Arbitration and Investment Incentives
Posted: 30 Mar 2006
Date Written: 2005
This paper presents a incomplete contracting model of arbitration. A fundamental notion that underlies our analysis is that it can be optimal (especially in terms of promoting productivity-enhancing, relationship-specific investments) to determine ex-ante - well before arbitration would actually be required (if at all) - whether or not parties in a long-term relationship would engage the services of an arbitrator in the eventuality that they fail to resolve any disputes by themselves. We embed this idea in a simple model of a long-term relationship between a firm and its workforce, in which they can make (non-contractable) productivity-enhancing, relationship-specific investments, and then negotiate over the division of the resultant surplus (revenue), which, if previously agreed, occurs in the shadow of arbitration. We derive several results and insights concerning whether or not it is optimal for the parties to commit (via a contract) to call an arbitrator (if and when required), in terms of arbitrator-preference and technological parameters.
Keywords: Arbitration, Non-Contractable Investments, Incomplete Contracts, Bargaining
JEL Classification: C78, D23, K40
Suggested Citation: Suggested Citation