Binding Versus Final-Offer Arbitration: A Combination is Best

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Abstract
A new procedure is proposed for settling disputes which combines binding arbitration (BA) and final-offer arbitration (FOA). Unlike either of the two pure procedures, combined arbitration (CA) induces the two parties to converge in making their final offers. Under BA, the arbitrator's settlement is binding on the two sides; under FOA, the arbitrator chooses the final offer of the party closer to what he/she considers a fair settlement. Under CA, FOA is used if the arbitrator's notion of a fair settlement falls between the two final offers or if the final offers converge or crisscross; otherwise, BA is used. When modeled as a two-person, zero-sum game of imperfect information, in which the two parties make final offers to maximize their expected payoffs—based on their perception of the arbitrator's probability distribution of fair settlements—convergence is to the median and constitutes a global equilibrium if the probability distribution is continuous, unimodal, and symmetric about the median. When the distribution is not symmetric or the two parties have different distributions, alternative solutions are derived—including one based on the parties' being within a “critical distance” of each other—and illustrated by examples. Alternatives to the arbitrator's decision calculus are considered, and questions about applying the new arbitration procedure are discussed.

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