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Wednesday, August 21, 2013

The Market Power Model of Contract Formation: How Outmoded Economic Theory Still Distorts Antitrust Doctrine

Posted by D. Daniel Sokol

Alan Meese (William and Mary) has written on The Market Power Model of Contract Formation: How Outmoded Economic Theory Still Distorts Antitrust Doctrine.

ABSTRACT: For decades courts have premised certain rules of antitrust liability upon the assumption that firms use preexisting market power to “coerce” or “force” trading partners to enter exclusionary agreements. Most notably, courts have held that a monopolist’s “use” of such power to obtain an exclusionary agreement violates § 2 of the Sherman Act, while at the same time presuming that such a use of power, without more, produces economic harm. Following similar logic, courts enforcing § 1 of the Act have banned tying agreements obtained by firms with market power, reasoning that sellers use their power to “force” buyers to enter such contracts and that such “forcing” constitutes antitrust harm. Finally, courts have invoked similar reasoning when holding that dealers or consumers can challenge unlawful agreements they have themselves entered and enforced, disregarding the common law doctrine of in pari delicto (‘in equal fault”) on the grounds that plaintiffs’ participation in such contracts is involuntary, because defendants use market power to impose them.

This article critiques these doctrines and the market power model of contract formation on which they depend, contending that these rules rest upon an outmoded account of the origins and effects of such agreements. In particular, the article locates the origin of the market power model in neoclassical price theory’s model of workable competition, often associated with the “Harvard School” of Antitrust. Assumptions informing the workable competition model excluded the possibility that exclusionary agreements produced benefits, giving rise to the natural inference that firms with market power used that power to impose such contracts against the will of trading partners. Courts embraced the Harvard School account of these agreements and announced hostile doctrines resting upon the assumption that such contracts were expressions of market power “used” to impose them. While Chicago School scholars questioned these doctrines, their critique ironically rested upon a more precise price-theoretic account of how firms purportedly used market power to impose these agreements.

Transaction cost economics (“TCE”) has radically altered economic theory’s explanation for so-called “non-standard contracts,” including “exclusionary” agreements that deprive rivals of access to inputs or customers. Building upon the work of Ronald Coase, scholars have argued that such integration usually reduces transaction costs, particularly anticipated costs of opportunism made possible by relationship-specific investments, without producing anticompetitive harm. TCE has accordingly exercised growing influence over antitrust doctrine, with courts invoking TCE’s teachings to justify revision of some doctrines. Still, old habits die hard, and courts have retained the habit of treating exclusionary agreements — even those that produce benefits — as expressions of market or monopoly power. However, TCE implies that firms can induce voluntary acceptance of these provisions by offering cost-justified discounts to trading partners who agree to them, thereby using the institution of contract to redefine background rights and obligations so as to minimize transaction costs.

To be sure, TCE does not teach that all non-standard agreements reduce transaction costs. Moreover, parallel developments suggest that some such agreements may reduce economic welfare by raising rivals’ costs and conferring market power. Here again, however, there is no reason to believe that proponents of such agreements use market power to imposed them. Instead, proponents can induce input suppliers to enter such contracts voluntarily, simply by sharing with them expected monopoly profits the arrangements will help create. Thus, such agreements are no more “coercive” than ordinary cartel arrangements.

The Article ends by exploring implications of these insights for antitrust doctrine. First, courts should discard substantive antitrust rules that depend upon the “market power” model of contract formation in favor of more direct analysis of the economic impact of challenged practices. Second, courts should reject any effort to infer the existence of such power from the presence of non-standard agreements, because the presence of such agreements is at least equally consistent with a conclusion that they are the result of harmless voluntary integration. Third, courts should discard exceptions to the in pari delicto doctrine based on the “market power” model of contract formation and reconsider current law allowing dealers and consumers to challenge agreements they have voluntarily entered.

http://lawprofessors.typepad.com/antitrustprof_blog/2013/08/the-market-power-model-of-contract-formation-how-outmoded-economic-theory-still-distorts-antitrust-d.html

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