The Informational Role of the Arbitration Clause

We analyse the role of an arbitration clause as a quality signal. We model a contractual relationship between one buyer and two sellers, one of which offers a high-quality product, the other a low-quality product. With a certain probability, the product is defective. The sellers have the choice of either taking the case to court if the product is defective, or including an arbitration clause in which case an arbitrator determines the indemnity payment. Under some conditions, only the high-quality seller offers an arbitration clause, which then serves as a quality signal.