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  5. Dynamic Outside Options and Optimal Negotiation Strategies

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Dynamic Outside Options and Optimal Negotiation Strategies

  • Andrew McClellan
American Economic Review (Forthcoming)

Abstract

We study the design of negotiation strategies when a principal and agent must decide how to split a pie while the agent's outside option changes over time. The principal's optimal strategy under commitment demonstrates a new, but intuitive, set of negotiation dynamics. When the agent is tempted to leave, the principal gradually promises a larger share (decreasing demands) and more time to explore the outside option (decreasing pressure), illustrating a complementarity between these two tools. Although the principal's expected utility is decreasing in the outside option, his expected utility and demands are increasing in the outside option's drift and volatility.

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