Try a simple psychology experiment. Look around the room
and make a short list of nearby objects, for example, your
desk lamp, a picture on the wall, a chair, and so on. Make
two copies of the list and put one aside for a moment.
Take the first list and write down the dollar amounts it
would take to get you to part with each item. If it helps,
imagine someone standing nearby, wallet open, ready to give
you the cash. Do this before going on to the next part of
the experiment, even if its only one item.
Next, take the second list and look at the same items, one by
one, and imagine yourself at a second-hand sale. Imagine
seeing each of these items offered for sale, and then write
down the price you would be willing to pay for each one.
Delivery would be free, and the items would be put back where
they are now.
If you've answered the way most people do, you'll notice
much higher values on the first list than on the second.
Psychologists call this the endowment effect, and it's so
named because people seem to endow items they own with
special value. No one knows why this effect exists. It is
one of those peculiar regularities in thinking that
psychologists can observe, but they can't explain. It is a
mystery, but the mystery may soon be ending.
Eric van Dijk, from Leiden University in The Netherlands,
devised an experiment to test a theory posed some years ago
to explain the endowment effect. This theory suggests that
loss aversion causes the effect, that is, it appears when
people irrationally fear that they will lose what they
already possess. Essentially, when people compare the known
and familiar to the unknown and unfamiliar, they feel fearful
and choose the known and familiar. Further, people are
coaxed into expressing this fear in a variety of situations,
and many of these intrude into our conduct of our businesses.
Van Dijk's experiment was designed to shed light on this
fear.
Van Dijk gave test subjects bottles of wine as payment for
participation in a study, and then, just before they left, he
offered them the option to trade their bottles among
themselves. He watched carefully what happened next. When
it was difficult to put a value on the bottles of wine,
people chose not to trade and displayed the endowment
effect -- an aversion to loss. But when it was easy to value
the wine, and when these values were roughly equal, people
were more willing to trade. In the first case, they
displayed the endowment effect, and in the second, their
fears disappeared, and so did the effect.
Van Dijk stated the principle this way: The more difficult
it is for people to compute the net gains of a trade, the
more likely it will be for them to feel fearful and to hang
on to what they have . . . to display the endowment effect.
Or, you could state it in terms of a cure: reduce the
uncertainty in valuing and comparing, and the endowment
effect will disappear.
The most obvious example of the endowment effect in our
businesses occurs as prospective employees walk away from
their interviews with us. Much is swimming through their
minds, and valuing and comparing everything you have said
with other potential employers and with their current jobs
invites the emergence of the endowment effect. Consider, for
example, benefits packages, and total compensation.
Comparing competing packages can be difficult.
You have an advantage in valuing benefits packages, and you
are in a position to help prospective employees do their math
and make an objective comparison. If you do your homework
and be ready to fill this role, you'll be less likely to find
good prospective employees choosing to stay where they are
out of fear of losing what they have when it is actually
inferior to your offer.
Reference: van Dijk, Eric and Daan van Knipenberg (1998) Trading Wine: On the Endowment Effect, Loss Aversion, and the Comparability of Consumer Goods. Journal of Economic Psychology, 19, 485-495.
Business Practice Findings, by James Larsen, Ph.D.
The Endowment Effect
Research investigates a thinking pattern that affects decisions.