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

Abstract

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.