Bazerman's Chip

Every year, Professor Max Bazerman sells twenty-dollar bills to Harvard Business School MBA students well above face value. His record is selling $20 for $204. And he does it as follows.

He shows the bill to the whole class and tells them that he will give $20 to the person who gives the most money for it. There is, however, a small condition. The person who was right behind the winner will have to give the professor the amount he was willing to give for $20.

To be clear - let's say the two highest bids were $15 and $16. The winner gets $20 in exchange for $16, and the second person would have to give the professor $15. Those are the terms.

Bidding starts at one dollar and quickly reaches $12-$16. At this point, most students drop out of the auction, and only the two people with the highest bids remain. Slowly but surely the auction approaches the $20 figure.

It is clear that it is impossible to win, but one does not want to lose, because the loser not only gets nothing - he will also have to pay the professor the face value of his last bid.

As soon as the auction crosses the $21 mark, the class bursts into laughter. MBA students, supposedly so smart, are willing to pay above par for a twenty-dollar bill. Indeed -comical and very accurately describes the behavior of MBA holders.

However, the auction goes on and quickly reaches $50, then a hundred, all the way up to $204 - Bazerman's record for his teaching career. By the way, during training sessions the professor does the same trick with top managers and CEOs of large companies - and always sells $20 above face value (the money received is spent on charity).

Why do people invariably pay more money for twenty dollars, and what is the professor trying to show? Humans, especially in business, have a weakness: loss aversion or fear of loss. Numerous experiments show that people behave extremely irrationally and even inadequately when they begin to lose money.

At first all students think that they can get free money. After all, they are not fools and will not pay more than twenty bucks for a twenty-dollar bill. However, as soon as the bidding reaches $12-$16, the second person realizes that he is in danger of losing money, so he begins to bid more than he intended to until the auction reaches $21. At that point, both bidders will lose money. But some will lose only a dollar, and some will lose twenty. To minimize losses, each person tries to be the winner. However, this race only results in both bidders losing more and more money, until the size of the losses reaches such an amount that it simply does not make sense to dig the hole any deeper.

Thus, the desire to get a free twenty turns out to be a loss. The interesting thing is that there is plenty of data-especially in the stock market and casinos-that show the Bazerman phenomenon in action. A person begins to lose money. Instead of fixing the loss, he hopes he can win back the loss-and he almost always loses more and more money.

So remember the tricky professor's lesson - fear of loss leads to more losses. Fix your losses while they are minimal.