Side-Payments and the Costs of Conflict

Conflict and competition often impose costs on both winners and losers, and conflicting parties may prefer to resolve the dispute before it occurs. The equilibrium of a conflict game with sidepayments predicts that with binding offers, proposers make and responders accept sidepayments, generating settlements that strongly favor proposers. When side-payments are nonbinding, proposers offer nothing and conflicts always arise. Laboratory experiments confirm that binding side-payments reduce conflicts. However, 30% of responders reject binding offers, and offers are more egalitarian than predicted. Surprisingly, non-binding side-payments also improve efficiency, although less than binding. With binding side-payments, 87% of efficiency gains come from avoided conflicts. However, with non-binding side-payments, only 39% of gains come from avoided conflicts and 61% from reduced conflict expenditures. JEL Classifications: C72, C91, D72