high to be acceptable. Firm A computes the expected value at (.4)(22)
(.6)(12) $16 million, so it will pay no more than this. Consequently, a cash
buyout is impossible. Both sides agree that the division will be worth more under
firm A than under firm T (regardless of the contract outcome). But the parties’
different, conflicting probability assessments make a straight cash purchase
impossible.
However, the acquisition can be consummated if a contingent-pricing
clause is included. Suppose the parties agree that the purchase price will be
$21 million if the government contract is won and $11 million if it is not.
Clearly these price terms provide each side a $1 million profit regardless of the
government contract outcome. Contingent pricing neatly overcomes the obsta-
cle posed by conflicting probability beliefs.
The use of contingent contracts is a common response to risk and uncer-
tainty in purchase and sale arrangements. Warranties and guarantees are
obvious examples. Here the terms of the agreement are adjusted in light of
future events. Another response to uncertainty is the use of incentive con-
tracts, which call for both buyer and seller to share the burden of cost over-
runs. Acquisition of an enterprise at a purchase price that depends on the
firm’s future earnings is still another example. Corporate acquisitions paid
for with securities of the acquiring firm embody an element of contingent
pricing. If the acquisition is truly valuable, the securities of the merged com-
pany will appreciate.MULTIPLE-ISSUE NEGOTIATIONS
Thus far, we have considered single-issue agreements in which price is the only
object of the negotiation. Here an agreement within a range of prices is mutu-
ally preferred to no agreement at all. The negotiation setting becomes more
complicated when the terms of an agreement involve multiple issues, such as
performance specifications, service requirements, or product attributes, as well
as price. When multiple issues are at stake, the parties cannot be satisfied in sim-
ply finding an agreement; rather, the goal is to uncover an optimal agree-
ment—one that, roughly speaking, is best for both parties.
Even if the parties have conflicting interests on each of many separate
issues, diligent negotiations can arrive at a well-crafted agreement that is bet-
ter for both sides than alternative agreements. The simplest of examples suf-
fices to make the point. Consider two members of a legislative committee
whose interests are directly opposed on each of two issues. Ms. A strongly
favors issue 1 and weakly opposes issue 2. Mr. B strongly favors issue 2 and
weakly opposes issue 1. Can these members fashion a mutually beneficial vot-
ing agreement? The answer is yes. They should agree to “swap votes” so that
both vote affirmatively on each issue. By gaining a vote on the issue that is
more important to him or her, each member is better off after the swap (even640 Chapter 15 Bargaining and Negotiationc15BargainingandNegotiation.qxd 9/26/11 11:03 AM Page 640