Large antitrust fines may increase distortions in the economy

Vasiliki Bageri, Yannis S. Katsoulacos, Giancarlo Spagnolo 23 March 2014

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Competition policy has become prominent in all developed economies and many developing ones, from Brazil to India. Indeed, the available evidence suggests that in countries where law enforcement institutions are sufficiently effective, a well designed and enforced competition policy can significantly improve total and labour productivity growth (see Bussirossi et al. 2013).

The emphasis in italic suggests the focus of the present piece. It is already well known that the private enforcement of competition policy can give rise to large distortions: since competition law is enforced by judges and not by economists, it is easy for firms to strategically use the option to sue under the provision of competition law to protect their market from competitors rather than to protect competition (see e.g. MacAfee and Vakkur (2004).

It is less widely known that poor public enforcement of competition law by publicly funded competition authorities can end up worsening market distortions rather than curing them. In the remainder of this column we explain why a mild and suboptimal enforcement of antitrust provisions – with fines that are too low to deter unlawful conduct (horizontal agreements, and cartels in particular) and are based on firm revenue rather than on the extra profits generated by the unlawful conduct – could significantly harm social welfare, even if we abstract from the direct cost to society of the public enforcement of competition law.

Current fining policy

A very important tool for the effective enforcement of competition law is the system of penalties imposed on violators by regulators and courts. In this column, we discuss a number of distortions that current penalty policies are likely to generate if fines are too small to deter cartels, and we explain how the size of the distortions is affected by market characteristics such as the elasticity of demand.

In contrast to what economic theory predicts, in most jurisdictions competition authorities (CAs) and courts use rules-of-thumbs to set penalties that – although well established in legal tradition and easy to apply – are hard to justify and interpret in economic terms. Since harm and benefits are very much correlated, they are both good proxies of what drives firm managers’ decisions – therefore, fines meant to achieve efficient deterrence could be based on either one. However, according to the current fining policy adopted by most jurisdictions, antitrust penalties are based on affected commerce rather than on collusive profits and caps on penalties are often introduced based on total firm sales rather than on affected commerce.

First distortion: Fine caps calculated using total revenue

An obvious distortive effect of penalty caps linked to total (worldwide) firm revenue is that specialised firms active mostly in their core market expect lower penalties than more diversified firms active in several markets. The reason is that if total firm turnover is used when calculating fine caps, specialised firms, whose affected revenue in the relevant market is not very different from total revenue, would be fined considerably lower than those acting in many markets other than the relevant one where the infringement occurs. This distortion (why should diversified firms active on many markets face higher penalties than more narrowly focused firms?) could induce firms that are at risk of antitrust action to inefficiently under-diversify or split their business to reduce their legal liability.

In a recent paper (Bageri, Katsoulacos and Spagnolo 2013), we examine two other, less obvious distortions that occur when the volume of affected commerce is used as a base to calculate antitrust penalties.

Second distortion: Cartel pricing when fines are based on revenue

The second distortion is not linked to caps, but to the current fining policies that suggest fines should be linked to total revenue.

If expected penalties are not sufficient to deter the cartel, which seems to be the norm given the number of cartels that CAs continue to discover, penalties based on revenue rather than on collusive profits induce forward-looking firms to increase cartel prices above the monopoly level, i.e. above the level that they would have set if penalties were based on collusive profits. Intuitively, this happens in order to reduce revenues at the margin, reducing the expected penalty. Expected fines then act like a distortionary tax. However, this exacerbates the harm caused by the cartel relative to a monopolised situation with similar penalties based on profits – or even relative to a situation with no penalties – due to the additional distortive effects of the higher price plus – in the case where the comparison is to a situation with no penalties – antitrust enforcement costs.

Third distortion: Fines on firms across the value chain

The third distortion is linked to the very different ratios between profits and revenue in different industries and for different firms when they are active in several industries.

Firms with a high revenue/profit ratio, e.g. firms at the end of a vertical production chain, expect larger penalties relative to the same collusive profits than firms that have a lower revenue/profit ratio, e.g. because they happen to be at the beginning of the production chain. In our paper we quantify the difference in the fines/profit ratios that fine caps can generate in terms of revenues, using real world data on revenues and profits for different firms in different sectors. Our empirically based simulations suggest that the welfare losses can be very large, and may generate penalties differing by over a factor of 20 for firms that should face the same penalty.

Note that this third distortion also takes place when, at least for some industries, fines are sufficiently high to deter cartels. In addition, note that our empirically based estimation is based only on observed fines, i.e. on fines paid by cartels that are not deterred. Since cartels tend to be deterred by higher fines, this suggest that if we could take into account the fines that would have been paid by those cartels that were deterred (if any), the size of the estimate of the distortion would likely increase.

Under-deterrence and criminal sanctions

The above-mentioned distortions are only relevant so long as expected fines and any additional sanctions that accompany them are not sufficient to deter the unlawful conduct.

In this sense, they present a new argument in favour of criminal sanctions against individual conspirators that was not considered in the past debates on criminalisation (e.g. Werden and Simon 1987, Buccirossi and Spagnolo 2008).

The fact that cartels are still forming and Competition Authorities continue to discover them suggests that at least in some jurisdictions, the current monetary fines plus the current ancillary sanctions may not be sufficient to achieve the required level of deterrence. There is a lively empirical debate on this issue and we are not sure how it will settle (contrast, for example, Connor and Lande 2012 with Allain et al. 2011). But this debate is about the countries where enforcement is stronger. From a European perspective, where criminal sanctions are typically absent or not enforced, one could think that if current fines are not sufficient to deter cartels – given the absence of criminal sanctions – they are likely to be producing enormous distortions in addition to these linked to collusive prices.

If higher fines are not politically feasible, then the distortions discussed earlier are a novel argument why it might indeed be a good idea to introduce (credible) criminal sanctions, like debarment, in Europe. In two recent articles, Ginsburgh and Wright (2010) and Joe Harrington (2010) (commenting on the former) discuss in detail the usefulness of criminal sanctions in inducing deterrence. Ginsburg and Wright emphasise debarment rather than monetary fines and imprisonment while Harrington suggests that criminal sanctions and monetary fines should be considered as complementary, and the introduction (or increase) of criminal sanctions should not lead to a reduction in monetary fines. According to his viewpoint, when adding debarment and imprisonment to existing monetary fines, “more is better” if the objective is to deter collusion. This seems to be a conclusion that should safely apply to Europe and other countries where criminal sanctions are absent and fines are rather mild if compared to collusive profits.

The point is relevant whenever wrongdoers cannot be fined at a sufficient level, e.g. because they may not have sufficient wealth, or may conceal it; or when they can transfer fines to other parties (uninformed shareholders, directors’ insurance funds, etc.); or be protected by limited liability (for corporate fines). If the monetary fines are not sufficiently large to deter cartels, the distortions above become relevant.

An obvious case where fines can hardly match the large gains from anticompetitive behaviour is the banking sector. As Spagnolo (2012) argued in this same publication, governments associate large, profitable banks with financial stability, so that corporate fines on banks cannot be increased enough to discipline bankers, and if they were, they might induce governments themselves in a re-capitalization, i.e. in paying a good part of the fines they administered in the first place. The need for tougher sanctions is self-evident there, and criminal sanctions seem to be the only good and credible remedy for financial misbehaviour. 

Concluding remarks

As usual, the message of this note is that if one wants to implement a policy, one must be ready to execute it properly; otherwise it may be better not to do it at all. This message is particularly relevant for countries with weaker institutional environments, where it is likely that political and institutional constraints will not allow for a sufficiently independent and forceful enforcement of Competition Law.

It is worth noting that the distortionary rules of thumb discussed above do not produce any saving in enforcement costs in jurisdictions where the prescribed cap on fines is based on collusive profits or harm, as such caps require courts or agencies to calculate firms’ collusive profits anyway (or violate the rules).

Further, the distortions we identified are not substitutes, so that either one or the other is present. Instead, they are all present simultaneously and compound one another in terms of poor enforcement.

Where sufficient resources allow for a proper implementation and enforcement of Competition Law, developments in economics and econometrics make it possible to estimate illegal profits from antitrust infringements with reasonable precision, as regularly done to assess damages. It is perhaps time to change these distortive rules-of-thumb that make revenue so central for calculating penalties, if the only thing the distortions buy for us is saving the costs of data collection and illegal profit estimation.

Where sufficient resources for an appropriate fine-tuning of antitrust fines are absent, it seems that the only solution left – besides not having any public enforcement of antitrust laws – is to introduce criminal sanctions (or enhance them, in jurisdictions where they already exist but are ineffective or not credible).

References

Allain, Marie-Laure, Marcel Boyer, Rachidi Kotchoni, and Jean-Pierre Ponssard (2011), “The Determination of Optimal Fines in Cartel Cases - The Myth of Underdeterrence,” CIRANO Working Paper 2011s-34.

Bageri, V., Katsoulacos, Y. and Spagnolo, G. (2013), “The Distortive Effects of Antitrust Fines Based on Revenue,” The Economic Journal, 123: F545–F557

Buccirossi Paolo & Lorenzo Ciari & Tomaso Duso & Giancarlo Spagnolo & Cristiana Vitale (2013), “Competition Policy and Productivity Growth: An Empirical Assessment,” The Review of Economics and Statistics, MIT Press, vol. 95(4), pp. 1324-1336.

Buccirossi, P and G Spagnolo (2006), “Optimal Fines in the Era of Whistleblowers”, CEPR Discussion Paper No. 5465, published in V Goshal and J Stennek (eds.) The Political Economy of Antitrust, 2007, Elsevier: North Holland.

Buccirossi, P and G Spagnolo (2007), “Corporate Governance and Collusive Behaviour”, CEPR Discussion Paper No. 6349, published in Dale W Collins (ed.) Issues in Competition Law and Policy, 2008, Antitrust Section, American Bar Association.

Connor, John M. and Robert H. Lande (2012), “Cartels as Rational Business Strategy: Crime Pays,” Cardozo Law Review, 34, 427-490.

Ginsburg, Douglas H. and Wright, Joshua D. (2010), “Antitrust Sanctions”, Competition Policy International, Vol. 6, No. 2, pp. 3-39.

Harrington, Joseph (2010), “Comment on ‘Antitrust Sanctions’,” Competition Policy International Journal, Vol. 6, pp. 41-51.

McAfee Preston R. & Nicholas V. Vakkur (2004), “The Strategic Abuse of Antitrust Laws”, Journal of Strategic Management Education, 3-4.

Spagnolo (2012), "Saving the banks, but not reckless bankers", VoxEU.org.

Werden, G. and M. Simon (1987), “Why Price Fixers Should Go to Prison”, Antitrust Bulletin 32, pp. 917-937.

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Topics:  Competition policy

Tags:  antitrust, Collusion, Cartels, tax distortion

PhD Candidate, Athens University of Economics and Business

Professor of Economics, Athens University of Economics and Business

Professor of Economics at University of Rome II and SITE - Stockholm School of Economics and CEPR Research Affiliate.