Working Paper BETA #2018-04

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Title : Bargaining and Hold-up: The Role of Arbitration

Author(s) : Yannick Gabuthy, Abhinay Muthoo

Abstract : This paper presents an “incomplete contracting” model of arbitration. A fundamental notion that underlies our analysis is that it is optimal (in terms of promoting productivity-enhancing, relationship-specific investments) to determine ex-ante – well before arbitration would actually be required (if at all) – whether or not parties would engage the services of an arbitrator in the eventuality that they fail to resolve any disputes by themselves. We embed this idea in a simple model of a long-term relationship between a firm and its workforce, in which they can make (non-contractible) investments, and then negotiate over the division of the resultant surplus, which, if previously agreed, occurs in the shadow of arbitration. We derive several results and insights concerning whether or not it is optimal for the parties to commit to call an arbitrator, in terms of arbitrator-preference and technological parameters.

Key-words : Arbitration, Non-Contractible Investments, Hold-up, Bargaining.

JEL Classification : D74, J52, K41