Signaling in the “Before” Model of Final Offer Arbitration

Abstract

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).