the Program on Negotiation at Harvard Law School(www.pon.harvard.edu)
In the midst of the current U.S. financial crisis, accusations of greed on Wall Street have sounded across the globe. Greed may be a significant factor in the collapse of credit markets, but it's not the only one. Overlooked in cries to punish the "bad apples" is the role of a mistake that virtually all negotiators make: ignoring how our short-term decisions will affect us and others in the future.
In their book "Predictable Surprises: The Disasters You Should Have Seen Coming and How to Prevent Them" (Harvard Business School Press, 2004), Max H. Bazerman and Michael D. Watkins describe the financial scandals of 2001 and 2002 that led to the fall of Enron, Arthur Andersen, Tyco, and other companies. They label such crises "predictable surprises" -- disasters that shock those involved even though they had the information needed to anticipate them.
The Enron-era crisis, Bazerman and Watkins argue, was rooted in a flawed U.S. accounting system that makes accountants financially dependent on clients they're supposed to audit in an unbiased manner -- a conflict of interest that could cause auditors to make compromised judgments. Looking at today's credit crisis, an unprecedented demand for affordable mortgages prompted banks, unhindered by significant regulations, to make risky lending decisions and equally risky investments. Defaults and foreclosures by overextended homeowners led to a credit crunch that brought down financial institutions and triggered a $700 billion taxpayer-funded Wall Street bailout package.
The details and effects of these two crises are different, but they share at least one common thread: the desire to maximize short-term returns blinded decision makers to predictable surprises lurking down the road. In both cases, warning signs went unheeded.
In 2006, the rate of mortgage defaults began to rise in the United States as subprime borrowers had trouble keeping up with mortgage payments. Choosing to ignore these early signs of danger, banks and other lenders continued to grant and invest in high-risk mortgages. Executives at investment bank Lehman Brothers, which invested heavily in mortgage-backed securities, were warned in January 2008 that the company was facing liquidity problems. Yet the firm proceeded with capital outlays, including $5 billion in bonuses, from 2007 until the firm went bankrupt in September 2008.
Many smart people, it seems, failed to adequately prepare for the possibility that the housing bubble might one day burst. Why? Three cognitive biases can keep us from anticipating predictable surprises, according to Bazerman and Watkins:
1. We discount the future. To avoid a predictable surprise, we must often make compromises and investments in the present. We need to contribute to our 401(k) plans now to ensure a comfortable retirement. To slow down global warming, we need to conserve energy now.
Unfortunately, such tradeoffs between the present and the future are often unappealing, so we avoid them. The widespread tendency to discount the future causes us to ignore looming problems, such as the current credit crisis. It also causes organizations to under-invest in long-term initiatives, such as customer loyalty and research and development, that could have big financial payoffs.
Taking the long view in negotiation can be especially difficult when others, including future generations, are more likely than we are to suffer from problems that could arise from our actions. From multinational negotiations about global warming to governmental spending decisions that deepen budget deficits, immediate concerns often rule the day.
2. We hold positive illusions. The very human tendency to view ourselves and the future more positively than reality can sustain enables us to persist at difficult tasks and protects our self-esteem. It can also cause us to think we have more control over the future than we actually do, to believe that a problem doesn't exist or warrant action, and to avoid responsibility for our mistakes.
3. We are egocentric. People tend to perceive the same situation in very different ways depending on their role. You may sincerely wish to reach a negotiated agreement that's fair to all parties involved, but your interpretation of what's fair is likely to be biased by what is best for you. During the housing boom, for instance, some lenders and mortgage brokers may have justified the profits they reaped from adjustable rate mortgages (ARMs) and loans to unqualified borrowers by congratulating themselves for enabling more Americans to become homeowners. But when ARMs exploded and credit dried up, many of these buyers went into foreclosure and found themselves worse off than before.
You can't control the U.S. financial markets, but you can take these three steps to make sure your deals don't contribute to a predictable surprise in your own home or organization:
1. Weigh long-term matters. As you prepare for your next negotiation, take time to think about how the issues at stake could play out down the road, advises Professor Kimberly A. Wade-Benzoni of Duke University. Bring up these concerns when you meet with your counterpart, and remind her of the value of reaching an agreement that will stand up over time. At any point in the negotiating process, you might also make a decision tree that charts the likely long-term results of various options. In the case of the mortgage crisis, both buyers and lenders of subprime mortgages failed to realistically assess the likelihood that the buyers would be able to keep up with their mortgage payments in the months and years ahead -- and the consequences of loan defaults.
2. Challenge broken systems. Because our cognitive biases are so deeply ingrained, simply talking about future concerns isn't enough to ward off predictable surprises. You'll also need to evaluate whether certain groups and structures in your organization are promoting short-term thinking at the expense of the future.
Perhaps your company's board of directors focuses myopically on short-term earnings reports. Maybe your company spends too much on lavish retreats. Brainstorm ways to fix the system and then lobby influential others to support your ideas.
3. Negotiate in stages. Negotiators often get into trouble when they implement long-term contracts for complicated, risky ventures. That was the case in 1998 when the U.S. spy satellite agency, the National Reconnaissance Office (NRO), awarded Boeing a $5 billion, five-year contract to build two different complex satellite systems. Six years later and billions of dollars over budget, NRO fired Boeing for failing to deliver. The lesson: Negotiate one project at a time, and insist on incremental progress before awarding additional work.