THE ENDOWMENT EFFECT

September 27, 2012

Transactional negotiators endeavoring to buy or sell commodities or trying to enter into licensing arrangements should appreciate the impact of the endowment effect. This theory suggests that people tend to value more highly property they possess than items they are thinking of buying. This phenomenon reflects the fact that someone who owns something begins to think it is worth more than it may objectively be worth as soon as someone else expresses an interest in purchasing it.

A perfect example involves the owner of a business or a patent. When someone indicates an interest in that business or patent, the owner remembers the long hours and extreme effort expended to develop the business or patent. They thus think it must be worth more than it actually is. Prospective purchasers should not be offended by this factor, but they should be careful not to insult the prospective seller. Instead of directly challenging the value placed on the business or patent by the seller, they should provide an objective valuation – preferably by a neutral appraiser – that will begin to move the negotiations in a more realistic direction.