Behavioral Economics and Its Impact on Divorce Negotiations
Stemming from my background in finance and business, combined with an interest in psychology, I have always been enamored by the field of Behavioral Economics – the study of psychology as it relates to economic decision-making. Over time, reading and studying Behavioral Economics became a hobby of mine and something I would apply in daily financial decisions.
I eventually began to think about how the field of Behavioral Economics, and understanding how people make decisions generally, could help me in my practice as a family law and divorce attorney. After reading several books written by pioneers in the field (Thinking Fast and Slow, Daniel Kahneman; Misbehaving, Richard Thaler; Predictably Irrational, Dan Ariely; etc.) and wanting to dive further into the subject matter, I enrolled in – and recently completed – a Behavioral Finance course through the University of Chicago.
In this blog, I will provide a few lessons about how Behavioral Economics can be utilized in matters of divorce and family law.
First, a primer on Behavioral Economics. An online search will tell you that the average adult makes more than 35,000 decisions per day, with 90% of those decisions made subconsciously. Daniel Kahneman describes two systems for decision-making: System 1, which is instinctual, automatic, and does not require effortful thought processes (e.g., driving, eating); and System 2, which is deliberate, controlled, and requires significant mental energy (e.g., mathematical calculations, deciding on an expensive purchase such as a house or car).
To conserve energy, our minds complete as many decisions with System 1 processing as possible. Because System 1 acts without deep thought, it relies on heuristics, or biases, which act as shortcuts to influence our decision-making processes. Some examples of biases that I will show in relation to divorce negotiations are as follows:
- Status Quo
- Loss Aversion
- Endowment Effect
It is impossible to ignore or eliminate our biases, but we can recognize the way they operate and use that to think more clearly with System 2. We can also use what is called Choice Architecture – designing choices and options in ways that influence the decision-making process.
Example 1 – Custody Negotiations
Custody issues are always one of the most difficult to negotiate. One reason is that both parties are strongly impacted by their Status Quo biases. Prior to a separation, each parent is accustomed to living in the same home as the child and now there is a necessary adjustment to two households. Any schedule, regardless of the split, will feel like a loss of time. Loss Aversion is the principle that drives people to protect and preserve what they already have. In this scenario, the entire family used to live in the same home and both parents will feel a strong sense of loss as soon as the child’s time is divided. Parents often have a hard time negotiating a parenting time schedule because it all feels like a loss of time and, therefore, the negotiation will feel like a loss regardless of the outcome.
One way that I support clients through Loss Aversion is to redirect the conversation around the issue of time. Working with a Divorce Coach or Child Specialist, as we often do in the Collaborative Divorce process, provides the parties with an experienced mental health professional to focus on the benefits of co-parenting. An expert is there to guide the parents and explain that a child will benefit from positive co-parenting and that the co-parenting relationship will have a greater impact on a child than a particular schedule. The schedule will still be an important component to the negotiation, but it can be viewed as one piece of the puzzle to address the child’s needs.
Example 2 – Expectations and Financial Negotiations
One of the biggest obstacles in divorce negotiations is overcoming expectations. Expectations are developed as early as a client’s initial consultation that includes a sales pitch and a promise. Unfortunately, legal advice can and usually does shift when more objective information becomes available.
The problem is that the initial expectations become Anchors from which it may be difficult to deviate. Receiving anything less than initially expected will seem like a loss, even if it is an objectively reasonable and likely outcome.
Another issue arises when there are drastic disagreements over subjective financial matters, such as valuation of property. People typically overvalue their belongings, which is known as the Endowment Effect. As a result, it may be difficult to settle a buyout of a house, which carries history, memories, and sometimes serves as a home base for custody-related reasons. In financial negotiations, parties are expected to be rational and value a home based on an objective financial analysis. In reality, one person must receive less than what he or she believes it is worth due to the Endowment Effect. That person then typically uses the money to purchase a new property unaffected by those same biases. The result is the feeling that the person received less for the marital home and acquired something worth less.
One way to assist in financial negotiations is to implement the aforementioned Choice Architecture, which is another way of saying that we can frame choices to influence decisions. One way I have accomplished this in a negotiation is by providing multiple options that account for the biases parties bring into their decision-making.
Example of Choice Architecture:
Mr. and Mrs. Smith are negotiating the issues surrounding their house and the amount of spousal support to be paid by Mr. Smith.
The goal is for my client, Mrs. Smith, to get the marital home and receive as much support as possible. My client is aiming for Option 3 in this offer.
- Option 1: Mr. and Mrs. Smith sell the house and each receive $80K ($40K in closing costs, divided equally). Mr. Smith pays $2,000 per month for 36 months in spousal support
- Option 2: Mrs. Smith buys the house for $100K. Mr. Smith pays $2,000 per month in support for 30 months
- Option 3: Mrs. Smith buys the house for $100K. Mr. Smith pays $1,800 per month in support for 36 months
Option 1 is completely unacceptable under any objective analysis, but it is valuable because:
- The presence of Option 1 shows that a buyout is better for Mr. Smith (an extra $20K), which will immediately narrow the focus between Options 2 and 3;
- Even though Option 1 is the higher amount of support for the longer period, it serves as an anchor for both numbers.
- Option 2 “saves” 6 months of support for Mr. Smith
- Option 3 “saves” $200 per month for Mr. Smith
There are different benefits to each option, but my guess is that most people would choose $1,800 per month because all support payments are perceived as losses and it is easier to picture a smaller loss for a longer period (Present Bias).
We have therefore constructed options that are aimed at Mr. Smith selecting Option 3, which provides for $4,800 in additional support as compared to Option 2.
Compare the above choices to a typical offer – I want $1,800 per month for a period of 36 months. $1,800 will not feel like $200 savings and 36 months will still seem too long. If I go even higher with my only offer, as most clients wish to do in order to give “negotiating room,” you run the risk of the offer coming across as unreasonable and not advancing the negotiations. Alternatively, you are negotiating all of the terms and slowing the negotiations to a crawl.
That is not to suggest that Choice Architecture will guarantee success, but that it is designed to account for our biases and instinctual decision-making processes.
Example 3 – Timing of Negotiations
Lastly, whether due to a lack of time, distractions, or even for perceived strategic advantage, settlement negotiations are often saved until just prior to a trial. Objectively and behaviorally, this is one of the worst times to settle a case for several reasons – mainly the following:
- Confirmation Bias: Through Confirmation Bias, we seek ideas and evidence that confirm our beliefs while reacting negatively to anything that contradicts our beliefs. As a client and attorney prepare for trial, they analyze the information in a light most favorable to their argument. It is likely that they ignore or even overlook the counterarguments. The positions become even more ingrained and the case becomes harder to settle.
- Overconfidence: Related to and often resulting from Confirmation Bias is Overconfidence. If we continue to support and confirm our beliefs while simultaneously devaluing contradictory information, we become overconfident in our chances of success. A client is less likely to negotiate a fair outcome if he or she is overconfident about his or her chances in Court.
- Sunk Cost Effect: The Sunk Cost Effect occurs when a person continues his or her behavior because of previously invested resources. Once we are invested in something, we have a hard time giving up on that investment. I have had clients openly admit that they would probably have accepted an offer if it came earlier in the case, but now that so much was spent on attorney fees, they feel it is “worth it to roll the dice” at trial.
Objectively, the amount spent on attorney fees should have no bearing on whether to accept the deal. Additional attorney fees have no effect on the outcome of the case. Even more puzzling is that proceeding to trial will cost even more money to take the same risks.
If attorneys are aware of these biases, they should be making a concerted effort to gather the necessary data and proceed to negotiations much earlier in the litigation process. Doing so would lessen the impact of these biases on the negotiations and increase the chances of success.
Behavioral Economics clearly plays an important role in the way we think about money and make financial decisions, but its principles also guide the way we make decisions in many other areas of life.
In matters of family law, it is important to have an attorney who accounts for our natural tendencies and considers those in his or her counsel. If you have questions about a Virginia divorce or other family law issue, or wish to discuss a fresh approach to your case, Curran Moher Weis has experienced family law attorneys who can assist you through the process.