curse: Paradoxes and Anomalies of Economic Life” by Richard Thaler who investigated irrational behaviours exhibited in economic decision-making, particularly in auctions and bidding scenarios. The book has excellent real-world examples to highlight how actual human behaviour frequently diverges from the predictions of traditional economic models. The titular concept of the "winner’s curse" refers to a paradox commonly observed in auctions. The phenomenon occurs when the winning bidder tends to overpay for an asset, leading to a net loss rather than a gain. This overpayment often results from incomplete information, competition, or overestimation of the asset’s value based on qualitative rather than quantitative assessments. In competitive bidding environments, especially when bidders have different information or are overly optimistic, the winner ends up paying more than the intrinsic value of the asset. This is particularly common in auctions when many bidders participate. If you want a good deal make an auction with many bidders... someone will overpay!

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