PRIVATE INFORMATION AND NONBINDING ARBITRATION:
A PROPOSAL FOR REDUCING THE COSTS OF LITIGATION

Ram Orzach and Stephen J. Spurr (1)
June 2003 

Abstract

       This paper analyzes a procedure called mediation,
that is really a form of nonbinding arbitration, applied to
cases filed in U.S. courts. Under the existing rules, a
party who rejects an award proposed by the mediator is
liable for sanctions unless the rejection turns out to be
justified, i.e., unless the trial verdict is more favorable
to the rejecting party than the mediation award.  This
penalty is designed to induce acceptance of the mediation
award by both parties, in order to minimize the frequency of
trial. 

       We find this procedure to be flawed since it is
myopic. It may be privately optimal for the parties to
mislead the mediator, with the result that the mediation
award deviates substantially from the claim's true value.
This increases the likelihood the mediation award is
rejected, thus increasing the probability of trial. We
propose an alternative procedure, under which a party would
be liable for sanctions if, and only if, she deliberately
provided false information to the mediator.  In our example
each party has private information, and the mediator must
acquire all his information from the parties.  In comparison
to the existing practice, our procedure has a lower
frequency of trial, and provides an ex ante gain to both
parties. 


JEL classification: C72, C78, K40, K41.

Keywords: partition, arbitration, Bayesian equilibrium,
sequential game, alternative dispute resolution, fee shifting.