Final-Offer Arbitration and Risk Aversion in Bargaining

Negotiations are often conducted under the stipulation that an impasse is to be resolved using final-offer arbitration (FOA). In fact, FOA frequently is not needed; in Major League Baseball, for instance, more than 80% of the salary negotiations that could go to arbitration instead reach a bargained agreement. We show that the risk aversion of at least one side explains this phenomenon. We then model pay negotiation in baseball by applying a bargaining solution with a variable disagreement outcome representing FOA, studying the existence of pure Nash equilibrium initial offers and their effects on the player's eventual pay, and considering the Nash solution as a special case.