Arbitration and Mediation L6 Goltsman et al. (JET 2006) Melumad and Shibano (RAND 1991) Blume, Bord and Kawamura (TE 2007) Aumann and Hart ECMA 2003, Krishna and Morgan 2004

Institutions CS assumes a particular extensive form of communication game Some institutions (message protocols) improve upon CS Two approaches Optimal design of institutions given incentive constraints Particular extensive forms Questions What is the upper bounds on welfare Mechanisms though which protocols improve communication How they compare to best CS equilibrium?

Mechanism design Two agents: Sender (S) and Receiver (R) Type space: Preferences Abstract Message space S sends message to intermediary, who makes recommendations to R Recommendation rule Intermediary: Arbitration (binding recommendations) Mediation (not binding)

Myerson’s revelation principle Commitment: Myerson’s revelation principle Direct mechanism Incentive compatibility S Incentive compatibility R

Outline Set of feasible - Arbitration - Mediation - generated in SPN equilibrium of some communication game We look for rules that are ex ante optimal for R Upper bounds For mediation and SPN equilibrium ex ante welfare of R and S aligned

Arbitration Problem: Incentive compatibility: Truth telling required to be ex post optimal for S (IC-S) Rule need not be (ex post) optimal for R.

Simplifying observation 1: sufficient statistics Fix recommendation rule For any report Expected utility of type given report For any statistics are sufficient S for payoff

Simplifying observation 2: principal agent problem Interim S welfare Define Problem Expectation is an ``action’’ and variance is a ``transfer’’ Difference: No participation constraint Bound on ``transfer’’

Incentive compatibility (IC-S) Fix and hence Double continuity of ICS constraints Mirrlees (1975) Let L: satisfies IC-S condition iff a) Is nondecreasing b) c) Proof

Incentive compatibility (IC-S) Is IC-S for some Is IC-S for some

Optimal arbitration rule Assume T: Optimal mechanism is deterministic with Melumad and Shibano (RAND 91) Remarks: Delegation with cap is optimal For bubbling is optimal for R (no information transmission) S -optimal rule

Heuristic argument :

Mediation Problem: Incentive compatibility: Truth telling required to be ex post optimal for S (IC-S) Rule has to be (ex post) optimal for R. Can optimal arbitration rule be implemented in a mediation setting?

Optimal Mediation Mechanism Partition T: Optimal mediation mechanism Upper bound for receivers ex ante utility is Mechanism is pooling Arbitrage mediation most informative equilibrium in CS Mediator’s only role is to introduce noise

Interpretation ``Broken’’ phone paradox Blume, Bord and Kawamura (TE 2007) With probability instead of signal receiver observes Informative equilibrium implements optimal mediation outcome Two effects of noise Makes the signal less informative Relaxes IC constraint for S fostering more truthful revelation The latter effect dominates

Negotiations Multistage cheap talk Aumann and Hart 2003, Krishna and Morgan 2004 Better than most informative CS Upper bound for welfare of R –mediation outcome-sometimes achieved Intuition: multistage noise allows for randomization

Conclusions Commitment of external party improves welfare Delegation is optimal if feasible Noisy cheap talk can improve information transition Can be implemented as multistage cheap talk