When companies are found guilty of such crimes as mis-selling, rate-rigging, tax evasion and anti-competitive practices, the penalties imposed by regulatory authorities such as the UK''s Office of Fair Trading should be based on corporate profits rather than revenues. That is the conclusion of a study by Professors Yannis Katsoulacos and David Ulph, published in the November 2013 issue of the Economic Journal.


Their research shows that because economic crimes typically last a long time and are often detected only after they have come to their natural end, penalties should be about 75% of the level indicated by conventional analysis to have the appropriate level of deterrence – in the range of 30-40% of revenue. But they also find that fines based on revenues rather than profits lead companies to reduce the amount they produce and sell, thereby driving up prices.


The study examines two issues surrounding penalties and their effectiveness in deterring companies from engaging in anti-competitive practices, such as cartels, mergers and abuse of dominance:


· The first is the appropriate level of penalty to set.


· The second is the impact that a tougher penalty regime will have on the price overcharge produced by anti-competitive behaviour – the extent to which such behaviour raises the prices faced by consumers above those they would otherwise have faced.


Both questions are particularly pertinent given the recent consultation by the Office of Fair Trading on its proposal to triple baseline penalties from 10% to 30% of company revenue. The questions are also relevant given the considerable recent interest in the issue of corporate crime, with revelations about various mis-selling, rate-rigging and tax evasion/avoidance scandals.


This raises the issue of what can be done to deter such activities. One obvious question is whether penalties are too low, with the result that companies see that crime pays.


Recent research by some US scholars, which draws on data on cartel overcharges, suggests first, that penalties need to be raised by a factor of at least five to generate the appropriate level of deterrence; and second, that raising penalties leads to lower overcharges.


The new study by Professors Katsoulacos and Ulph challenges both these findings.


Research on the appropriate level of penalties, draws on pioneering work by Nobel prize-winning economist Gary Becker on the economics of crime. But economic crimes have two features that are absent from most other crimes, such as robbery, and these have not been taken into account in previous research on optimal penalties:


· The first is that economic crimes last a long time – on average six to seven years. This increases the chance that the authorities can intervene and stop the action before it would have come to a natural end. In other words, with economic crimes, companies are more likely to be ''caught in the act''. To the extent that they are, the economic return to misbehaviour is reduced and so penalties can be lower than conventional analysis suggests with the same deterrence effect.


· The second feature is that economic crimes are sometimes detected and penalised long after they have come to a natural end – on average about three years later. This reduces the value of the penalty in relation to the reward from the crime and so suggests that penalties need to be even higher than conventional analysis suggests to have the same deterrence effect.


The new research shows that, taken together, these two factors suggest that penalties should be about 75% of the level indicated by conventional analysis to have the appropriate level of deterrence. The appropriate penalty is in the range of 30-40% of revenue.


But would raising penalties lower prices? The research shows that the reverse could happen. Since penalties are related to revenue they lower companies'' revenue – but not their costs. The natural response of companies is to cut back the amount they produce and sell and this will drive up prices. The researchers show that this conclusion is robust to many refinements.


''Antitrust Penalties and the Implications of Empirical Evidence on Cartel Overcharges'' by Yannis Katsoulacos and David Ulph is available free in the November 2013 issue of the Economic Journal. Yannis Katsoulacos is at the Athens University of Economics and Business. David Ulph is at the University of St. Andrews.