Passing-on Defence and the “Output Effect” in Cartel Damages Claims Theon van Dijk ACLE Workshop on Forensic Economics in Competition Law Enforcement Amsterdam, 17 March 2006

2 Background “Damages Claims under a Passing-on Defence” with Frank Verboven, working paper, March 2006 −Conceptual framework “Quantification of damages”, with Frank Verboven, chapter in: W.D. Collins (ed.), Issues in Competition Law and Policy, ABA Section of Antitrust Law (forthcoming) −Empirical approaches

3 Amsterdam, 17 March 2006 Overview 1.Motivation 2.General framework 3.Common price overcharges 4.Firm-specific price overcharges 5.Policy discussion 6.Conclusion

4 Amsterdam, 17 March 2006 Motivation In most jurisdictions “price overcharge” is the basis for damage claims in price cartel competition law violations −“Price overcharge” is the difference between the actual price and the price that would have occurred “but for” the cartel (the counterfactual price) “Passing-on defence”: defendant argues direct purchaser claimant suffered less damage because part of the price overcharge was passed on to the next layer −In the EU and most EU Member States passing-on defence is allowed −In the US use of passing-on defence is not allowed by Federal Courts (Hanover Shoe) – although in some District Courts it is (following California v. ARC America Corp)

5 Amsterdam, 17 March 2006 Motivation II Economic discussion on the passing-on defence has focussed on the relative likelihood of direct purchasers and indirect purchasers successfully bringing claims Direct purchasers more likely to be successful (Landes & Posner, 1979 UChicLR): −Informational advantage; −Larger individual incentives to bring claims; −Less “complexity” involved in bringing claims  implication: from deterrence perspective, do not allow passing-on defence Assuming use of passing-on defence is allowed, we focus on the quantification of this defence and identify the “output effect” that so far has been neglected

6 Amsterdam, 17 March 2006 General framework Claimant profits under constant returns to scale: π = pq – cq Change in claimant profits due to the cartel: dπ = -qdc + qdp + (p - c)dq −Direct effect: -qdc −Pass-on effect: qdp −Output effect: (p - c)dq (can only be ignored in perfectly competitive claimant’s market (p = c))

7 Amsterdam, 17 March 2006 Common price overcharge Cartel affects all firms in the market Symmetric market equilibrium: all firms charge the same price dπ = -qdc + qdp + (p - c)q p (p)dp The change in profit due to the price overcharge can be written as: dπ = -qdc + (1 – λ) τ qdc where τ is pass-on rate and λ = ((p – c)/p) ε (where ε is market-level elasticity) “Discount factor” applicable to direct effect of price overcharge: (1 – λ) τ −The more competitive the claimant’s market, the closer λ to 0, and the smaller the output effect adjustment to the pass-on effect −The closer the claimant’s market to monopoly or perfect collusion, the closer λ to 1, and the larger the output effect adjustment to the pass-on effect

8 Amsterdam, 17 March 2006 Common price overcharge II Simple expressions for λ are given for specific models of competition Bertrand competition (symmetric Bertrand-Nash equilibrium): −λ = ε / η (ratio of market-level elasticity over firm-level elasticity) −λ = δ (where δ is “diversion ratio”: firm’s cross-price over own-price elasticity) Bertrand with logit demand model: −Pass-on discount factor λ is equal to the number of consumers who do not buy from any firm, over the number of consumers who do not buy from the claimant. Cournot competition: −λ = 1 / J (where J is the number of firms in the claimant’s market)

9 Amsterdam, 17 March 2006 Firm-specific price overcharge Cartel leads to cost increases for some firms in the market Circumstances in which the cartel itself is active in the claimant’s market (vertical integration), and cartel-related purchasers are not affected by the cartel Circumstances in which some firms in the claimant’s market have access to other inputs unaffected by the cartel (relevant geographic market of claimant larger than that of defendant)

10 Amsterdam, 17 March 2006 Firm-specific price overcharge II Output effect with selective price overcharge is similar to output effect with common price overcharge, but now analysis is more complicated (no simple expressions – simulation on next slide) − General finding: the more firms in the claimant’s market are unaffected, the larger the output effect Eye-catching result: under Cournot competition and if sufficiently many firms in the claimant’s market are unaffected, then finding of “passing-on offence” −Output effect dominates pass-on effect and consequently the claimant’s damage grows larger than the direct price overcharge effect −Intuition: unaffected firms respond aggressively to claimant’s output reduction by expanding their output

11 Amsterdam, 17 March 2006 Required percentage discounts to the claimant’s damage claim in the Cournot competition model: two unaffected firms Market share of the claimant Number of firms10%20%30%40%50% Linear demand Quadratic demand

12 Amsterdam, 17 March 2006 Policy discussion United States Hanover Shoe (US SC 1968): US Supreme Court rejected passing-on defence mainly on grounds of practical difficulties to establish the degree of pass-on (“ … the task would normally prove insurmountable …”) Illinois Brick (US SC 1977): indirect purchasers were not given standing, again mainly on grounds of practical difficulties −Justice White in delivering the Court’s opinion points at two complicating factors: “… Overcharged direct customers often sell in imperfectly competitive markets. They often compete with other sellers that have not been subject to the price overcharge …” California v. ARC America Corp (US SC 1989): indirect purchaser suits are legitimized in state courts – does this “offensive” use imply a “defensive” use?

13 Amsterdam, 17 March 2006 Policy discussion II Europe Few antitrust damage claims cases before Courts (recently Courage, ECJ 2001, confirmed Article 81 and 82 infringement provides legal basis for damages actions) In non-antitrust cases Courts have been open to passing-on defence (Comateb, ECJ 1997) EC Commission has recently published Green Paper on damages actions for breach of EC competition rules: main issue is whether or not to allow the defendant to use a passing-on defence

14 Amsterdam, 17 March 2006 Conclusion Passing-on defence should not be rejected on the basis of too much complexity and practical difficulties If passing-on defence is accepted, then an “output effect” adjustment should be made to the pass-on effect The output effect reduces the traditional passing-on “discount” on damage claims – this makes the policy question choice less tense (stake is smaller)