Players who have three or more years of Major League service but less than six years of Major League service become eligible for salary arbitration if they do not already have a contract for the next season. Players who have less than three but more than two years of service time can also become arbitration eligible if they meet certain criteria; these are known as "Super Two" players. Players and clubs negotiate over salaries, primarily based on comparable players who have signed contracts in recent seasons. A player's salary can indeed be reduced in arbitration -- with 20 percent being the maximum amount by which a salary can be cut.
If the club and player have not agreed on a salary by a deadline (typically in mid-January), the club and player must exchange salary figures for the upcoming season. After the figures are exchanged, a hearing is scheduled (typically in February). If no one-year or multi-year settlement can be reached by the hearing date, the case is brought before a panel of arbitrators. After hearing arguments from both sides, the panel selects either the salary figure of either the player or the club (but not one in between) as the player's salary for the upcoming season.
The week prior to the exchange of arbitration figures is when the vast majority of arbitration cases are avoided, either by agreeing to a one- or multi-year contract. Multi-year deals, in these instances, serve as a means to avoid arbitration for each season that is covered under the new contract.
Once a player becomes eligible for salary arbitration, he is eligible each offseason (assuming he is tendered a contract) until he reaches six years of Major League service. At that point, the player becomes eligible for free agency.