Imagine a hypothetical M&A transaction with two players at the negotiation table: a seller and a buyer. Each party to the transaction seeks to maximize the value it receives, a concept that is understood by each side (i.e. the seller understands the buyer seeks to maximize its payout and the buyer understands the seller seeks to maximize its payout). Each party can make one of two choices to maximize their value: either Create or Claim. The Create action results in an open and candid exchange of information whereby value creating opportunities are identified and shared  between the parties. The Claim action results in a closed exchange whereby value creating information is withheld from the other party and any known value creating opportunities are seized.

The theory that plays out is referred to as the Negotiator’s Dilemma, contrived by David Lax and Jim Sebenius in the 1980s (an adaptation of the Prisoner’s Dilemma). In essence, there are three possible outcomes depending on the actions taken by each side. If the buyer and seller each play the Create action whereby both parties are openly seeking and exchanging opportunities to create value, the total value is expanded and each side reasonably shares in the increased profits; resulting in a Good outcome for both side. If each party plays the Claim action, neither party will share value creating information for fear of being taken advantage of. The result is no incremental value is created and the total value stays the same with each party taking a smaller payout; concluding in a Mediocre outcome for both parties.

However, If one party chooses to Create and one chooses to Claim, the payout will skew towards the party that chose to Claim; resulting in a Great outcome for the claimer and a Terrible outcome for the creator. In this instance, the creator was forthcoming in their efforts to increase the total value only to be trumped by the claimer’s self-interest to capture that increase in value. See the below figure for a graphical representation of this dilemma.

Figure 1: The Negotiator’s Dilemma

Assuming that each party is not oblivious to other side’s interest in maximizing their own value without exposing their own interest to the potential for a Terrible outcome, the only logical conclusion is for each party to choose to Claim. For example, if the seller chooses to Create, the Claim action would serve the buyer’s interest better than Create. If the seller chooses to Claim, the buyer would still choose to Claim. The same logic applies when the roles are switched. If we believe the logic of the negotiator’s dilemma, the end state is that rational investors are likely to leave value on the table simply to avoid a Terrible deal. But is this how negotiations play out in the real world?

Practical Application?

If the Negotiator’s Dilemma sounds like a futile game of tic-tac-toe and/or too simple to have a meaningful application in real M&A negotiations, you might be correct (mostly). So, why does the Negotiator’s Dilemma fail in the real world?

Probability of Success

For starters, the Negotiator’s Dilemma assumes that the parties must agree to a deal. In reality, however, a seller is not obligated to make any deal, much less one that results in a Terrible outcome. And neither is the buyer. If both parties understand that the probability of completing a Terrible deal is not likely (or impossible), each party is likely to change the way they play the game. With this understanding in mind, rational negotiators shift much of their focus to the probabilities of each outcome and the appropriate actions required to achieve it. If a Terrible outcome is not acceptable to either party, the only options left are for both parties to Claim value or both parties to Create value. Left with only these choices, the rational negotiator’s best approach is then to openly seek value creating opportunities (i.e. Create). If one party deviates from the desired Create value action, negotiations would theoretically reach an impasse.

Multiplexity of Issues

A second aspect that causes the Negotiator’s Dilemma to fail (or at least stumble) in the real world is the number of issues actually being negotiated at any one time. M&A is inherently complex with multiple interconnected issues on the negotiation table. Issues can be connected in a variety of ways.  Outside of a direct cause and effect relationship between issues, for example, there may be an expectation that certain concessions will be reciprocated with the concessions from the other side on a separate issue. The more issues that are simultaneously negotiated, the more difficult it is to apply the Negotiator’s Dilemma theory to any one issue being negotiated.

It could be argued, however, the mere fact that each party is discussing the give and take of all the issues represents an open and forthcoming exchange of value that leads to the Create/Create outcome. But to simplify it in this manner is to ignore what is actually going on within the negotiation, which is a concurrent use of both value creation and value claiming maneuvers.

So What’s the Lesson

Despite its rudimentary logic, the Negotiator’s Dilemma is still a cornerstone lesson in many game theory and negotiation classes and worthy of our understanding. Unfortunately, this means that its simple to understand logic never really disappears from the toolkit of many negotiators, which can create problems if the they never reform the theory to consider the impact each action has on the probability of successfully completing a deal. Individuals who believe solely in a Claim strategy are most likely take the form of the aggressive negotiator who refuses to make any concessions and is always looking to claim value. If there is a lesson to be learned by studying the Negotiator’s Dilemma, it’s this: be on the lookout and cautious of a counterpart who consistently plays an aggressive Claim strategy. If you choose to (or must) negotiate with a Claim(er), you will either need to diffuse your opponent and attempt to educate them on the value of a cooperative approach or find satisfaction with claiming a diminished payout. In other words, attempt to convince the irrational negotiator to make the rational choice or become an irrational negotiator.