The literature on the optimal design of antitrust monetary penalties has identified four main sanctions’ regimes: damages-based, illegal gains-based, revenue–based and overcharge–based. This paper – which can be found here – analyses an alternative (fifth) regime: a sophisticated revenue-based penalty regime, in which the penalty-base is the revenue of the cartel but the penalty rate depends on (and increases with) the cartel overcharge rate.
The operating assumption is that a penalty regime is better if it easier to implement, it generates less legal uncertainty, and it has a superior overall welfare impact. The authors find that, unfortunately, regimes that are superior in terms of their welfare properties are not superior (and may be inferior) in terms of the other assessment criteria we mentioned above. Their argument is that, if one takes into account a number of policy concerns other than welfare-maximisation, the sophisticated revenue-based approach emerges as a superior alternative
The paper is structured as follows:
Section 2 provides a brief description of the main penalty regimes and of how they perform in relation to the assessment criteria identified above. Covering each regime in turn:
- Damages to society were proposed in the seminal article of Becker examining optimal (first-best) penalties, which assumed that the objective of the enforcing agency is to maximise (total) social welfare. However, damages to others are very difficult to estimate accurately and their estimation is likely to be subject to quite significant errors;
- Penalties based on illegal gains were originally advocated by Lande as the most appropriate sanction for enforcement authorities whose objective is to deter conduct that does not generate any efficiencies (such as price fixing). Such a penalty would avoid the reduction in consumer surplus that results from such conduct. Illegal gains are defined as cartel’s profits over and above the counterfactual level of profits. However, and apart from their welfare properties not being very good – since they induce cartel prices that are equal to the monopoly level – penalties based on illegal gains are difficult to estimate accurately and their estimation is (again) likely to be subject to quite significant errors. Thus, it is no surprise that while penalties based on illegal gains are included in the penalty structures adopted in many countries, they are very rarely implemented in practice.
- Revenue–based regimes are the most common regime for estimating monetary penalties throughout the world. Revenue–based penalties score very high in terms of easiness of implementation and legal certainty, even if empirical evidence seems to suggest they are weak regarding their effects on welfare.
- Overcharge-based regimes are assumed by the authors to be superior in terms of their overall welfare impact relative to the revenue-based and profit-based regimes. However, calculation of penalties on this basis requires estimates of the overcharge (the difference between the cartel and the counterfactual price) and, more importantly, of the counterfactual volume of sales. As a result, this regime is difficult to implement and creates substantial legal uncertainty.
The paper then argues that a sophisticated revenue-based penalty regime, in which the penalty base is the revenue of the cartel but the penalty rate depends on (and increases with) the cartel overcharge rate, is preferable. Such a regime still requires enforcement authorities to estimate revenue – as under revenue-based regime – and the price overcharge – as under the damages-based, illegal gains-based and overcharge-based regimes. However, these three latter regimes require additional information in order to obtain an accurate estimate of the penalty base which is quite hard to obtain and is easily open to dispute. By dispensing with this information, the proposed regime is relatively easier to implement and performs well on legal uncertainty. At the same time, it performs much better than a revenue-based regime on welfare grounds.
Section 3 looks in detail at the sophisticated revenue-based regime and purports to show that it has the same welfare properties as the overcharge–based regime. The authors argue that their proposed regime is superior to the overcharge-based regime in terms of welfare, while avoiding the problems of legal uncertainty and implementation that plague overcharge-based regimes. The authors also undertake a systematic comparison of their proposed regime with the simple revenue-based penalty regime that is currently widely employed across the world, and argue that the sophisticated regime will achieve lower prices and better deterrence.
This section has lots of mathematics, but the bottom line is that order to overcome the main deficiency of the simple revenue-based penalty regime – where the penalty is a decreasing function of the overcharge – the penalty rate needs to be raised in tandem with the overcharge. This will allow the penalty to increase with the magnitude of the harm/overcharge, and gives firms an incentive to price below the monopoly overcharge.
Section 4 offers a brief comparison with other penalty regimes, and Section 5 concludes that: “a sophisticated revenue-based penalty regime in which the penalty rate that is applied to revenue rises linearly with the level of overcharge that a cartel is found to have set, according to a pre-announced formula, will welfare-dominate the existing widely used simple revenue-based penalty regime in terms of both the prices that it induces cartels to set and the levels of deterrence achieved. Moreover it is easy to implement and does not give rise to legal uncertainty concerns: the rate at which the penalty rises with the overcharge can be readily justified and calculated from publicly available information.”
I think this paper provides a good overview of the literature on monetary sanctions for antitrust infringements, and suggests an interesting new way to set out the amount of that penalty. I must say that calling your own policy proposal “sophisticated” does not sit that well with me, but that is a matter aesthetic preference.
A more serious concern I have with this paper reflects a bug-bear I hold against some economics literature in our field: I’m not sure what all the economic modelling is supposed to be doing here. Ultimately, the point of the paper is that a revenue-based penalty does not really reflect the impact of the anticompetitive practice on welfare. It stands to reason that, as a rule, a revenue-based penalty that is able to take into account the cartel overcharge will be a better fit for welfare losses. If one is able to develop a formula for this, great; but given that it’s unclear how to quantify the assessment criteria (i.e. legal certainty; implementation) , I am left with a suspicion that the mathematics are there to present a veneer of seriousness and rigour to an instinctive formula that could as easily (and more clearly) be explained without resource to these formulas.
This is reflected in how the authors purport to show that “overcharges” can easily be used improve on a revenue-based system. They do this on the basis of a number of “policy criteria” they identify. However, it is unclear why these policy criteria are the ones that should be adopted, so any such “demonstration” in effect requires the acceptance of these (dubious) premises on faith. Furthermore, the argument builds on a premise that “overcharges” are easy to identify and implement which is untested at best, and naïve at worst. Ultimately, I don’t see how one can measure “legal certainty” or “implementability”, and hence I don’t see how you can do better than to just argue that such as option may be superior in practice to a revenue-based approach– I cannot see how such a thing can be “demonstrated”.
Having said that, I think the authors’ argument deserves some attention and further research – I too believe that revenue-based fines are a very rough instrument (even if I have no one way to show it).