Arbitration with Uninformed Consumers

Mark L. Egan, Gregor Matvos, Amit Seru

NBER Working Paper No. 25150
Issued in October 2018, Revised in June 2019
NBER Program(s):Corporate Finance Program, Law and Economics Program

This paper argues that firms have an informational advantage over consumers in selecting arbitrators in consumer arbitration. We document how the selection process impacts arbitration outcomes by studying roughly 9,000 consumer arbitration cases in the securities industry. Securities disputes present a good laboratory: arbitration is mandatory for all disputes, eliminating selection concerns; the parties choose arbitrators from a randomly generated list, and arbitrators are compensated only if chosen; and the selection mechanism is similar to other major arbitration forums. We document three facts. First, some arbitrators are systematically more industry friendly than others. Second, firms appear to exploit this information: despite a randomly generated list of potential arbitrators, industry-friendly arbitrators are forty percent more likely to be selected. Third, more experienced firms and less sophisticated consumers select more industry friendly arbitrators. We develop and calibrate a model of arbitrator selection with uninformed consumers. We find that competition between arbitrators exacerbates the informational advantage of firms resulting in all arbitrators slanting towards being industry friendly and resulting in roughly $16,000 lower awards. Counterfactuals suggest that several proposals aimed at improving customer outcomes in arbitration, such as increasing arbitrator incentives and increasing the number of strikes, lead to quantitatively more industry friendly arbitration due to firms' informational advantage.

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Document Object Identifier (DOI): 10.3386/w25150

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