The Use of Final Offer Arbitration as a Screening Device

Abstract

Arbitration outcomes are uncertain. When risk preferences are unobservable, players may make offers that attempt to extract the willingness of risk-averse bargaining partners to pay to avoid the uncertainties of arbitration. When such a “hard” offer is made to a risk-neutral bargaining partner, it will be refused and arbitration will result. This is true even when the distribution of outcomes is common knowledge. Importantly, risk preferences may be difficult to communicate, even if it is in the interest of both parties to do so.