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The Economic Sources of Beneficial Agreements 631

Amidst the sides’ conflicting assessments of the acquisition and given its poten-

tial risks, could a mutually beneficial deal be achieved? If so, how should it be nego-

tiated and structured?

Negotiation and bargaining are important features of many economic settings.

Examples include negotiating the terms of a sales transaction, management-

labor bargaining, and settling a dispute out of court, to name just a few.

Generally speaking, these are situations in which both parties stand to benefit

from a cooperative agreement. Nonetheless, a significant degree of conflict

remains because each side seeks to secure an agreement at terms most favor-

able to itself.

Many economic transactions are completed by means of bargaining under

bilateral monopoly, that is, in settings in which a single seller faces a single

buyer. In contrast to organized markets, in which competition among large

numbers of buyers and sellers determines price and quantity, in bargaining set-

tings the competition is one on one. Although the analysis of market compe-

tition obviously deserves attention (see Chapters 7, 8, and 9), it is worth

remembering that there are other important means of resource allocation.

Our objectives in this chapter are twofold. In the first two sections, we ana-

lyze the economic forces underlying the bargaining setting: What economic fac-

tors create the opportunity for mutually beneficial agreements? What form do

economically efficient bargains take? Next, we examine bargaining strategy from

the perspective of decision making under uncertainty: What bargaining strategy

maximizes management’s expected profit from the transaction? What are the

risks of such a strategy? Finally, we apply the principles of negotiation to the his-

toric takeover dispute between Texaco and Pennzoil.

THE ECONOMIC SOURCES

OF BENEFICIAL AGREEMENTS

It takes two to tango and three to form a ménage á trois. In other words, eco-

nomic agents enter into transactions because the transactions are mutually ben-

eficial. A well-crafted agreement is better for both parties than no agreement

at all. Moreover, some agreements are better (for both parties) than others.

Given this observation, it is natural to explore the economic factors that create

the opportunities for mutually beneficial agreements. We begin our discussion

by considering a typical negotiated transaction involving a buyer and a seller.

SELLING A WAREHOUSE Two firms are locked in negotiations concerning the

sale of a warehouse, the equipment therein, and a considerable inventory of

industrial machinery. The main issue is price. The present owner is closing down

its current operation in a move to redirect its resources into other businesses.

The warehouse is in a valuable location for the would-be buyer, who also could

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