R2. Creating value in negotiation - Chapter 2.pdf

Technically this contingency clause does not actually

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Technically, this contingency clause does not actually "create" value in the way that logtolling or adding issues creates value. This is because when the ratings are revealed next year, the contract will sirriply force one party to transfer $1 million to the other party. Although essen- rially a zero-sum transfer, the contingency contract does create ex- pected value. At the time of the deal, both parties are made better off in terms of expected revenue from the deal-a Pareto improvement. Such Clauses are of even greater value and consequence when the beliefs of each party are extremely different and no deal is possible unless
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70 qll]> NEGOTIATlON ,GENIOS these different expectations are managed.· For example, if a client doubts her lawyer's ability to win in court, she may choose to hire the lawyer based on a contingency contract: the lawyer wiU be paid a large sum if the client wins and not at aIl if she loses. Similarly, book pub- lishers typically pay the author a su,m of money up front, follow~d by a fixed percentage of sales revenue. If the publisher is skeptical about the author's ability to write a best seIler, it should be willing to pay the author a higher percentage of sales revenue (or offer abonus if the book becomes a best seller) in exchange for less money up front. If the author is confident, he will agree., As a final exarriple of the ability of contingency contracts to salvage deals, consider the 1997 negotiations between basketball star Dennis Rodman and the Chicago BtiIls. Rodman was known for his superior ability to rebound and play defense; he was also known for his unpre- dictability, his disdain for professionál norms, and his propensity to miss games. In the previous season alone, he had missed twenty-seven of eighty-two games. As a result of his guaranteed con~ract, the Bulls paid Rodman close to $3 million for games he did not even play! Determined not to repeat the mistake, the team negotiated an un- precedented contingency-laden contraet with Rodman. He would have the ability to earn as much as $10.5 million, but he would be guaran- teed only $4.5 million. The rest of the salary was tied to various clauses, inch;tding $1 million for playing in all playoff games, $500;000 for winning anothei: rebounding title, and $185,000 for each game he played aboye fifty-nine. What ~as the result? Rodman won his seventh consecutive rebounding title and played in eighty of the season's eighty-two games (he missed two games due to injury), and the Bulls won another championship. While contingency contracts are powerful tools for creating value and motivating performance, they are not always desirable. Here are some caveats to keep in mind: '" Contingency contracts are dangerous if the other party is more knowledgeable than you. For example, if WCHI has access to better ratings data than Hollyville, and WCHI is offering to bet on the basis of ratings, Hollyville should be wary.
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