The problem: You and your negotiating counterpart express differing opinions about the future success, performance, or timeliness of an item or service. A homeowner might be skeptical of a contractor’s promise to complete an extensive remodeling project within six months, for instance. Differing forecasts can breed suspicion and stand in the way of agreement.
The tool: A contingent contract allows negotiators to bet on their predictions based on how events unfold. By specifying different incentives and penalties, both sides are protected from the possibility that the other party will fail to meet the terms of the agreement.
Operating instructions: The homeowner could ask the contractor to agree to pay a penalty in the event of delays or offer a bonus if the contractor finishes early, or both. Similarly, companies often tie CEO salaries to stock prices, and publishers link authors’ royalties to book sales.
What it can do: A contingent contract allows negotiators to capitalize on their differences, thereby avoiding the need to compromise or decide who is “right.” Contingent contracts also lower the risk of noncompliance, decrease the odds of litigation, and reduce the need to renegotiate terms.
Safety warning: Before adding bets to your deal, consider these four potential hazards:
1. Unequal information. If the other side has access to better information than you do, you might unwittingly agree to a bad deal. Check the validity of your predictions before signing on the dotted line.
2. Distorted incentives. Unrealistic contingencies could create a conflict of interest. If your contractor rushes to meet an imposed deadline to avoid incurring penalties, you might not be pleased with the finished project. Set terms that are reasonable.
3. Ties that bind. A contingent contract creates an ongoing relationship, as the two sides will need to assess the final terms of their agreement at a later date. If you’d rather not deal with someone again, a contingent contract may not be a good idea.
4. Ambiguity. To be enforceable, contingent contracts must be clear and measurable. Don’t make a bet on an event that is ambiguous or otherwise difficult to measure.
Adapted from “Capitalize on Differing Forecasts with a Contingent Contract,” first published in the Negotiation newsletter, December 2007.