Cheap Talk and the Economics of Negotiation

The Coase Theorem demonstrates that when property rights are well defined and negotiating parties have perfect information, bargaining leads to efficient outcomes. However, real bargaining doesn’t usually proceed with perfect information—parties’ true valuations are not known. Each party has an incentive to overstate the strength of its position in order to extract surplus, resulting in efficiency losses. These losses can manifest themselves in the form of delays, or the complete breakdown of negotiations, with real economic costs. However, can sellers credibly signal their private information to reduce the informational frictions in negotiations?

In a new study, Matthew et al. find that impatient sellers use round numbers to signal their willingness to cut prices in order to sell more quickly. They test this theory against a novel dataset of millions of bargaining transactions on eBay’s “Best Offer” platform, where sellers offer items at listed prices and invite buyers to engage in alternating, sequential-offer bargaining. Beginning with the empirical observation of eBay bargaining transaction data, they find that eBay sellers who list goods at round numbers with the Best Offer mechanism usually sell their items more quickly, albeit at lower prices relative to sellers using more precise numbers in the same price range.

The researchers identify puzzling patterns in the data. Sellers who post items at “round number” prices—namely multiples of $100—obtain first-round offers that are significantly lower than the offers obtained by sellers whose posted prices are not round numbers. This is confusing because, rather than post an item at, say $200, it seems that a seller would be better off by choosing a lower, “precise” number such as $198. And yet, such round number listings are very common in our setting, even among experienced sellers. How can this be consistent with equilibrium behavior in a well functioning marketplace with millions of participants?

A stylized cheap-talk model provides simple yet compelling intuition behind the counterintuitive observation. In the model, round numbers, such as multiples of $100, are chosen strategically by impatient sellers to signal their willingness to take a price cut in order to sell more quickly; then, the buyers who correctly interpret the signal respond more quickly and reach the better deal. On the contrary, patient sellers prefer to hold out for higher prices and hence have no incentive to signal weakness, so they choose precise number listings.

With the eBay data, the model tests a set of hypotheses. First, round number listings not only attract lower offers but sell at prices that are five to eight percent lower on average than nearby precise number listings. Second, round number listings receive offers much sooner, approximately six to 11 days sooner on average, than precise number listings. Third, round number listings are three to five percent more likely to sell than precise number listings. These findings all support the premise of the model—that round numbers are a cheap-talk signal used by impatient sellers. Researchers also find that sellers who use precise listing prices are less likely to accept similar offers than those using round listing prices, and, conditional on countering, they make more aggressive counter offers. This is consistent with a connection between a seller’s eagerness to sell and the seller’s propensity to list at round numbers.

A concern with the basic empirical findings may be that, for round number listings, there are unobservable differences in the seller attributes or in the products themselves, resulting in lower offers and lower prices. The researchers address this possibility by taking advantage of the fact that items listed on eBay’s site in the UK will sometimes appear in search results for user queries on the US site. Furthermore, the prices of the items proposed by UK sellers will be automatically converted into dollars for US buyers. Hence, some items listed at round numbers in the UK will appear to be in precise number prices for US buyers. Since both the UK and US buyers are presented with the same item, the unobserved heterogeneity would be perceived by buyers in both countries. Consequently, the unobserved bias can be differenced out by comparing their behaviors. The comparison demonstrates the robustness of the researchers’ hypotheses.

In order to verify that the finding is not only applicable to the eBay bargaining environment, the researchers also obtain data from the Illinois real estate market, where they observe both original listing prices and final sale prices. There, they find evidence that homes listed at round numbers sell for less than those listed at precise numbers.

The supporting evidence from the real estate market further strengthens the conclusion that round numbers play a signaling role in bargaining situations. People have used one form or another of bargaining for millennia. But, it seems unrealistic that all people are literally playing a sophisticated equilibrium of a complex game; rather, it’s more convincing to believe that they are playing as if they were. In other words, it suggests that, over time, players find rather sophisticated ways to enhance the efficiency of bargaining outcomes in situations with incomplete information.

This study supports the idea that cognitive heuristics and social norms fundamentally support the bargaining strategies of sellers and buyers, whether in small, informal transactions or in the Illinois real estate market. By understanding the heuristic underlying the round number bargaining strategy, policymakers will be better informed when trying to improve market efficiency.

Article Source: Cheap Talk, Round Numbers, and the Economics of Negotiation. Matthew Backus, Steven Tadelis and Tom Blake, NBER Working Paper No. 21285, June 2015.

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