Arbitrators as Lie Detectors

Perhaps the most puzzling aspect of grievance arbitration is the question of why two parties would ever pay a third to redistribute income between them. In this paper labor-management disputes are modelled as the outcome of a bilaterally asymmetric principle-agent relationship, in which neither side can directly observe the inputs of the other. Third party arbitrators are interpreted as ex post signals, whose role in the collective bargain is to force a more efficient equilibrium between the contracting parties. The arbitrator's determination of fact provides a basis for rewards or penalties between the parties that generate incentives for more cooperative behavior. In this light, a characterization of more effective arbitrators is developed, and the use of arbitration as a joint punishment strategy is discussed. Then an extended example is presented and numerically simulated. The simulation results suggest that arbitration can be very effective in increasing the efficiency of the firm in the presence of unobserved inputs from workers and managers.