Arbitrators Gil Vernon, Jeanne Wood and Steven Wolf made their decision Thursday, a day after hearing arguments.
Watson, 31, had a 3.06 ERA and 2-5 record in 70 relief appearances for the Pirates last year. The 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.
Teams have won seven of 13 arbitration cases and the sides are on track for 15 hearings, the most since teams won 10 of 16 decisions in 1994.