Arbitration with Uninformed Consumers
78 Pages Posted: 15 Oct 2018 Last revised: 16 Jun 2020
Date Written: May 10, 2020
This paper studies the impact of the arbitrator selection process on consumer outcomes by examining roughly 9,000 consumer arbitration cases in the securities industry. Securities disputes present a good laboratory: arbitration is mandatory for all disputes, eliminating selection concerns; the parties choose arbitrators from a randomly generated list; and the selection mechanism is similar to other major arbitration forums. We establish several facts that suggest that firms hold an informational advantage over consumers in selecting arbitrators, resulting in industry-friendly arbitration outcomes. We then develop and calibrate a quantitative model of arbitrator selection in which firms hold an informational advantage in selecting arbitrators. Arbitrators, who are compensated only if chosen, compete with each other to be selected. The model allows us to decompose the firms’ advantage into two components: the advantage of choosing pro- industry arbitrators from a given pool, and the equilibrium pro-industry tilt in the arbitration pool that arises because of arbitrator competition. Selecting arbitrators without the input of firms and consumers would increase consumer awards by $40,000 on average, relative to the current system. Forty percent of this effect arises because the pool of arbitrators skews pro-industry due to competition. Even an informed consumer cannot avoid this equilibrium effect. Counterfactuals suggest that redesigning the arbitrator selection mechanism for the benefit of consumers hinges on whether consumers are informed. Policies such as increasing arbitrator compensation or giving parties more choice, benefit informed consumers but hurt the uninformed.
Keywords: Arbitration, Financial Advisers, Brokers, Consumer Finance, Financial Misconduct and Fraud
JEL Classification: G24, G28, D14, D18
Suggested Citation: Suggested Citation