Chapter 8 The High Price of Ownership

Why We Overvalue What We Have

At Duke University, basketball is somewhere between a passionate hobby and a religious experience. The basketball stadium is small and old and has bad acoustics—the kind that turn the cheers of the crowd into thunder and pump everyone’s adrenaline level right through the roof. The small size of the stadium creates intimacy but also means there are not enough seats to contain all the fans who want to attend the games. This, by the way, is how Duke likes it, and the university has expressed little interest in exchanging the small, intimate stadium for a larger one.

To ration the tickets, an intricate selection process has been developed over the years, to separate the truly devoted fans from all the rest. Even before the start of the spring semester, students who want to attend the games pitch tents in the open grassy area outside the stadium. Each tent holds up to 10 students. The campers who arrive first take the spots closest to the stadium’s entrance, and the ones who come later line up farther back. The evolving community is called Krzyzewskiville, reflecting the respect the students have for Coach K—Mike Krzyzewski—as well as their aspirations for victory in the coming season.

So that the serious basketball fans are separated from those without “Duke blue” running through their veins, an air horn is sounded at random times. At the sound, a countdown begins, and within the next five minutes at least one person from each tent must check in with the basketball authorities. If a tent fails to register within these five minutes, the whole tent gets bumped to the end of the line. This procedure continues for most of the spring semester, and intensifies in the last 48 hours before a game. At that point, 48 hours before a game, the checks become “personal checks.” From then on, the tents are merely a social structure: when the air horn is sounded, every student has to check in personally with the basketball authorities. Missing an “occupancy check” in these final two days can mean being bumped to the end of the line.

Although the air horn sounds occasionally before routine games, it can be heard at all hours of night and day before the really big contests (such as games against the University of North Carolina-Chapel Hill and during the national championships). But that’s not the oddest part of the ritual. The oddest part is that for the really important games, such as the national titles, the students at the front of the line still don’t get a ticket. Rather, each of them gets a lottery number. Only later, as they crowd around a list of winners posted at the student center, do they find out if they have really, truly won a ticket to the coveted game.

Ziv Carmon and I listened to the air horn during the campout in the spring of 1994 and were intrigued by the real-life experiment going on before our eyes. All the students who were camping out wanted passionately to go to the basketball game. They had all camped out for a long time for the privilege. But when the lottery was over, some of them would become ticket owners, while others would not.

The question was this: would the students who had won tickets—who had ownership of tickets—value those tickets more than the students who had not won them even though they all “worked” equally hard to obtain them? On the basis of Jack Knetsch, Dick Thaler, and Daniel Kahneman’s research on the “endowment effect,” we predicted that when we own something—whether it’s a car or a violin, a cat or a basketball ticket—we begin to value it more than other people do.

Think about this for a minute. Why does the seller of a house usually value that property more than the potential buyer? Why does the seller of an automobile envision a higher price than the buyer? In many transactions why does the owner believe that his possession is worth more money than the potential owner is willing to pay? There’s an old saying, “One man’s ceiling is another man’s floor.” Well, when you’re the owner, you’re at the ceiling; and when you’re the buyer, you’re at the floor.

The endowment effect, as Thaler first named it, was discovered in a simpler form. As a graduate student, Thaler noticed that his professor R (later revealed to be Richard Rosett), an economist and wine lover, would never pay more than $35 for a bottle but would refuse to sell any bottle from his collection for less than $100. In standard economic theory, the maximum buying price and minimum selling price for the same bottle should be identical, determined by a single stable valuation. The gap of $65 made no sense—unless owning the bottle changed its value in the owner’s mind.

The explanation came from Kahneman and Tversky’s prospect theory, which abandons the idea that utility depends solely on the present state of wealth. Instead, outcomes are evaluated relative to a reference point—usually the status quo. Losses relative to that reference point hurt much more than equivalent gains please. The value function is steeper in the negative domain; a loss is weighted about twice as heavily as a gain. Once you own a bottle of wine, giving it up is coded as a loss, while buying it when you don’t own it is coded as a gain. Because losses loom larger than gains, the owner demands far more money to part with the bottle than a non-owner would pay to acquire it. This same asymmetry explains the Duke ticket lottery.

We telephoned the winners and the losers. William, a senior who had not won, was willing to pay about $175. He figured that for the same money he could watch the game at a sports bar, buy food and beer, and still have cash left over. Joseph, who had won, demanded at least $2,400. He described the game as a defining memory of his time at Duke, an experience he would pass on to his children and grandchildren. “Can you put a price on memories?” he asked. Across all our calls, the average selling price (around $2,400) was about 14 times the average buying price (around $170). Not a single ticket owner was willing to sell at a price that any non-owner was willing to pay. In an instant after the lottery, an emotional chasm had opened between those who now imagined the glory of the game and those who imagined what else they could buy with the money.

From a rational perspective, both groups should have valued the experience the same way. The anticipated atmosphere and enjoyment did not depend on the lottery. Yet a random drawing dramatically changed their valuations—a powerful demonstration of the endowment effect.

OWNERSHIP PERVADES OUR lives and, in a strange way, shapes many of the things we do. Adam Smith wrote, “Every man [and woman] . . . lives by exchanging, or becomes in some measure a merchant, and the society itself grows to be what is properly a commercial society.” Much of our life story can be told by describing the ebb and flow of our particular possessions—what we get and what we give up. Since so much of our lives is dedicated to ownership, wouldn’t it be nice to make the best decisions about this? Unfortunately, we are mostly fumbling around in the dark. Why? Because of three irrational quirks in our human nature.

The first quirk is that we fall in love with what we already have. Suppose you decide to sell your old VW bus. Even before you put a FOR SALE sign in the window, you begin to recall trips you took. You were much younger, of course; the kids hadn’t sprouted into teenagers. A warm glow of remembrance washes over you and the car. This applies not only to VW buses, of course, but to everything else. And it can happen fast. For instance, two of my friends adopted a child from China and told me this remarkable story. They went to China with 12 other couples. When they reached the orphanage, the director took each of the couples separately into a room and presented them with a daughter. When the couples reconvened the following morning, they all commented on the director’s wisdom: Somehow she knew exactly which little girl to give to each couple. The matches were perfect. My friends felt the same way, but they also realized that the matches had been random. What made each match seem perfect was not the Chinese woman’s talent, but nature’s ability to make us instantly attached to what we have.

This attachment is not merely sentimental; it literally shifts our reference point. Once an object becomes “ours,” giving it up feels like a loss, not a neutral return to a prior state. Standard economic indifference curves, which map combinations of goods that yield equal utility, misleadingly omit the current reference point. They assume that your preferences are stable and independent of your history. In reality, the reference point acts like a gravitational force. Suppose you and your identical twin, Albert and Ben, start in the same job with low income and little leisure. The firm offers you both improved positions—one gets a $10,000 raise, the other an extra day of paid vacation each month. You are indifferent and toss a coin; Albert gets the raise, Ben the extra leisure. After getting used to your new positions, the company offers you the chance to switch. Standard theory says you would still be indifferent. But prospect theory predicts—and experiments confirm—that neither twin wants to switch. For Albert, giving up $10,000 looms larger than gaining 12 vacation days; for Ben, the loss of now-precious leisure outweighs the extra money. The status quo exerts a powerful hold because losses are weighted more heavily than gains.

The second quirk is that we focus on what we may lose, rather than what we may gain. When we price our beloved VW, therefore, we think more about what we will lose (the use of the bus) than what we will gain (money to buy something else). Likewise, the ticket holder focuses on losing the basketball experience, rather than imagining the enjoyment of obtaining money or on what can be purchased with it. Our aversion to loss is a strong emotion, and one that sometimes causes us to make bad decisions. Do you wonder why we often refuse to sell some of our cherished clutter, and if somebody offers to buy it, we attach an exorbitant price tag to it? As soon as we begin thinking about giving up our valued possessions, we are already mourning the loss.

This asymmetry is not universal, however. Many routine market transactions occur without any sense of loss—changing a $5 bill for five singles, or buying shoes from a merchant. The merchant who hands over the shoes feels no loss because those shoes are held “for exchange,” as a proxy for money they intended to collect. In the same way, you experience no loss when you pay because the money was held for the purpose of buying shoes. The pain of loss kicks in primarily for goods held “for use,” like wine, Super Bowl tickets, or a family home.

Kahneman, Knetsch, and Thaler demonstrated this distinction in a classic experiment. In the first phase, they created a market for tokens that could be redeemed for cash. The tokens, pure instruments of exchange, traded exactly as rational economic theory predicted—half the tokens changed hands. Then they repeated the procedure with a physical good held for use: a decorated coffee mug. Half the participants were randomly given a mug (Sellers), the others (Buyers) could use their own money to purchase one. The results were dramatic. Sellers demanded about $7 to give up their mug; Buyers were willing to pay only around $3. A third group, Choosers, who did not own a mug but could choose between receiving a mug or an equivalent amount of cash, set a value very close to the Buyers’—about $3. The gap between Sellers ($7.12) and Choosers ($3.12) is particularly striking, because both groups faced the identical choice: leave with either a mug or money. The only difference was the momentary emotion of owning. Selling an object we use activates brain regions associated with disgust and pain; the same regions fire in buyers only when prices seem excessively high. The ratio of selling price to buying price in these experiments hovers around 2:1, mirroring the loss aversion coefficient found in risky choices. This same 2:1 ratio appears in household responses to price changes, where the effect of price increases (a loss relative to the reference price) is about twice as large as the effect of decreases.

Jack Knetsch demonstrated the same reluctance with an even simpler setup. He gave one class an expensive pen and another a bar of Swiss chocolate as a reward for filling out a questionnaire. At the end, he showed them the alternative gift and offered a chance to trade. Only about 10 percent exchanged their gift. Mere ownership—even of a trivial item assigned by chance—made people reluctant to swap.

The third quirk is that we assume other people will see the transaction from the same perspective as we do. We somehow expect the buyer of our VW to share our feelings, emotions, and memories. Or we expect the buyer of our house to appreciate how the sunlight filters through the kitchen windows. Unfortunately, the buyer of the VW is more likely to notice the puff of smoke that is emitted as you shift from first into second; and the buyer of your house is more likely to notice the strip of black mold in the corner. It is just difficult for us to imagine that the person on the other side of the transaction, buyer or seller, is not seeing the world as we see it.

OWNERSHIP ALSO HAS what I’d call “peculiarities.” For one, the more work you put into something, the more ownership you begin to feel for it. Think about the last time you assembled some furniture. Figuring out which piece goes where and which screw fits into which hole boosts the feeling of ownership. In fact, I can say with a fair amount of certainty that pride of ownership is inversely proportional to the ease with which one assembles the furniture; wires the high-definition television to the surround-sound system; installs software; or gets the baby into the bath, dried, powdered, diapered, and tucked away in the crib. My friend and colleague Mike Norton and I have a term for this phenomenon: the “Ikea effect.”

Another peculiarity is that we can begin to feel ownership even before we own something. Think about the last time you entered an online auction. Suppose you make your first bid on Monday morning, for a wristwatch, and at this point you are the highest bidder. That night you log on, and you’re still the top dog. Ditto for the next night. You start thinking about that elegant watch. You imagine it on your wrist; you imagine the compliments you’ll get. And then you go online again one hour before the end of the auction. Some dog has topped your bid! Someone else will take your watch! So you increase your bid beyond what you had originally planned. Is the feeling of partial ownership causing the upward spiral we often see in online auctions? Is it the case that the longer an auction continues, the greater grip virtual ownership will have on the various bidders and the more money they will spend?

A few years ago, James Heyman, Yesim Orhun, and I set up an experiment to explore how the duration of an auction gradually affects the auction’s participants and encourages them to bid to the bitter end. As we suspected, the participants who were the highest bidders, for the longest periods of time, ended up with the strongest feelings of virtual ownership. Of course, they were in a vulnerable position: once they thought of themselves as owners, they were compelled to prevent losing their position by bidding higher and higher.

“Virtual ownership,” of course, is one mainspring of the advertising industry. We see a happy couple driving down the California coastline in a BMW convertible, and we imagine ourselves there. We get a catalog of hiking clothing from Patagonia, see a polyester fleece pullover, and—poof—we start thinking of it as ours. The trap is set, and we willingly walk in. We become partial owners even before we own anything.

There’s another way that we can get drawn into ownership. Often, companies will have “trial” promotions. If we have a basic cable television package, for instance, we are lured into a “digital gold package” by a special “trial” rate (only $59 a month instead of the usual $89). After all, we tell ourselves, we can always go back to basic cable or downgrade to the “silver package.” But once we try the gold package, of course, we claim ownership of it. Will we really have the strength to downgrade back to basic or even to “digital silver”? Doubtful. At the onset, we may think that we can easily return to the basic service, but once we are comfortable with the digital picture, we begin to incorporate our ownership of it into our view of the world and ourselves, and quickly rationalize away the additional price. More than that, our aversion to loss—the loss of that nice crisp “gold package” picture and the extra channels—is too much for us to bear. In other words, before we make the switch we may not be certain that the cost of the digital gold package is worth the full price; but once we have it, the emotions of ownership come welling up, to tell us that the loss of “digital gold” is more painful than spending a few more dollars a month. We may think we can turn back, but that is actually much harder than we expected.

Another example of the same hook is the “30-day money-back guarantee.” If we are not sure whether or not we should get a new sofa, the guarantee of being able to change our mind later may push us over the hump so that we end up getting it. We fail to appreciate how our perspective will shift once we have it at home, and how we will start viewing the sofa—as ours—and consequently start viewing returning it as a loss. We might think we are taking it home only to try it out for a few days, but in fact we are becoming owners of it and are unaware of the emotions the sofa can ignite in us.

OWNERSHIP IS NOT limited to material things. It can also apply to points of view. Once we take ownership of an idea—whether it’s about politics or sports—what do we do? We love it perhaps more than we should. We prize it more than it is worth. And most frequently, we have trouble letting go of it because we can’t stand the idea of its loss. What are we left with then? An ideology—rigid and unyielding.

THERE IS NO known cure for the ills of ownership. As Adam Smith said, it is woven into our lives. But being aware of it might help. Everywhere around us we see the temptation to improve the quality of our lives by buying a larger home, a second car, a new dishwasher, a lawn mower, and so on. But, once we change our possessions we have a very hard time going back down. As I noted earlier, ownership simply changes our perspective. Suddenly, moving backward to our pre-ownership state is a loss, one that we cannot abide. And so, while moving up in life, we indulge ourselves with the fantasy that we can always ratchet ourselves back if need be; but in reality, we can’t. Downgrading to a smaller home, for instance, is experienced as a loss, it is psychologically painful, and we are willing to make all kinds of sacrifices in order to avoid such losses—even if, in this case, the monthly mortgage sinks our ship.

My own approach is to try to view all transactions (particularly large ones) as if I were a nonowner, putting some distance between myself and the item of interest. In this attempt, I’m not certain if I have achieved the uninterest in material things that is espoused by the Hindu sannyasi, but at least I try to be as Zen as I can about it.

Reflections on the Challenges of Ownership

In 2007 and 2008, home values across America plummeted as fast as George W. Bush’s approval ratings. Each month brought with it more bad news: more foreclosures, more new homes for sale in a stagnant real estate market, and more stories of people who couldn’t get mortgages. Results from a study by Zillow.com illustrated just how strongly this news affected home owners: in the second quarter of 2008, nine out of ten home owners (92 percent) said there had been foreclosures in their local real estate market, and they were concerned that these foreclosures had lowered home values in their neighborhoods. Moreover, four in five home owners (82 percent) did not see much hope for improvement in the real estate market in the near future. On the face of it, Zillow’s research suggested that homeowners had been paying attention to the media, had an idea of what was happening in the economy, and understood that the housing crunch was a reality. But this study also found that these seemingly well-informed people believed that the values of their own homes had not decreased as much. Two out of three home owners (62 percent) believed that the value of their own home had increased or stayed the same, and about half (56 percent) planned to invest in home improvements, even as they watched the housing market collapse around them. What explained the wide gap between their inflated perception of their homes’ values and the gloomy market reality? Ownership fundamentally changes our perspective. In the same way that we think our own kids are more wonderful and special than our friends’ and neighbors’ children (regardless of whether our children deserve such esteem), we overvalue everything that we own, whether it’s a pair of basketball tickets or our domiciles.

But home ownership is even more interesting and complex than, say, the regular case of owning a coffee mug or a pair of baseball tickets—because we invest so much in our houses. Think, for example, about all the changes and tinkering we do to our homes once we move into them. We replace laminate countertops with granite. We take out a wall and install a new window that lets the light shine just so on the dining room table. We paint the living room walls a deep earthy clay color. We change the bathroom tile. We add a porch and install a koi pond in the backyard. Little by little, we make changes here and there until the house feels perfectly tailored to our unique individual tastes, until it expresses our elegant or eclectic sense of style to everyone else. When the neighbors come over, they admire our countertops and light fixtures. But in the end, do other people value the changes we have so lovingly made as much as we do? Do they value these changes at all?

Consider a home owner who compares her own beautifully remodeled house with a similar one down the street that has been languishing on the market for months, or with another that has recently sold for much less than the asking price. In so doing, she understands why the owners of these other homes had such a hard time selling them. They had the laminate and not the granite countertops, no earthy clay paint or light that fell just so on the dining room table. “No wonder those houses didn’t sell,” she thinks to herself, “they simply are not as nice as mine.”

My wife, Sumi, and I also fell victim to this bias. When we worked at MIT, we bought a new house in Cambridge, Massachusetts (the house was originally built in 1890, but it felt new to us). We promptly went about fixing it up. We took down some walls to give the house an open feel, which we loved. We renovated the bathrooms and set up a sauna in the basement. We also converted the carriage house in the garden into a small combination office-apartment. Sometimes we would pack our laundry basket with some wine, food, and clothing, and escape to the carriage house for a “weekend away.” Then, in 2007, we took jobs at Duke University and moved to Durham, North Carolina. We assumed that the housing market would continue to decline, and that it would be in our best interest to sell the Cambridge house as quickly as possible. We also wanted to avoid having to pay for heating, taxes, and a mortgage on two homes. Many people came to see our beautifully remodeled Cambridge home. They all seemed to appreciate the structure and the feel of the place, but no one put in an offer. People told us that the house was beautiful, but somehow they could not fully appreciate the benefit of the open floor plan. Instead, they wanted something with more privacy. We heard what they said, but it didn’t fully register. “Clearly,” we said to each other after each set of prospective buyers had come and gone, “those people are just dull and unimaginative, and have no taste. Surely our beautiful, open, airy home will be just right for the perfect someone.” Time passed. We paid double mortgages, double heating bills, and double taxes while the housing market continued to slow down. Many more people came to see the house and left without extending an offer. Eventually Jean, our real estate agent, delivered the bad news to us the way a doctor tells a patient there’s something funny looking on his X-ray. “I think,” she said slowly, “that if you want to sell the house, you will have to rebuild some walls and reverse some of the changes you have made.” Until she said those words, we had not accepted this truth. Despite our disbelief, and still fully convinced of our superior taste, we took the plunge and paid a contractor to re‑erect some walls. A few weeks later the house was sold. In the end, the buyers didn’t want our home. They wanted theirs. This was a very expensive lesson, and I certainly wish we had had a better sense of the effect of our modifications on potential buyers.

Our propensity to overvalue what we own reflects a more general tendency to fall in love with, and be overly optimistic about, anything that has to do with ourselves. Think about it—don’t you feel that you are a better-than-average driver, are more likely to be able to afford retirement, and are less likely to suffer from high cholesterol, get a divorce, or get a parking ticket if you overstay your meter by a few minutes? This positivity bias, as psychologists call it, has another name: “The Lake Wobegone Effect,” named after the fictional town in Garrison Keillor’s popular radio series A Prairie Home Companion. In Lake Wobegone, according to Keillor, “all the women are strong, all the men are good-looking, and all the children are above average.” I don’t think we can become more accurate and objective in the way we think about our children and houses, but maybe we can realize that we have such biases and listen more carefully to the advice and feedback we get from others.