A Game Theoretic Model for Determining When Baseball Arbitration Creates the Proper Incentives for Litigants

Abstract

This paper creates a game theoretic model to determine how pendulum arbitration or baseball arbitration impacts the incentives of litigants. Pendulum arbitration is when both parties submit competing proposals and the arbitrator chooses only one of the bids, in its entirety, to be binding on both parties. Pendulum arbitration is most famous for its use in salary disputes between baseball players and their team when both parties can’t agree on contract terms. Many believe that pendulum arbitration incentivizes both parties to submit more “conservative” bids and, thus, creates the proper incentives for parties in a dispute. Our game theoretic model explains that this is not always the case. Whether or not pendulum arbitration will create the proper incentives for litigants is largely based on other factors such as the arbitrator’s error rate and the ability of the litigants to “lever up.” Using this model we are able to explain the success of pendulum arbitration in labor disputes and baseball. We can also use our model to explain why pendulum arbitration would not work in corporate valuation situations. Finally, we use our model to propose a few disputes such as marital asset distribution and consumer/business disputes which, according to our model, would be ideal for pendulum arbitration.

Keywords: arbitration, mediation, dispute resolution, game theory, pendulum arbitration, baseball arbitration, marital assets, divorce, consumer/business disputes, online dispute resolution, hedge fund, corporate valuation, baseball, valuation in bankruptcy

JEL Classification: A1, A14, C7, C70, C72, C79, D61, D7, D74, D8, D80, D81, G33, H3, H30, H31, J5, J50, J52,K12, K2, K4