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  • 2020
  • Working Paper
  • HBS Working Paper Series

Arbitration with Uninformed Consumers

By: Mark Egan, Gregor Matvos and Amit Seru
  • Format:Print
  • | Language:English
  • | Pages:80
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Abstract

This paper studies the impact of the arbitrator selection process on consumer outcomes by examining 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 the selection mechanism is similar to other major arbitration forums. We establish several facts that suggest that firms hold an informational advantage over consumers in selecting arbitrators, resulting in industry-friendly arbitration outcomes. We then develop and calibrate a quantitative model of arbitrator selection in which firms hold an informational advantage in selecting arbitrators. Arbitrators, who are compensated only if chosen, compete with each other to be selected. The model allows us to decompose the firms’ advantage into two components: the advantage of choosing pro-industry arbitrators from a given pool, and the equilibrium pro-industry tilt in the arbitration pool that arises because of arbitrator competition. Selecting arbitrators without the input of firms and consumers would increase consumer awards by $40,000 on average, relative to the current system. Forty percent of this effect arises because the pool of arbitrators skews pro-industry due to competition. Even an informed consumer cannot avoid this equilibrium effect. Counterfactuals suggest that redesigning the arbitrator selection mechanism for the benefit of consumers hinges on whether consumers are informed. Policies such as increasing arbitrator compensation or giving parties more choice, benefit informed consumers but hurt the uninformed.

Keywords

Arbitration; Financial Advisers; Financial Advisors; Brokers; Consumer Finance; Financial Misconduct; Fraud; Personal Finance; Conflict and Resolution; Information; Fairness

Citation

Egan, Mark, Gregor Matvos, and Amit Seru. "Arbitration with Uninformed Consumers." Harvard Business School Working Paper, No. 19-046, October 2018. (Revise and Resubmit at the Review of Economic Studies. Revised May 2020. NBER Working Paper Series, No. 25150, October 2018)
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About The Author

Mark L. Egan

Finance
→More Publications

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More from the Authors
  • Conflicting Interests and the Effect of Fiduciary Duty: Evidence from Variable Annuities By: Mark Egan, Shan Ge and Johnny Tang
  • How Do Investors Value ESG? By: Malcolm Baker, Mark Egan and Suproteem K. Sarkar
  • Recovering Investor Expectations from Demand for Index Funds By: Mark Egan, Alexander J. MacKay and Hanbin Yang
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