Final Offer Arbitration and the Incentive to Bargain: A Principal-Agent Approach


This paper presents a model of final-offer arbitration that distinguishes
between the union rank and file and their negotiator. If the union negotiator
has better information than the rank and file with regard to the bargaining
enviroment and the negotiated wage depends not only on this enviroment but also
the effort exerted by the negotiator, then the rank and file may not be able to
tell whether a poor wage outcome resulted from a poor bargaining enviroment or
because the negotiator was shirking. This is the classic principal—agent problem
with asymmetric information.
Through contract design the union rank and file could elicit the correct
behavior from the negotiator without resort to arbitration. But, as is shown in
this paper, under certain circumstances the rank and file could do better by
having the union negotiator go to arbitration some of the time. In a two state,
model it is shown that arbitration will occur only in the ‘bad’ state (where the
bargaining enviroment is unfavorable to the union). Arbitration is more likely
to serve a useful purpose in contract design the less risk averse the rank and
file, the smaller the direct costs of arbitration to the union, the more likely
the ‘good’ state of nature and the more difficult it is to induce 'truth
telling‘ in the absence of arbitration.

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