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Economics Research Institute Study Paper




Utah State University Department of Economics

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This article examines the incentive effects of final-offer arbitration (FOA) in the presence of optimistic disputants. Common disputant expectations about the likely arbitrator settlement preferences are not a necessary condition for equilibrium final offers. It is shown that equilibrium final offers can exist under at least two forms of disputant optimism: naIve optimism and more sophisticated beliefs. Additionally, equilibrium final offers diverge more when disputants are optimistic than when they are not, and even more when optimism is naIve as opposed to sophisticated. The implication is that FOA rules, though instituted to lessen the "chilling" effect of arbitration on negotiations, interact with optimistic beliefs in a way that worsens the chilling effect. Data from controlled laboratory experiments confirm that optimistic expectations increase the distance between the disputants' final bargaining positions as well as the probability of dispute. These results highlight the importance of improving disputant expectations as an effective way of improving bargaining outcomes.