There's no clear right or wrong decision here. Sisko very well can't play Solomon with the child, and both Pa'Dar and Rugal's Bajoran parents had legitimate claims to him. Both sides can convincingly make a case, which is why it's such a compelling scenario. You can argue Bajoran law or Cardassian law all you want in a circle too. Technically Bajor was part of the Cardassian Empire when Rugal was lost giving them claim to jurisdiction, whereas Bajor's argument that they're not any more.
I wouldn't be surprised if Sisko's decision was made in hopes of gaining goodwill in the Cardassian government as well as to spite Dukat, that was a weak part of the episode as Sisko really didn't elaborate on that and his decision was made almost as an afterthought to Dukat's scheme being exposed. Certainly O'brien was right in telling Rugal that he should be telling them what he wants, but that didn't seem to factor in to Sisko's decision.