Reputational Bargaining with External Resolution Opportunities

Mehmet Ekmekci, Boston College and Hanzhe Zhang, Michigan State University

Two parties negotiate in the presence of external resolution opportunities (e.g., court, arbitration, or war). The outcome of external resolution depends on the privately held justifiability/strength of their claims. A justified party issues an ultimatum for resolution whenever possible, but an unjustified party strategically bluffs with an ultimatum to establish a reputation for being justified. We show that the availability of external resolution opportunities can benefit or hurt an unjustified party in equilibrium. When the chances of being justified become negligible, agreement is immediate and efficient; and if the set of justifiable demands is rich, our solution modifies the Nash-Rubinstein bargaining solution of Abreu and Gul (2000) in a simple way.