Negotiations involve gaps in perceived value. When we are sellers, we feel that buyers offer too little. When we are buyers, we feel that sellers demand too much. This is true whether we’re actually exchanging goods or services for money, or whether we’re simply trying to make a fair trade.
This gap in the perception of value is called the endowment effect. If we own a good, we value it more than if we did not. The endowment effect influences us all, whether we are young children deciding whether to keep or trade a toy, or adults deciding the value of intangible things like our ideas and rights. Even chimpanzees show an endowment effect for food they are given! It influences the way we value everything from concert tickets to the environment.
The endowment effect creates frictions in negotiations. At least one party may feel shortchanged. Worse, both may walk away from the table. It creates all sorts of adverse effects in markets. We value government and employment benefits like health and safety regulations more if they are ours to lose than if we are asked to pay taxes or give up income to acquire them. We think public goods like drinking water, clean air, and public space are more valuable when they are owned by the government and sold or leased to firms in the form of a water bill, carbon tax, or development rights than when they are purchased by the government from private owners.
Explaining the endowment effect
Researchers trying to understand the origins of the endowment effect in the laboratory typically examine how it influences the value of simple consumer goods using three different methods. In an exchange paradigm, people who are randomly given one good are reluctant to trade it for another good of comparable value. In one illustrative study, only 11% of people given a coffee mug traded it for a large bar of Swiss chocolate, whereas only 10% of people given the chocolate bar traded it for the coffee mug. In a valuation paradigm, the minimum amount of money that people who are randomly given a good (“sellers”) demand to relinquish it is usually about two times as much as people who are not given the good (“buyers”) are willing to pay to acquire it. This gap is even higher for more unique and abstract goods (see the chart below). In a mere-ownership paradigm, people randomly given a good believe it is objectively better than do people to whom it was not given.
Traditionally, the endowment effect has been explained as a byproduct of loss aversion. When we are buyers, not owning the good is the status quo so acquiring the good is a gain. When we are sellers, owning the good is the status quo so giving it up is a loss. Because we are loss averse — losses impact us more than equivalent gains — this difference in perspective leads us to value goods more when we are sellers than when we are buyers.
More recent work has challenged this view. My collaborators, Lisa Shu of London Business School, Daniel Gilbert of Harvard University, Timothy Wilson of the University of Virginia, and I showed that losing a good is not required to find the endowment effect. Simply owning a good is sufficient. We found that research participants who were given a coffee mug were willing to pay as much to buy an identical second mug as they demanded to sell the first mug they were given. Both of these “endowed-buyers” and “endowed-sellers” valued these mugs more than buyers who were not first given a mug, whether these “unendowed buyers” were asked how much they would pay to buy one mug or two mugs.
In a second experiment, we endowed half of our research participants with a mug and did not endow the other half of the participants with a mug. We then had them act as “brokers” for the next participant. Brokers decided how much money that “client” would pay to buy or accept to sell an identical mug. We found that the amount of money brokers were willing to pay or would accept to sell depended on whether they’d been endowed with a mug or not, not whether they were buying or selling a mug of behalf of their client:
These and other recent findings have prompted several alternative psychological process explanations to loss aversion.
Biased information processing theories suggest that buying and selling evoke different cognitive frames. Buyers focus on reasons to keep their money and reasons not to buy. Sellers focus on reasons to keep the item and reasons not to take the money. When buying a ticket to a sold-out basketball game, we might think about the hassle of getting there and what else we could do with the money. By contrast, when selling we might think about how much we paid for the ticket and the quality of the game.
But these theories don’t explain mere ownership effects, when we simply value a good more because we own it. Psychological ownership theories suggest that the endowment effect is due to the association that owning a good creates between it and our self. Associative ownership theories suggest that because we usually think positively of ourselves, a good gains an additional positive association when we acquire it—its link to us (e.g., “This is MY mug”). As evidence, people with higher self-esteem show a stronger endowment effect for the goods they own than people with lower self-esteem. Attachment ownership theories suggest that when we acquire a good, it becomes incorporated into our self-concept (e.g., “I’m a BMW owner”) and giving up the good is painful because it feels like losing part of our self.
In a recent paper in Trends in Cognitive Sciences, Colleen Giblin of Carnegie Mellon University and I suggested a cognitive framing account of psychological ownership effects. We suggest that owning a thing changes the way we think about it. Most of us exhibit a memory bias for things related to ourselves. We tend to pay more attention to and better remember information that is associated with us than other people, places, or facts.
Because we relate what we own to ourselves, owning may act as a cognitive frame, amplifying our attention to and memory for our possessions. Most “goods” have more good features than bad features. You probably wouldn’t buy a home, car, or pair of shoes if you didn’t like it more than you disliked it. If owners pay more attention to and better remember the features of the goods they own, those goods should then seem more valuable to owner than to non-owners.
Our theory can also explain why the endowment effect reverses for “bads”—things that are on the whole more negative than positive, like a traffic fine, an unpleasant task at work, or a broken appliance. We suggest that because ownership increases our attention to and memory for the things we own, bads seem worse when they’re our problem than when they are someone else’s problem.
Reducing the endowment effect
Fortunately, research has shown that it is possible to reduce the endowment effect.
One effective tactic is to direct the attention of buyers and sellers to the information that they ignore. Asking buyers to first think about the valuable attributes of the good they might acquire leads them to value the good more. Asking sellers to first think about what else they might do with the money they would receive—the opportunity cost of owning the good—seems to also reduce the price they demand to give up what they own.
Another effective tactic is to change the reference price that people use to evaluate the good. When buying or acquiring a good, one might remind sellers of cheaper alternatives, like used versions of the same good or similar more economical goods. When selling or trading a good, one might remind buyers of more expensive alternatives to what one is offering.
A third tactic is to get buyers to touch, hold, or imagine owning the good. Experiences like interacting with a product through a touchscreen, receiving a coupon for it, or temporarily being the highest bidder for it in an auction all have the potential to induce the endowment effect for the product if they make us feel like we own it.
No matter which side of the table we sit on, the endowment effect has the potential to lead to disagreements in the value of what is being negotiated. Being aware of its influence and how to defuse it can help us understand differences of perceived value, reduce them, and increase our likelihood of coming to a more satisfactory agreement for everyone involved.