Welcome to the Ultimatum Game on Decision Making

Published in the San Diego Union-Tribune, November 2, 2015

Today we are going to play a game. It is called the Ultimatum Game.

Let’s pretend that $1,000 shows up in your lap with only one condition as follows. You have to decide how to share it with me. You are going to make me an offer – you can split it with me 50-50 or you can decide to do it any other way you want, e.g. 72-28 in your favor.

And I can then decide to either accept or reject this proposal. If I accept, then the money is split as you suggested, but if I reject your offer (in other words, I deem the proposal “unfair”), then neither of us will receive any of the money. Simple.

Oh no – not so simple. Rational choice theory says that I should accept any amount you offer, because it is all found money to me. It is more than I had when we started. So there is no “rational” reason to reject any offer.

But I have feelings, and so while economically you should only offer me $1, the fact is that the decision of whether to accept or reject has very little to do with the actual dollars and everything to do with “perceived fairness.” If you want to delve a bit deeper on this one, study the “Nash equilibrium.”

Now, why would I reject an offer? “Altruistic punishment” is a concept that essentially says I will reject an offer to teach you a lesson with the hope that you will behave differently in the future with other people. There appears to be a human unwillingness to accept or endorse perceived injustice.

So let’s see how our readership thinks about money. I have started an email account: neilultimatumgame@gmail.com. And you, dear reader, are invited to send me your proposals on how you would split the $1,000 with me. And I will publish the results.

This concept is sharply in focus in my current life, as I am the lead negotiator for a complex and high-value transaction, in which the elements are similar. If we do not sign the deal as proposed, the new buyer will walk and the deal will crater – (or so we are led to believe by the founder/promoters). If we do sign the deal, we will get something, but not what we think we should, while the “bad guys” get the vast majority of the loot – essentially we would get 15 cents and they would get 85 cents.

We said to them, “We will sign if you give us 30 cents and you can keep 70 cents – and all the cents that will continue to accrue to the company thereafter. All the future monies are yours, you do not have to share them with us. And there are many cents left to be earned, but we don’t want to stick around and wait.”

That is code for we are not that trusting that we will ever see the future cents. (There are milestones and options and spin moves that lower the likelihood, in our opinion).

For additional insight into how to act in your own best interests, you might also look at the famous study known as the “prisoner’s dilemma.”

In the end, the dissident shareholders held their righteous ground, but the founders were able to persuade the buyer to close the deal around them. Now we will hope their future spin moves spin our way. As you can see, shifting sands make different alliances.

The subtext of this column is that decision-making should be driven by math – simple numerical calculations, but often they are not. If you aspire to rational man behavior, then your decisions should be driven by computational economics.

I am also acting as the lead for a venture financing of one of my companies. The initial conversation at the board was all about dilution, amount of dough, pre-money valuation and greed, but in the end it was simple: Do you want to be rich or do you want to be king? Take the smart money (and the lower valuation), because it comes with a chance to build a much bigger company.

I think math as a decision tool is underrated. It should drive almost all your rational man decisions, whether cost of customer acquisition, business model, burn rate or gross margin. There is the wonderful joke about the merchant who only loses a penny on each sale, but then assumes he can make it up on volume.

How would you share $1,000 with me?

Rule No. 442

Rational economics precedes cooperative behavior.


Leave a Reply

You can use these HTML tags

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>