In my last game I had an interesting situation. The PCs took a Goblin captive and interrogated him. After that they decided to bind him up with rope, and use the Goblin as a living shield against other Goblins. How should I play this as a DM? Cover modifier +4 against ranged attacks, Goblin's will saves?
This answer is about the mechanics I would apply, and not about intended results or morals of the PC behaviour.
First, use the Grapple rules, because they seem most appropriate for dragging a creature around:
I don't think there should be any automatic effect that causes goblins to not attack due to a risk to their comrade. I don't think this scores very high on normal goblin behaviour or priorities. My own monstrous goblins would probably consider their ally already lost, but would cheerfully accept a minor victory from a lucky shot that hit the PC.
However, I do think it would be reasonable to allow the PC to use Intimidate skill, and give perhaps a small situational bonus to it, because the PC has clearly over-powered at least one goblin. As DM, you get to interpret what is or is not allowed due to effects of Intimidate. In this case it would seem reasonable, and in keeping with the scenario, to use it to persuade the otherwise Hostile goblins to perform actions such as back off or simply not attack the PC holding the captive.
In addition to the fine answer about the grapple rules, if you were to just simply let the players wield the goblin as an item, you would have to first consider the size of the goblin and whether they would be treated as a large or tower shield if you're looking for an AC bonus and armor penalty. Also keep in mind I doubt your players have any Exotic Shield Proficiencies and would thus take the armor penalty to all other checks.
If they are just going for the cover factor, then simply treat the 20% concealment miss chance as the change the goblin takes damage from the hit instead.
No matter what you do, never forget Encumbrance. Your standard goblin weighs 40 to 45lbs. Even your standard character if carrying nothing gets dropped into Medium Load territory if their strength is 12 or lower. Start counting up the weight of things if this becomes a tactic. Frankly, I'd have them make a Str based Fort save every time a drastic move, any attack, etc. to not drop the heavy object seemingly on one arm (two handed bonus where necessary)