Cash versus opportunity costs and revenues in bilateral bargaining

We extend previous experimental research on the relevance of cash versus opportunity costs for decision making to a bilateral bargaining setting in which we consider not only cash and opportunity costs, but also cash and opportunity revenues. In the negotiation between a seller and a buyer, a seller’s additional cash cost (cash revenue) reduces (increases) the welfare from trade, i.e., the sum of the partners’ payoffs in case they agree to cooperate, whereas an opportunity cost (revenue) represents a foregone profit (loss) outside the cooperation which does not affect the welfare from trade, but only the gain from trade, i.e., the increase in total payoffs of the two bargaining partners relative to the payoffs they can realize without cooperation. We employ theories of mental accounting and loss aversion to derive hypotheses that contrast bargaining outcomes with a standard-theoretic benchmark prediction implying that the bargaining partners will equally split the gain from trade irrespective of whether the additional item is a cash or opportunity cost or revenue. We hypothesize that prices are less sensitive to the additional item and thus deviate more strongly from the benchmark prediction when the item is an opportunity instead of a cash cost or revenue, because an opportunity cost or revenue is outside, whereas a cash cost or revenue is inside the relationship. We further hypothesize that prices are less sensitive to the item and thus deviate more strongly from the benchmark prediction when the item is an opportunity cost instead of an opportunity revenue, because the opportunity cost is in the gain domain, whereas the opportunity revenue is in the loss domain. Our experimental results support the former, but not the latter prediction. We conclude that the effect of cash versus opportunity costs or revenues on decision making critically depends on the strategic context in which they occur.