March 29, 2024

Jim Wagner

“Thinking, Fast and Slow” about the Legal World and Contract Negotiations

The world lost a brilliant mind this week with the passing of Daniel Kahneman, the renowned psychologist and Nobel laureate whose groundbreaking work, “Thinking, Fast and Slow,” sparked an enhanced understanding and dialogue about human decision making. Kahneman’s insights into the dual process theory of the mind – thinking quickly and intuitively vs more methodical decision-making – and the cognitive biases that influence our decisions have had a profound impact on various fields, including economics, business and politics. And for the legal world? Simply put – there is a long way to go in applying Kahneman’s insights to drive meaningful change in this domain.

In our recent case study, “NDA Moneyball: The Results of M&A NDA Negotiations Don’t Change,” we employed advanced AI and data analytics to examine the negotiation patterns of over 20,000 M&A NDA deal points. Our findings unveiled a stark contrast between the traditional approach to these negotiations and the potential for a more efficient, data-driven process. By viewing our study through the lens of Kahneman’s work, we can identify the specific cognitive biases that hinder progress and explore how countering these biases can lead to better outcomes.

Availability bias and confirmation bias are two prime examples of cognitive biases that plague traditional M&A NDA negotiations. Availability bias refers to the tendency to overestimate the likelihood of events that are easily remembered, while confirmation bias is the tendency to use information in a way that confirms one’s preexisting beliefs. The countless “top 10 issues in M&A NDA negotiations” articles that dominate search engine results are a testament to these biases. These articles often rely on the authors’ personal experiences and anecdotal evidence, leading readers to overestimate the importance of issues that are easily remembered or frequently mentioned. For instance, the “confidential information definition” clause is often touted as a critical and contentious issue, even though our data shows that the final outcomes of these clauses are remarkably consistent, regardless of the initial drafting. Moreover, these articles tend to confirm existing beliefs and ignore evidence that contradicts them, perpetuating a cycle of inefficiency.

More significantly, our study highlights the “illusion of control” bias, which is evident in the popular assumption that the party drafting the initial NDA dictates the course of negotiations. This belief is deeply ingrained in the M&A community, with sellers often focusing on crafting the “perfect” NDA to gain an advantage. However, our analysis reveals that the starting point of negotiations has minimal impact on the final outcomes, with market norms consistently prevailing. This finding challenges the illusion of control and emphasizes the need for a more pragmatic approach to NDA drafting.

Anchoring and adjustment is another cognitive bias that our study addresses. Anchoring refers to the tendency of relying too heavily on the first piece of information encountered (the “anchor”) when making decisions or estimates. By setting initial terms closer to market norms, parties can minimize the need for extensive negotiations and adjustments. Our data shows that adopting a market-based approach to M&A NDA drafting can reduce the overall negotiation process by 80% or more, without compromising on substantive outcomes. This insight demonstrates the power of setting the right anchor and leveraging data to streamline negotiations.

Lastly, our case study exposes the “sunk cost” fallacy that plagues many contract negotiations. We found that a significant portion of these negotiations, in their current form, are a time waste with no meaningful benefit. Parties often continue to invest time and resources into unproductive negotiations, simply because they have already invested so much. Recognizing and avoiding this fallacy is crucial to optimizing negotiation processes and achieving more efficient outcomes.

As we pay tribute to Daniel Kahneman’s legacy, it is essential to acknowledge that his work has laid the foundation for a more rational and efficient approach to decision making. However, it is up to us to apply these insights and drive meaningful change in our respective fields. In the context of contract negotiations, this means embracing data-driven approaches, challenging our biases, and striving for a more collaborative and efficient process. Despite some of our acknowledged biases, I think we all know that this would be a good idea.