Loss and Regret

A friend is considering suing someone. The lawyer thinks it is a 50-50 chance to win. If she wins, she should expects minimally $400k, otherwise nothing. The lawyer gave her two options on legal fees: she can pay a flat $50k for whatever the outcome, or 50% of the settlement (this is called contingency fee). In the latter case, she pays the lawyer nothing if she loses. This friend is not wealthy and earns about $90k per year. She has savings to cover the $50k, but really does not know what to do.

Let’s assume a 50% chance to win $400k and equal probability to lose. For the flat fee payment option, she gets $350k if she wins, and negative $50k otherwise. For the contingency option, she gets $200k if wins and walk away clean otherwise. If she is rational and logical, flat fee is the better choice.

But the thought of losing $50k really hurts. On the other hand, she will kick herself if she chooses the contingency option and wins. We have two emotions at war against each other: the fear of loss and the fear of regret. Interestingly, people rarely make logical decisions. Instead, they decide based which emotion they dread more: loss or regret.

From the lawyer’s point of view, though, one option is a guaranteed income and the other is not. He “priced” the certainty of the $50k as 50% of a $200k. The value of the certainty is, therefore, $50k (the expected value of the gambit minus the “sure thing.”) The lawyer has a huge advantage here. First of all, he knew this psychology well. Secondly, he handles many cases and will benefit from the statistics. If things work out as their probabilities, he stands to gain much more from the contingency option.

This is why I am not a professional negotiator.

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