Sequential negotiations with loss-averse buyers

Abstract

This paper analyzes sequential negotiations with exogenous breakdown risk between a risk-neutral seller and a loss-averse buyer who is privately informed about his valuation. I show that, compared to the risk-neutral benchmark, loss aversion on the buyer's side softens the rent-efficiency trade-off for the seller. The reason is that the higher the buyer's valuation is, the more he has to lose by rejecting the seller's offer. Thus, in equilibrium the seller's profits and overall efficiency are both higher than in the risk-neutral case. Moreover, I also show that loss aversion has a redistributive effect by increasing the equilibrium payoff of some low-valuation buyers and decreasing that of high-valuation ones.