Fines on companies for anti-competitive practices are often based on rules-of-thumb that have a distortive effect on corporate behaviour. That is the central conclusion of research by Vasiliki Bageri, Yannis Katsoulacos and Giancarlo Spagnol, published in the November 2013 issue of the Economic Journal.


The penalties that regulators and courts impose on violators of competition law are a very important tool for effective enforcement. But the new study uncovers a number of distortions that current penalty policies generate. Two examples are antitrust penalties based on affected commerce rather than on collusive profits; and caps on penalties based on total corporate sales rather than on affected commerce.


A first and obvious distortive effect of penalty caps linked to a company''s worldwide revenues is that specialised companies that are active mostly in their core market expect lower penalties than more diversified companies active in several other markets than the relevant one.


This distortion – why should diversified companies active in many markets face higher penalties than more narrowly focused companies? – could in principle induce companies that are at risk of antitrust legal action to under-diversify or split their business to reduce their legal liability.


The researchers examine two other, less obvious distortions that occur when the volume of affected commerce is used as a base to calculate antitrust penalties.


The first distortion is that if expected penalties are insufficient to deter a cartel (which seems to be the norm given the number of cartels that competition authorities continue to discover), penalties based on revenue rather than on collusive profits induce companies to increase cartel prices above the monopoly level that they would have set if penalties were based on collusive profits.


Intuitively, this reduces revenues and thus the penalty, but the outcome exacerbates the harm caused by the cartel relative to a monopolised situation with similar penalties related to profits. It even exacerbates the harm relative to a situation with no penalties, due to the distortive effects of the higher price and the presence of antitrust enforcement costs.


The second distortion is that companies with high revenue/profit ratios (for example, companies at the end of a vertical production chain) expect larger penalties relative to the same collusive profits than companies that have lower revenue/profit ratios (for example, because of the fact that they are at the beginning of the production chain).


The empirically-based simulations in this study suggest that the welfare losses produced by these distortions can be very large, and that they may generate penalties differing by over a factor of 20 for companies that should instead have the same penalty. The authors explain how the size of the distortions is affected by market characteristics, such as the elasticity of demand, and they quantify the distortions based on market data.


It is worth noting that in the US case, the rules-of-thumbs do not produce any saving in enforcement costs because the prescribed cap on fines requires courts to calculate companies'' collusive profits anyway. Further, the distortions that the researchers identify 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.


Professor Katsoulacos comments:


''In contrast to what economic theory predicts, in most jurisdictions, competition authorities and courts use rules-of-thumb 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.


''Developments in economics and econometrics make it possible to estimate illegal profits from antitrust infringements with reasonable precision, as is regularly done to assess damages.


''It is time to change these distortive rules-of-thumb that make revenue so central for calculating penalties, if the only thing the distortions buy is saving the costs of data collection and illegal profits estimation.''


''The Distortive Effects of Antitrust Fines Based on Revenue'' by Vasiliki Bageri, Yannis Katsoulacos and Giancarlo Spagnol is published in the November 2013 issue of the Economic Journal. Vasiliki Bageri and Yannis Katsoulacos are the Athens University of Economics and Business. Giancarlo Spagnol is at the Stockholm School of Economics.