Arbitration and bargaining across the pacific.

• Author: Deck, Cary

1. Introduction

   The increasingly global nature of the economy increases the likelihood of disputes between geographically and culturally separated people from different nations. These international interactions increasingly extend to labor relations, business contracts, and legal conflicts. To the extent that cultural norms and other factors that may vary with nationality affect concepts of fairness, patterns of negotiation, or even beliefs regarding the proper procedure for settling disputes, these differences may increase the degree of conflict or make the probability of self-negotiated settlements decline. This creates an imperative that we understand the role that such differences play in conflict resolution in order to facilitate negotiations and/or choose dispute resolution procedures that can encourage settlements.

   A significant literature has addressed international negotiations in a variety of contexts; this literature identifies how individuals in various countries behave differently in dimensions that may matter for resolving conflicts. While this information is critical to understand, the literature has failed to ask whether these preferences or behaviors vary when people interact with a fellow countryman or a foreigner. In other words, do the identified differences change when agents are working with individuals outside of their own nation or culture? Leung (1997) argues that despite a plethora of research on cultural differences in negotiations, there is a lack of research on intercultural negotiations. This paper helps to fill this void through laboratory experiments in which subjects in the United States and Japan interact in real-time final offer arbitration negotiations, not only within their own groups but also across groups. As such, we are not only able to identify differences in within-group behavior; we are also able to identify how subjects alter their behavior when bargaining across international and cultural boundaries. We find that such changes in behavior do occur, suggesting that the vast literature identifying cultural differences is incomplete in helping us understand the interactions of agents. This finding is of importance irrespective of the specific form of negotiations or the countries involved; rather, in documenting behavioral changes when agents bargain across cultures, this research suggests that the quickly expanding literature documenting cultural bargaining differences may not generalize to negotiations between agents of different cultures.

   The specific form of dispute resolution addressed in this paper is final-offer arbitration (FOA). In the United States, arbitration is widely applied in settling disputes that fail to be negotiated. (1) FOA requires that each party formally submit a final offer, and an arbitrator then selects one. Contrary to the standard usage, in FOA an "offer" is the amount of money a party is requesting for herself. Proposed by Stevens (1966), FOA has been employed in Major League Baseball since the 1970s to resolve salary disputes for players who are not yet eligible for free agency and can only bargain with their current team. It also has been applied to settle public sector labor contract issues, where the right to strike is not available to laborers in many countries. As we outline below, there has been an inability for researchers to fully explain agents' behavior in FOA. Given that individuals deviate from theoretically predicted behavior, it is possible that beliefs and social norms--factors that could vary by culture or nationality--may influence behavior. To the extent that we can identify such behavior, this work also contributes to the arbitration literature seeking to understand the failure of agents to settle when they are predicted to do so.

   Specifically, this paper compares pre-arbitration bargaining and the performance of FOA within and between residents of two countries: the United States and Japan. (2) We have two reasons for this choice. First, Japan and the United States have been major trading partners for several decades (Graham and Sano 1989), and a successful dispute resolution method has implications for both economies. Second, the nations are geographically separated and many papers find that they are quite different in cultural background. For example, Hofstede (1980, 1991) and Schwartz (1994) argue that these cultures differ in two important dimensions: Japan is generally considered collectivist and hierarchical, while the United States is individualistic and egalitarian. (3,4) Buchan, Croson, and Johnson (2004) find that the people in these two countries have different viewpoints of fairness and the role of power that might determine their bargaining behavior. In addition to studies documenting differences in values and bargaining culture, Lituchy (1997), Brett and Okumura (1998), Beard, Beil, and Mataga (2001), and Oosterbeek, Sloof, and van de Kuilen (2004) find that economic behavior differs significantly between these two countries in many situations. However, Slemrod and Katuscak (2005) find that both the United States and Japan are societies that exhibit high levels of trust, potentially making economic transactions across national boundaries less difficult.

   It is difficult to investigate the issue using field data. While naturally occurring data from FOA are available from the United States, (5) its application in Japan is rare. (6) Therefore, we rely upon laboratory methods to make this cultural comparison. Laboratory studies also have the advantage that the experimenter can control factors that typically vary across naturally occurring disputes and are often unobservable. For example, in the lab we can control the information each party has about the arbitrator's preferences and the cost of going to arbitration. This could be potentially important in our examination of interactions across the two cultures.

   As a prelude to our experimental results, we find that the average settlement rates were lower within Japan at 64% than within the United States at 70%, but the difference is not statistically significant. When agents bargain internationally, we observe a significantly higher settlement rate of 82%. In part, this result may be due to the increased amount that U.S. disputants demand when facing a Japanese rival. Importantly, these results indicate that bargainers alter their behavior when faced with an opponent from the other country. While this study documents such changes in a specific bargaining environment between two specific countries, it suggests that in addition to fully understanding this application, the literature comparing intracultural negotiations across cultures is incomplete and potentially misleading.

   This paper is organized as follows: Section 2 provides a more extensive discussion of the literature, section 3 presents a basic model of FOA, and section 4 describes our experimental design. The results are presented in section 5, followed by conclusions in section 6.

2. Literature Review

   Relevant Arbitration Literature

   Under FOA, an aggressive offer that requests a large share is likely to lose, resulting in the opponent's offer being implemented. Therefore, researchers originally expected disputants to present compromising offers in the arbitration process. However, game-theoretical studies showed that the offers are unlikely to converge when the arbitrator's notion of fairness is not completely known to the disputants (see Farber 1980; Brams and Merrill 1983). Despite this result, rational disputants are still expected to reach an agreement in the pre-arbitration negotiation process because it is rational to save their arbitration costs. In other words, the costs create a contract zone within which disputants prefer to settle rather than pursue arbitration. (7) Despite this prediction, real-world disputes frequently enter the arbitration process.

   Many authors have addressed the puzzle of why players do not behave as theory suggests. For example, Shavell (1982) and Priest and Klein (1984) argue that settlement failure arises because parties make mistakes in their assessment of the disputes. Bebchuk (1984) and Reinganum and Wilde (1986) also stressed the role of asymmetric information in explaining settlement failure. However, the empirical study of Farmer, Pecorino, and Stango (2004) shows that even in cases where information is widely available, such as baseball labor negotiations, the disputants often fail to settle.

   The lack of pre-arbitration settlement has consistently been observed in the laboratory through a variety of experimental designs and arbitration mechanisms. Ashenfelter et al. (1992) compare FOA with conventional arbitration and tri-offer arbitration, all of which are used in practice; Dickinson (2004, 2005) compares FOA and conventional arbitration with combined arbitration of Brams and Merrill (1986) and double-offer arbitration of Zeng, Nakamura, and Ibaraki (1996); and Deck, Farmer, and Zeng (2007) compare FOA with amended final-offer arbitration of Zeng (2003). (8) With the exception of Deck, Farmer, and Zeng (2007), settlement rates for FOA are typically below 50% in the lab.

   Relevant Cultural/Nationality Literature

   The above arbitration studies draw upon data from the United States. Culture and national character are believed to play an important role in economic decision making, which in part may explain why observed behavior deviates from the predictions of positive game theory. In fact, recent laboratory research has already identified the potential role of cultural norms in influencing economic outcomes. For example, Roth et al. (1991) have investigated the difference of bargaining and market behavior across four countries. Their results are amplified by Henrich (2000). Although cultural factors are not explicitly incorporated in game-theoretical models yet, it is natural to guess that dispute resolution depends on culture, since it is related to...