Maria Goltsman Department of Economics, University of Western Ontario, Social Science Centre, London, Ontario N6A 5C2, Canada, email@example.com
Johannes Hörner Kellogg School of Management, Managerial Economics and Decision Sciences, 2001 Sheridan Road, Evanston, IL 60208, USA, firstname.lastname@example.org
Gregory Pavlov Department of Economics, Boston University, 270 Bay State Road, Boston, MA 02215, USA, email@example.com
Francesco Squintani Department of Economics, Universita’ degli Studi di Brescia, Via San Faustino 74B, 25122 Brescia, Italy, firstname.lastname@example.org
We compare three common dispute resolution processes – negotiation, mediation, and arbitration – in the framework of Crawford and Sobel (1982). Under negotiation, the two parties engage in (possibly arbitrarily long) face-to-face cheap talk. Under mediation, the parties communicate with a neutral third party who makes a non-binding recommendation. Under arbitration, the two parties commit to conform to the third party recommendation. We characterize and compare the optimal mediation and arbitration procedures. Both mediators and arbitrators should optimally filter information, but mediators should also add noise to it. We find that unmediated negotiation performs as well as mediation if and only if the degree of conflict between the parties is low. 1. Introduction Mediation is a procedure of dispute resolution broadly adopted in a number of con- texts, from international crises, to legal confrontations, and business transactions. Despite the relevance and pervasiveness of mediation, applied experts report that the theoretical characterization of optimal mediation techniques is largely under-developed.1 This paper characterizes the properties of optimal mediation and arbitration, for the cases in which the source of conflict is informational, and transfers cannot be established to the disputants. Furthermore, we compare the performance of mediation and arbitration with unmediated negotiation. Despite the possibly complex information transmission strategies that a mediator can adopt, we find that in our context a mediator acts optimally by gathering information from the parties, filtering it, and strategically adding noise to it.