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Signaling in the “Before” Model of Final Offer Arbitration

Amy Farmer and Paul Pecorino ()

The Journal of Law, Economics, and Organization, 2023, vol. 39, issue 2, 521-556

Abstract: We develop a signaling model of final offer arbitration (FOA) in which the informed party makes the final settlement demand to the uninformed party. In FOA, each party submits a proposal to an arbitrator and if no agreement is reached, the arbitrator must select one of the two submitted proposals. We analyze a “before” model of FOA in which all settlement activity occurs prior to the exchange of proposals. We characterize the pure strategy separating, equilibrium associated with this game. Relative to a model of conventional arbitration (CA), the pure strategy separating equilibrium is associated with a higher dispute rate because weak player types have an enhanced incentive to bluff in this setting. This result continues to hold in semi-pooling equilibria. Thus our model is consistent with a higher dispute rate in FOA compared to CA. We also compare the incentive to engage in costly voluntary disclosure and costly discovery (JEL K4, C7, J52).

Date: 2023
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