Final-Offer Arbitration with Uncertainty Averse Parties

Abstract

Final-offer arbitration (FOA) is a widely used binding dispute resolution mechanism, where an impartial arbitrator is constrained to choose one of the two final offers pro- posed by two disputing parties. We build an equilibrium model of FOA with agents averse to arbitral uncertainty to study three important issues: the role of FOA in incentivizing negotiated settlements, convergence of final offers, and the effect of diversity of arbitrator opinion on welfare. Uncertainty increases the likelihood of non-arbitrated settlement and make the final offers converge to each other. Risk aversion is not necessary. Precision and mean of arbitral uncertainty matter differently and can be con- trolled separately. Moreover, as also argued by the industry practitioners, diversity (of opinion) in the arbitrator pool increases the welfare of negotiating parties.