Dispute Resolution in the Signaling Model: A Comparison of Arbitration Mechanisms

We conduct an experimental analysis of signaling games using three models of arbitration. In the signaling model, the informed party in the dispute makes a settlement demand to the uninformed party. In conventional arbitration (CA), the arbitrator is free to impose her preferred settlement on the disputing parties. In Final Offer Arbitration (FOA), each party submits a proposal to the arbitrator who must choose one of the two submitted proposals. In one version of FOA we consider, settlement bargaining (which occurs separately from proposal submission) occurs prior to the submission of proposals and in one version it occurs after. We find the lowest dispute rate in CA and the highest dispute rate in FOA when settlement negotiations take place prior to the submission of proposals. The difference in dispute rates across these two mechanisms is 10 percentage points, which is about 25% of the average dispute rate. One factor in the lower CA dispute rate is that fewer disputes result from anomalous demands, which in turn may be a function of the simplicity of the mechanism compared with FOA.