Compromise vs. Capitulation in Bargaining with Incomplete Information

Abstract

We analyse a two-sided incomplete information negotiation that can reach three possible settlements: either the extreme proposal of one of the parties prevails, or an intermediate compromise is reached. Our main results are (i) that the outcome of the game in which no compromise is possible is an equilibrium of the game with compromise and that (ii) there exist equilibria in which compromise is reached with positive probability that are (ex-ante) Pareto improving. The results support the perception that mediators, restricting direct communication and/or coordinating the timing of concessions, enhance the efficiency of bargaining.