Can prior offers and arbitration outcomes be used to predict the winners of subsequent final-offer arbitration cases?

• Author: Marburger, Daniel R.
• Position: Resolution of disputes

1. Introduction

   Interest arbitration is a dispute resolution procedure in which an independent arbitrator determines the terms of a new contract. The intent of interest arbitration is not to have arbitrators impose settlements on the bargainers but rather to encourage negotiation by the parties. Two main variations of interest arbitration exist. In conventional arbitration (CA), each party submits an offer to the arbitrator, who may select either offer as the settlement or choose one of his or her own. Final-offer arbitration (FOA) requires the arbitrator to select one of the two submitted offers as the award. By forcing the arbitrator to choose one offer over the other, the parties are thought to have an incentive to submit reasonable offers.

   In the standard FOA model, the arbitrator formulates a notion of the ideal settlement and then chooses the closest offer as the award. Farber (1980) and Miller (2000) suggest that FOA bargainers strategically align their final offers around the median of the arbitrator's preferred award distribution. The closer the offer is to the median preferred award, the more concessionary it is. Consequently, the submitted offers balance the expected benefits/costs from a more concessionary final offer. Once the offers have been exchanged, the parties may continue to negotiate their own agreement with the knowledge that one of the two offers will be selected by the arbitrator should the bargainers reach an impasse. Presumably, most bargainers would prefer negotiating their own mutually acceptable agreement to the risk of having the opponent's offer imposed on them by the arbitrator.

   Given the intent of FOA to encourage negotiated settlements (or at least quality settlements), several factors hinder FOA in practice. First, as the arbitration period begins, each bargainer must file an offer based on some knowledge of the arbitrator's preferred award distribution. Once the final offers are exchanged, the bargainers must also assess the likelihood of winning the case should they remain at impasse. This may be problematic given that between the exchange of offers and the beginning of hearings in the present period, evidence of arbitrator preferences exists only from prior arbitration periods.

   Second, prior period FOA outcomes do not directly reveal the preferred award but merely the offer that lies nearest the preferred award. Moreover, the nature of the FOA game suggests that submitted final offers should be fairly "reasonable." Combined, these factors are likely used to draw inferences from historical cases.

   Finally, during most (if not all) of this time frame, the bargainers do not know which arbitrator will hear the case should it reach the arbitration stage. Consequently, bargainers must assess the probability of winning the case based on pooled information from prior period arbitration outcomes. (1)

   We test the hypothesis that information from past FOA cases can be used to infer the likely outcomes of future cases. In essence, we seek to test the basis of FOA as a viable dispute resolution mechanism--that bargainers can file and exchange offers in an arbitration period and assess, either perfectly or imperfectly, the probability of winning the case before any hearings begin in that period and prior to any knowledge as to which arbitrator will hear the case.

   We use data from major league baseball's FOA to test our hypothesis because it has advantages over other FOA settings. First, the factors that may be entered as evidence are clearly specified. Second, abundant baseball performance statistics are convenient proxies for the relevant facts of the cases. Third, baseball represents a "pure" use of FOA as a dispute resolution mechanism. Baseball arbitrators are not permitted to explain their choice of awards; they merely write the award into the Uniform Player's Contract. Consequently, the actual preferred award is never revealed and must be inferred indirectly.

   Our analysis provides evidence that, subsequent to the exchange of offers, the outcomes of past FOA cases may be used to infer the likelihood of winning. However, although the outcomes of future cases are correlated with those of past cases, historical outcomes do not perfectly convey the precise position of a pair of offers on the preferred award distribution. This is consistent with the findings of Olson, Dell'omo, and Jarley (1992), who suggest that a fair amount of uncertainty in determining arbitration outcomes exists. This addresses points raised by Farber (1980) and Burgess and Marburger (1993) that FOA drives quality-negotiated settlements while still allowing bargainers the freedom to negotiate their own agreement.

   We also find that when FOA arbitrators are confronted with a pair of offers in which one offer is extreme relative to the opponent's offer, they tend to rule in favor of the more "'reasonable" one. Moreover, when the final offers are more or less "equally reasonable," the likelihood of winning one's case takes on the appearance of randomness. Consequently, baseball FOA not only encourages bargainers to submit reasonable offers, it creates an incentive to negotiate a settlement to avoid the risk of an unfavorable arbitrated settlement.

2. Prior FOA Literature

   Ashenfelter and Bloom (1984) examined FOA decisions among New Jersey policemen. The governing statute allowed the bargainers to use conventional arbitration to settle their disputes and compelled them to use FOA if they did not agree to use CA. This created a pool of both CA and FOA awards. Assuming that the arbitrator's conventional award was the same as his or her preferred award, Ashenfelter and Bloom (1984) found the same standards used to determine CA awards could be applied to determine FOA winners. In contrast to the arbitration environment used in our study, Ashenfelter and Bloom (1984) had a directly observable proxy for the preferred award, and they used this proxy to determine FOA winners.

   Owing to the potential for omitted variables to mask arbitrator decision-making in actual cases, Farber and Bazerman (1986) distributed a set of hypothetical cases to practicing arbitrators and analyzed the decisions arbitrators made. They concluded that arbitrators paid attention to the facts in selecting awards but that there was much variation across arbitrators.

   Because the rehire incentive, which is generally assumed to be the objective of arbitrators, is not present in experimental studies, Olson, Dell'omo, and Jarley (1992) compared arbitration decisions in experimental and field settings. (2) Relying on FOA decisions for Wisconsin school teachers, they found that decision rules for cases were essentially the same for both experimental and field cases when the wage was the only disputed issue. Regarding the ability to explain arbitration decisions from pooled data, Olson, Dell'omo, and Jarley (1992) found a substantial amount of uncertainty in determining the preferred award even after controlling for the facts and their respective coefficients. The model improved only slightly when controlling for the identity of the arbitrator. Consequently, although the evidence supported the contention that FOA decisions could be explained through pooled data, the study did not examine the possibility that pooled awards from prior periods could be used to predict awards in the current period. (3)

   Efforts to explain FOA decisions in major league...