Arbitrators Gil Vernon, Jeanne Wood and Steven Wolf made their decision Thursday, a day after hearing arguments.
Watson had a 3.06 ERA in 70 relief appearances for the Pirates last year along with a 2-5 record. The 31-year-old left-hander earned $3.45 million.
He was an All-Star in 2014, when he was 10-2 with a 1.63 ERA. He had a 1.91 ERA in 2015.
Watson is eligible for free agency after this season.