Arbitration with Uninformed Consumers

71 Pages Posted: 15 Oct 2018 Last revised: 18 Oct 2018

See all articles by Mark Egan

Mark Egan

Harvard Business School

Gregor Matvos

University of Texas at Austin - Department of Finance

Amit Seru

Stanford University

Date Written: October 4, 2018

Abstract

We examine whether firms have an informational advantage in selecting arbitrators in consumer arbitration, and the impact of the arbitrator selection process on outcomes. We collect a novel data set containing roughly 9,000 arbitration cases in securities arbitration. Securities disputes present a good laboratory: the selection mechanism is similar to other major arbitration forums; arbitration is mandatory for all disputes, eliminating selection concerns; and the parties choose arbitrators from a randomly generated list. We first document that some arbitrators are systematically industry friendly while others are consumer friendly. Firms appear to utilize this information in the arbitrator selection process. Despite a randomly generated list of potential arbitrators, industry-friendly arbitrators are forty percent more likely to be selected than their consumer friendly counterparts. Better informed firms and consumers choose more favorable arbitrators. We develop and calibrate a model of arbitrator selection in which, like the current process, both the informed firms and uninformed consumers have control over the selection process. Arbitrators compete against each other for the attention of claimants and respondents. The model allows us to interpret our empirical facts in equilibrium and to quantify the effects of changes to the current arbitrator selection process on consumer outcomes. Competition between arbitrators exacerbates the informational advantage of firms in equilibrium resulting in all arbitrators slanting towards being industry friendly. Evidence suggests that limiting the respondent's and claimant's inputs over the arbitrator selection process could significantly improve outcomes for consumers.

Keywords: Arbitration, Financial Advisers, Brokers, Consumer Finance, Financial Misconduct and Fraud

JEL Classification: G24, G28, D14, D18

Suggested Citation

Egan, Mark and Matvos, Gregor and Seru, Amit, Arbitration with Uninformed Consumers (October 4, 2018). Harvard Business School Finance Working Paper No. 19-046. Available at SSRN: https://ssrn.com/abstract=3260442 or http://dx.doi.org/10.2139/ssrn.3260442

Mark Egan

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

Gregor Matvos

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

Amit Seru (Contact Author)

Stanford University ( email )

Stanford, CA 94305
United States

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