Proposal Convergence and Settlement under Final Offer Arbitration

Abstract

Under final offer arbitration (FOA), each party to the dispute submits a proposal to the arbitrator who must choose one of the two submitted proposals in the event of a dispute. A long line of research on FOA has assumed that the submitted proposals to the arbitrator are the final bargaining positions of the parties to the dispute. One consequence of this assumption has been a focus on whether proposals submitted to the arbitrator converge to one another. However, current practice implies a separation between settlement negotiations and proposals submitted to the arbitrator. We use a simple setting to show that proposal convergence can be consistent with an increase in disputes, a decrease in disputes or no effect on the dispute rate. In order to be fully evaluated, mechanisms which lead to proposal convergence must be embedded in a model in which disputes arise endogenously.

Keywords: Final Offer Arbitration, Proposal Convergence, Settlement

JEL Classification: J52, D82, K41