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Agreement by conduct as a coordination device

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Abstract

In distributive bargaining, bargainers may have an impulse to bluff and thereby risk an impasse. The current paper does not explain bargaining impasses. For our purposes, it suffices to recognize that bargaining impasses may occur without assuming irrationality. The design problem is to ensure that impasses are avoided as often as possible. One possible solution is to allow for the formation of an agreement by “conduct”. The ‘agreement by conduct’ outcome as a commercial norm may coordinate bargainers’ expectations so as to enable them to perform the same contract, even if they made written demands above ½ (as a bluff). The idea that the “deal-is-on” philosophy as expressed in the “agreement-by-conduct” rule affects and promotes economic exchange is probed in the context of a modified Divide-the-Dollar game.

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Notes

  1. See, Schelling (1960, Chapter 3).

  2. Formally, a two-person bargaining problem is described by a pair (S, d), where S ⊂ \( {\mathbb{R}}^{2} \) is the set of feasible agreements with a disagreement point d = (d1, d2) ∈ S being the allocation that results if no agreement is reached. Nash’s solution requires only that S is compact and convex, and that it contains some (x1, x2) with x1 > d1 and x2 > d2 (that is, gains from agreement are available); these conditions will be satisfied for the bargaining problems considered in this paper.

  3. See, Young (1998b: 774, 783; 2008: 5) and Binmore et al. (2003: 313).

  4. For example, Tirole (1999, 2009) and Battigalli and Maggi (2002) discuss the main ideas of the incomplete contract literature at length.

  5. “A Nash equilibrium is a possible prediction of behavior for all players in a game such that, if every player believes that the others will behave according to this prediction, then, it is rational for each player himself to behave according to this prediction” (Myerson 2004: 93). See also Myerson (1999: 1069–1070).

  6. The formal process of contract formation is the subject of a rich legal literature (see, e.g. Baird and Weisberg 1982; von Mehren 1990; Murray 2000; White 2004; Ben-Shahar 2004; Goldberg 2007; Davies 2010, 2018).

  7. See, e.g., Poel & Arnold v. Brunswick-Balke-Collender Co., 110 N.E. 619, 620 (N.Y. 1915). The Poel case is a quintessential example of the “mirror-image” approach to contract formation. This approach is modified with respect to merchants dealing in the sale of (movable) goods under the U.S. Uniform Commercial Code (1958) (UCC Section 2-207). Karl N. Llewellyn was considering cases like Poel when drafting UCC Section 2-207. To be sure, the “mirror-image” approach still applies in situations not covered by the UCC (e.g., sale of immovable goods and sale of services).

  8. For example, Baltimore & Ohio Railroad Co. v. United States, 261 U.S. 592 (1923) is a U.S. Supreme Court case on contract formation. In this case, the Court held that an implied-in-fact contract exists as, “agreement … found upon a meeting of minds, which, although not embodied in an express contract, is inferred, as a fact, from conduct of the parties showing, in the light of the surrounding circumstances, their tacit understanding.”

  9. For example, RTS Flexible Systems Limited v Molkerei Alois Müller GmbH& Company KG, [2010] UKSC 14 (10 March 2010) is a United Kingdom Supreme Court case on contract formation. In this case, the Court held that: “The general principles are not in doubt. Whether there is a binding contract between the parties and, if so, upon what terms depends upon what they have agreed. It depends not upon their subjective state of mind, but upon a consideration of what was communicated between them by words or conduct, and whether that leads objectively to a conclusion that they intended to create legal relations and had agreed upon all the terms which they regarded or the law requires as essential for the formation of legally binding relations. Even if certain terms of economic or other significance to the parties have not been finalised, an objective appraisal of their words and conduct may lead to the conclusion that they did not intend agreement of such terms to be a pre-condition to a concluded and legally binding agreement.”

  10. ‘Agreement by conduct’ as a coordination device falls squarely in the class of institutions-as-equilibria (see, e.g. Greif and Kings 2011; Teraji 2017.

  11. The participation constraint is in line with Crawford’s observation that the rules which govern bargaining over mechanisms must, at some level, be imposed by a third party rather than derived within the model (1985: 823–824).

  12. Unlike many models of final-offer arbitration (see, e.g. Yildiz 2011; Rong 2012), the courts do not choose the contract proposal (as demand) that is closest to the ideal settlement they would like to impose.

  13. Fehr and Schmidt (2010: 103) complain that: “[O]ne important problem with this alternative approach is that the set of social norms that affect people’s behavior is not defined.”

  14. A number of leading theories suggest that people care intrinsically about “fairness”—that is, either about the distribution of payoffs or about how the game is played. In this regard, the interested reader might refer to the discussion as featured in the Journal of Economic Behavior and Organization between, on the one hand, Binmore and Shaked (2010a, b) and, on the other, Fehr and Schmidt (2010) about the explanation of social behavior based on social (other-regarding) preferences or culturally determined social norms. See also Binmore (2010).

  15. Levitt and List (2007: 168) observe that: “[I]n contrast to the lab, many real-world markets operate in ways that make pro-social behavior much less likely. In financial markets, for instance, the stakes are large, actors are highly anonymous, and little concern seems to exist about future analysis of one’s behavior. Individuals with strong social preferences are likely to self-select away from these markets, instead hiring agents who lack such preferences to handle their financial dealings.”

  16. Anbarci and Feltovich (2012) modify the “standard” Nash Demand Game so that incompatible demands do not necessarily lead to the disagreement outcome. Rather, with exogenous probability q, one bargainer receives her demand, with the other getting the remainder. They use an asymmetric bargaining set (favoring one bargainer) and disagreement payoffs of zero, and they vary q over several values. In the spirit of typical results for conventional arbitration, they observe a strong chilling effect on bargaining for values of q near one, with extreme demands and low agreement rates in these treatments.

  17. Needless to say, in actual legal practice,in view ofthe court decision of finding no agreement, a party may (for example) seek reliance damages or restitution damages (see, e.g. McKendrick 1988: 207).

  18. Wakker (2010) provides a comprehensive and accessible textbook treatment of the way decisions are made both when we have the statistical probabilities associated with uncertain future events (risk) and when we lack them (ambiguity).

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Acknowledgements

I wish to acknowledge valuable comments from Jean-Jacques Herings and Peter Wakker. The usual disclaimer applies.

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    Arnald J. Kanning

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Kanning, A.J. Agreement by conduct as a coordination device. Mind Soc 19, 77–90 (2020). https://doi.org/10.1007/s11299-020-00225-5

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