Strategic bidding and investments in final offer arbitration: Theory and experimental evidence

Given the sizeable savings, many disputes are resolved via arbitration. Numerous studies have considered the strategic incentives of various forms of arbitration, most notably final offer arbitration (FOA). While previous work focused exclusively on optimal offers, in reality disputants make a series of perhaps interrelated choices. This paper considers FOA disputants making an additional investment decision regarding their case. We consider four cases distinguished by the sequence and observability of choices. The theoretical results indicate that it is socially optimal for disputants to make publicly observable offers prior to investment decisions. Behavior in controlled laboratory experiments weakly confirms this conclusion.