Bargaining Over an Uncertain Value: Arbitration Mechanisms Compared

Abstract

This article explores the theoretical and behavioral impact of conventional arbitration and final-offer arbitration (FOA) when parties are bargaining over an uncertain value. In this context, one player receives a fixed payment while the other player receives the uncertain residual. Although both forms of arbitration have identically sized contract zones, we show theoretically that in FOA the contract zone shifts in favor of the residual claimant. In addition, as the variance of the possible values rises, the contract zone shifts further in favor of the residual claimant. In laboratory testing, the contract zone roughly reflects the central tendencies of behavior; however, both forms of arbitration increase conflict relative to a no-arbitration baseline. This is caused by residual claimants being more aggressive when arbitration is available while fixed-payment recipients are not. However, both parties play a role in the conflict escalation due to the increased proposal variation.