“Oil is big business.” A classic example of this is the Texaco-Pennzoil court case, which appeared in the book Making Hard Decisions5 and in a subsequent case study by T. Reilly and N. Sharpe (2001). In 1984, a merger was hammered out between two oil giants, Pennzoil and Getty Oil. Before the specifics had been agreed to in a written and binding form, another oil giant—Texaco—offered Getty Oil more money. Ultimately, Getty sold out to Texaco.
Pennzoil immediately sued Texaco for illegal interference, and in late 1985 was awarded $11.1 billion—an enormous award at the time. (A subsequent appeal reduced the award to $10.3 billion.) The CEO of Texaco threatened to fight the judgment all the way to the U.S. Supreme Court, citing improper negotiations held between Pennzoil and Getty. Concerned about bankruptcy if forced to pay the required sum of money, Texaco offered Pennzoil $2 billion to settle the case. Pennzoil considered the offer, analyzed the alternatives, and decided that a settlement price closer to $5 billion would be more reasonable.
The CEO of Pennzoil had a decision to make. He could make the low-risk decision of accepting the $2 billion offer, or he could decide to make the counteroffer of $5 billion. If Pennzoil countered with $5 billion, what are the possible outcomes? First, Texaco could accept the offer. Second, Texaco could refuse to negotiate and demand settlement in the courts. Assume that the courts could order one of the following:
• Texaco must pay Pennzoil $10.3 billion.
• Texaco must pay Pennzoil’s figure of $5 billion.
• Texaco wins and pays Pennzoil nothing.
The award associated with each outcome—whether ordered by the court or agreed upon by the two parties—is what we will consider to be the “payoff” for Pennzoil. To simplify Pennzoil’s decision process, we make a few assumptions. First, we assume that Pennzoil’s objective is to maximize the amount of the settlement. Second, the likelihood of each of the outcomes in this high-profile case is based on similar cases. We will assume that there is an even chance (50%) that Texaco will refuse the counteroffer and go to court. According to a Fortune article,6 the CEO of Pennzoil believed that should the offer be refused, Texaco had a chance to win the case with appeals, which would leave Pennzoil with high legal fees and no payoff. Based on prior similar court cases and expert opinion, assume that there is also a 50% probability that the court will order a compromise and require Texaco to pay Pennzoil the suggested price of $5 billion. What are the remaining options for the court?
Assume that the probabilities of the other two alternatives—Pennzoil receiving the original total award ($10.3 billion) or Pennzoil getting nothing—are almost equal, with the likelihood of the original verdict being upheld slightly greater (30%) than the likelihood of reversing the decision (20%). Evaluate the expected payoff and risk of each decision for Pennzoil.