Is it ethical to “arm-twist” a faculty-member into passing more students or improving the class average?

I think the ethics depends on a few things. First and most importantly, what was the intention of the department chair and dean of faculty when they “arm-twisted you” into passing those students? One can imagine two different scenarios: in the first one, the chair and dean are greedy, amoral people who are driven by selfish, short-term considerations such as maximizing their institution’s profits and winning themselves a promotion, and are pursuing a strategy that they know for a fact is bad for the students. That would be pretty unethical. In the second scenario, the chair and dean are passionate educators who are looking out for the students’ best interests, and simply disagree with you about what is best for the students, and believe that the students you wanted to fail deserved to pass. In that case, you could argue that they’re wrong, but it would be quite unreasonable to accuse them of unethical behavior.

Of course, there are also situations between those two extremes that fall in a gray area where it would be hard to say much about the ethics of the actions. You simply haven’t given us enough information to say anything meaningful.

Another factor that I think matters is what you mean by “arm-twisting”. How exactly did they twist your arms? Did they literally command you to change your grading decisions and refuse to listen to any opposing arguments? Or did they leave you some room to argue the case? It’s clear that you think they behaved unreasonably, but it’s not clear to me if they also would agree to your description of your actions as “arm-twisting”. Could it be that their perception was that they had convinced you of the merit of their request and that you went along with it willingly? In that case, the responsibility for the actions might lie (at least partially) with you. It all depends on the details of what took place, so again I don’t think anyone can give a general answer based on the information you’ve provided.

Edit following clarifications by OP: I understand that you perceive that you were pressured to change students' grades, and that the department chair specifically is an unpleasant person to deal with. All of those things may well be true. However, ultimately I think that it is a mistake, both logically and from a strategic/practical point of view, to use the words "unethical" or “immoral” to describe the behavior of any of the actors in this story. These are very strong terms (stronger than you may realize, I suspect) that suggest the worst possible intentions behind the actions you have observed. It would only be reasonable to use these words if you had very concrete evidence that something truly nefarious is going on (e.g., the department chair taking a bribe from one of the students, or telling you to pass all the students because his own nephew was one of the below-average students who were about to fail).

A much more likely interpretation is that the department chair simply has a broader set of concerns than you and a broader perspective on the situation. Perhaps he feels that it is important to have consistency across all instructors, to avoid students feeling that they were treated unfairly just because they had the misfortune of taking a class from an especialy harsh instructor. Or there could be any number of other legitimate concerns or causes for disagreement between you and the chair. None of this involves anything remotely unethical - it is simply a professional disagreement between colleagues.

Finally, I will add that the mere fact that the department chair "put pressure" on you is also not evidence of anything unethical, or even bad. I was a department chair for several years and had occasions where I had to go to an instructor and have a frank discussion about their grading methods, and even suggest that they retroactively change a few grades. I never had to resort to any sort of direct pressure (I suspect because of a combination of my being fairly good at articulating my side of the argument on its merits, and dealing with people who were ultimately pretty reasonable), but it was very clear to me that by my mere presence as a party to the discussion I was exercising a kind of "soft authority" that may well have been perceived as pressure by the other party. This is unavoidable and sometimes necessary, and in fact I dare say that a department chair who hesitates to exercise his/her authority in this way is unlikely to be doing a very good job.

That being said, if the chair's behavior is indeed "borderline-toxic" as you say, then that's a problem, but it sounds in any case like a very different issue than them being "unethical".