Passing-on Defence and the “Output Effect” in Cartel Damages Claims

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

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. Overview • Motivation • General framework • Common price overcharges • Firm-specific price overcharges • Policy discussion • Conclusion

4. 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. 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. 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. Common price overcharge Cartel affects all firms in the market • Symmetric market equilibrium: all firms charge the same price dπ = -qdc + qdp + (p - c)qp(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. 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. 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. 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

12. 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. 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. 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)