Negotiation Strategy 655April 1987.Texaco offers to pay $2 billion. Pennzoil refuses and demands
$4.1 billion. Texaco refuses and files for bankruptcy, stopping
Pennzoil from immediately securing its $10 billion judgment.
November 1987.Pennzoil demands $1.5 billion and offers to cap its award
at $5 billion even if the full award is upheld. Texaco refuses.
December 1987.Pressured by a shareholders’ committee, Texaco offers to
pay $1.5 billion in exchange for a $3.5 billion cap. Pennzoil refuses.
December 19, 1987.Texaco and Pennzoil agree on a $3 billion payment.
The overriding feature of this prolonged conflict was the enormous col-
lective costs borne by the parties throughout the dispute. The most direct and
best evidence of these costs is provided by the changes in stock market valua-
tions of the two companies during the conflict. Financial economists have
shown that the dispute reduced the companies’ combined equity values by $3.4
billion.^9 (Of course, Pennzoil’s stock market value rose upon the initial Texas
verdict. The point is that the fall in value of Texaco shares far exceeded this.)
Only a small part of the collective fall in value can be attributed to legal costs—
some $600 million as an upper-bound estimate. More important were the costs
posed for Texaco of insolvency and bankruptcy: the potential disruption of
current operations of the company as a whole and the harm done to buyer and
supplier relationships. Following the settlement in late 1987, the combined
stock market values of the companies rose some $2.6 billion. Thus, the best
estimate of the ultimate cost of the Texaco-Pennzoil conflict is $.8 billion.
In view of these costs, why did the parties take so long to settle? Were their
actions consistent with rational bargaining behavior? Our earlier discussion of
out-of-court settlements provides one possible reason: differing expectations of
the parties as to the ultimate court outcome. This reason would appear to have
been important early in the dispute, before the Texas jury’s decision and in
the initial appeals process. Because Texaco believed Pennzoil’s suit to be totally
without merit, no serious settlement negotiations took place before the jury
decision. Most legal and economic experts attacked the jury’s decision as being
of dubious merit and expected it to be overturned or the damages substan-
tially reduced. Thus, even at this stage, there was substantial uncertainty about
the ultimate legal disposition of the dispute. The disputants might still have
held radically different expectations about various court outcomes, leaving no
ground for a settlement. However, one would expect that, as the appeals
process progressed, the disputants—guided by similar expert legal advice—
would have had little reason to differ in their assessments. Indeed, some com-
mentators have argued that changes in the firms’ stock market values were the
most accurate barometers of court expectations. For six litigation events dur-
ing the dispute that went against Texaco, there were significant concurrent(^9) D. M. Cutler and L. H. Summers, “The Costs of Conflict Resolution and Financial Distress,” Rand
Journal of Economics(1988): 157–172.
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