One thought experiment is to suppose that the predictions of the financial community are correct. Suppose the merger, while not sailing through the regulatory process, is likely to remain relatively intact. If true, ask the following question: if Comcast can acquire TWC, what prevents Comcast from extending its footprint across America by acquiring all the remaining cable companies?
It seems difficult to discern a limiting principle, since the same justification for the Comcast/TWC transaction could easily be offered for a Comcast/TWC/Charter deal. Cable companies tend not to compete with one another for customers. Comcast principally argues that it does not compete with TWC in the same geographic markets. Without any competitive overlap, according to Comcast, the acquisition does not really change anything.
This, we argue in our article, is wrong for several reasons.
- First, a merger can violate section 7 of the Clayton Act without the parties competing in the same geographic market.
- Second, the Congressional command for section 7 is to “preserve competition among many small businesses by arresting a trend toward concentration in its incipiency before the trend developed to the point that a market was left in the grip of a few big companies.” One potential consequence of this merger is to accelerate the trend toward concentration among content providers and cable companies.
- Third, one reason Congress sought to thwart a market dominated by a few firms is to prevent coordination or collusion. We are already beyond that point in this industry.
- Fourth, Comcast’s “no-competitive-overlap” argument considers only cable and internet subscribers. It ignores how the competition laws were also enacted to protect sellers from powerful buyers. Thus another concern is how the acquisition increases Comcast’s power to disadvantage sellers of television content (and raise the costs of Comcast’s rivals).
- Fifth, in investigating Comcast’s deal with General Electric that ultimately enabled Comcast to control NBC Universal, the DoJ discussed various ways Comcast could disadvantage its traditional competitors (direct broadcast satellite and telephone companies) plus the emerging online video programming distributors (OVDs). In acquiring Time Warner Cable, Comcast will have even more power to thwart Netflix or other emerging OVD rivals by impairing or delaying the delivery of their content. (Although Netflix recently sought to contractually resolve this issue with Comcast, other OVDs may lack the clout.)
Current Antitrust Fines May Increase Distortions in the Economy
Vasiliki Bageri, Athens University of Economic and Bussiness
Yannis Katsoulacos, Athens University of Economic and Bussiness
Giancarlo Spagnolo, Stockholm School of Economics-SITE, DEF-Tor Vergata & CEPR
Competition policy has become a prominent policy 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 labor productivity growth.
The emphasis of the italic already 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 use strategically the possibility to sue under the provision of competition law to protect their market from competitors rather than to protect competition. A well-known example is the Digital Equipment Corp. vs. Intel Corp case. In this case there is strong evidence that Digital exploited antitrust law to prevent Intel from developing competing technology in the microprocessor market. That is why not only was Digital taking Intel in a patent-infringement suit but it was doing it in a way to gain maximum publicity so as to impel Intel to an out-of-court settlement in order to avoid not only further scrutiny but a damage to its public reputation as well.
It is somewhat less known that a poor public enforcement of Competition Law by publicly funded competition authorities can also end up worsening market distortions rather than curing them. In the reminder of this piece we explain why, according to recent research, a mild and suboptimal enforcement of antitrust provisions – in the sense of 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 for society the public enforcement of competition law.
Current Fining Policy
A very important tool for the effective enforcement of Competition Law is the penalties imposed on violators by regulators and courts. In this piece, 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 as the elasticity of demand.
In contrast to what economic theory predicts, in most jurisdictions, Competition Authorities (CAs), but also courts where in charge, use rules-of-thumbs to set penalties that – although well established in legal tradition and in sentencing guidelines and possibly easy to apply – are hard to justify and interpret in logical 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
A first and obvious distortive effect of penalty caps linked to total (worldwide) firm revenue is that specialized firms active mostly in their core market expect lower penalties than more diversified firms active in several other markets than the relevant one. The reason being that if total firm turnover is used when calculating fine caps, specialized 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 for God’s sake should diversified firms active on many markets face higher penalties than more narrowly focused firms? – could in principle induce firms that are at risk of antitrust legal action to inefficiently under-diversify or split their business to reduce their legal liability.
In a recent paper of our, published in the Economic Journal (Bageri, V., Katsoulacos, Y. and Spagnolo, G. (2013), The Distortive Effects of Antitrust Fines Based on Revenue. The Economic Journal, 123: F545–F557), 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 that 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. This happens – intuitively – in order to reduce revenues at the margin, and thus the expected penalty. Expected fines then act like a distortionary tax. However, this exacerbates the harm caused by the cartel relative to a monopolized 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 that they may generate penalties differing by over a factor of 20 for firms that should instead have 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
As already mentioned, if expected fines are not sufficient to deter unlawful conduct they are likely to create the above distortions. This fact enhances the obvious need for higher levels of deterrence since cartels are still forming and Competition Authorities continue to discover such actions.
It seems clear that monetary fines alone are not adequate to achieve the required level of deterrence. The problem is that not always can wrongdoers be fined at a sufficient level since they may: not have sufficient wealth, or may conceal it; transfer fines to other parties (uninformed shareholders, directors’ insurance funds, etc.); or be protected by limited liability (for corporate fines).
In two recent articles in Competition Policy International, Ginsburgh and Wright (2010) and Joe Harrington (2010) (comment on the former) discuss in detail the usefulness of criminal sanctions in inducing more deterrence. Ginsburg and Wright emphasize 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 to existing monetary fines and imprisonment is concerned, then “more is better” if the objective is to deter collusion.
The problem of under-deterrence and the need for relying also on criminal sanctions holds especially for banks and bankers. The recent Libor case proves exactly that. More than a dozen banks, including JP Morgan, Deutsche Bank AG and Citigroup Inc., manipulated the benchmark interest rates such as the London interbank offered rate, known as Libor, which is used to price trillions of dollars worth of loans, from at least 2006 until 2010. However, despite the massive fines paid by investment banks to regulators, banks may well have benefited from rate manipulation. Even if profits are being deflated now, they could easily have been inflated in the good times. Furthermore, since governments associate large, profitable banks with financial stability, corporate fines on banks cannot be increased enough to discipline bankers. The need for tougher sanctions is self-evident and criminal sanctions seem to be a good remedy for financial misbehavior.
As usual, the message of this note is that if one wants to implement a policy, it must be ready to do it well, or 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 to 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 add to one another in terms of poor enforcement.
Where sufficient resources to allow for a proper implementation and enforcement of Competition Law are available, 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 profits estimation.
Furthermore, in order to increase deterrence and thus reduce the distortive effects we mention, we propose that criminal sanctions should be introduced (or enhanced in jurisdictions where they already exist).