Discovery and Disclosure in a Signaling Model of Final Offer Arbitration

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. Within the context of this model we analyze costly voluntary disclosure and costly discovery. In standard litigation models, costly disclosures may occur in the signaling game, but costly discovery never takes place. By contrast, under FOA if information transmission takes place prior to the submission of proposals to the arbitrator, costly discovery may take place. However, the incentive to engage in a voluntary disclosure is weakened relative to a standard litigation model. If information transmission takes place after the submission of proposals to the arbitrator, then the results are analogous to those found in a standard litigation model. Understanding FOA is important, because it is widely used, including in telecommunications rate disputes.