Abstract
In this paper we make three contributions to the literature on optimal competition law enforcement procedures. A first contribution, of more general interest, is to clarify the concept of “legal uncertainty”, relying on ideas in the literature on Law and Economics, but formalising it by associating legal uncertainty with the information structure of what firms know about the process by which potentially harmful actions are treated by competition authorities. What firms know is clearly distinct, though influenced, from the decision errors made by authorities. We use this framework to show that information structures with legal uncertainty need not imply lower welfare than information structures with legal certainty—a result echoing a similar finding obtained in a completely different context and under different assumptions in earlier Law and Economics literature (Kaplow and Shavell in J Law Econ Organ 8:306–320, 1995). Our second contribution is to revisit and significantly generalise the analysis in our previous paper, Katsoulacos and Ulph (J Ind Econ LVII(3), 2009), involving a welfare comparison of Per Se and Effects-Based legal standards. In that analysis we considered just a single information structure under an Effects-Based standard and also penalties were exogenously fixed. Here we allow (a) for different information structures under an Effects-Based standard and (b) for endogenous penalties. We obtain two main results. Under all information structures (including complete legal uncertainty) an Effects-Based standard dominates a Per Se standard. Moreover, optimal penalties may be higher when there is legal uncertainty than when there is no legal uncertainty. These conclusions run counter to a number of prescriptions by legal scholars in the recent literature.
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Notes
Legal scholars and social scientists have, of course, discussed the issue of legal uncertainty in a much wider context than that of economic regulation. Among early prominent authors, Max Weber, thought of legal certainty as necessary for capitalist progress—see discussion in D’Amato (1983) with extensive references to legal scholars including Posner (8th edition, 2010). For a discussion of the importance of legal certainty by a EU competition law expert, see Forrester’s (2000) account in the context of Competition Policy. In Sect. 3 we provide a review of the extensive Law and Economics (mainly US) literature that has examined over many years various implications of legal uncertainty for law enforcement.
Or, lack of ability to predict the outcome of a legal dispute. D’Amato (1983) defines “legal uncertainty” as a “situation that obtains when the (legal) rule that is relevant to a given act or transaction is said by informed attorneys to have an expected official outcome at or near the 0.5 level of predictability”. For a recent extensive treatment by a legal expert see Davis (2011).
As has been recognised in the Law and Economics literature reviewed in Sect. 3. These include interventions associated with the application of Environmental Policy, determining eligibility for welfare benefits, Tax Compliance mechanisms, as well as, Competition Policy, Sectoral Regulation, etc.
Sometimes alternatively called discriminating or Rule-of-Reason procedures. One can think of what in US is termed Rule-of-Reason as an extreme form of the Effects-Based approach under which competition authorities have the discretion to apply different economic methodologies and criteria on a case-by-case basis. For this last distinction see also Vickers (2007).
Often also referred to as object or form-based procedures.
Usually it is “harm to others” that is the adopted criterion, or a consumer surplus substantive standard is used (see also below).
This distinction is similar to the comparison between unconditional/rigid and conditional/flexible contracts. In the context of welfare policy the analogous distinction is of universal and targeted benefits.
The issue has gained even more in importance recently as CAs worldwide have adopted significant reforms in decision and enforcement procedures, with an increasing use of Effects-Based rather than Per Se procedures. Examples include the adoption of a Rule-of-Reason standard for treating RPM in US, in the recent Leegin case (2007)—see for a discussion, Katsoulacos and Ulph (2009)—and the reforms in the assessment of article 102 practices by EU and national authorities (see the Commission Guidance Paper 2008). These have followed earlier reforms adopting Effects-Based assessment procedures in merger, vertical and certain horizontal agreement cases. See also Katsoulacos and Ulph (2011), Kokkoris and Lianos (2008), Will and Schmidtchen (2008).
Very high fines were imposed also in Microsoft and other recent cases—see for a review pp. 86–89 of Dethmers and Engelen (2011). As the authors also note “The courts do not appear to impose any constraint on the Commission’s discretion” to impose very high fines—p. 91.
This Latin phrase may be translated as “no penalty unless there is certainty under the Law”.
Ibid. p. 98.
See also Kwak (2010) that deals with related issues to those discussed here, concerning judicial errors and the choice of the liability standard.
Or, state of the world (below we refer to this as the “environment”).
As explained below, Complete Legal Uncertainty is the situation where both of the potential dimensions of uncertainty are present: firms do not know the true type of their actions and are also uncertain about how an error-prone authority will assess these actions were they to be detected and investigated.
This is the substantive standard used by most Competition Authorities—see Motta (2004) or O’Donohue and Padilla (2007)—and employed in our previous paper—Katsoulacos and Ulph (2009). It is the standard advocated by Salop (2010). It differs from a total welfare standard that would include the private benefit to the firm taking the action—advocated by Carlton (2007). The implications of using a total welfare standard are examined in Katsoulacos and Ulph (2015).
Subsequently we will use the term “environment” to refer to the “states of the world” H or B.
Which we take to be the present value of the expected change in profits from the action over its ‘natural’ lifetime.
The “symmetry” assumption—see Katsoulacos and Ulph (2009), which also discusses implications of its relaxation.
For simplicity we assume in this paper that the delay is the same whatever legal standard is used.
That is, the threshold level of harm caused by an action such that if the authority perceives the harm caused by a firm’s action to be above this threshold it will disallow and penalise the action, while if the perceived level of harm is below this threshold then the authority will allow the firm’s action.
Note that, as in Katsoulacos and Ulph (2009) it is not necessary for the analysis that follows to use a more restrictive assumption such as that \(p_{j} > (1/2),\quad j = H,B.\)
In Katsoulacos and Ulph (2009) we say that in this case the Effects-Based procedure can effectively discriminate.
This, of course, relies on the main ideas introduced in the different strands of the existing literature, concerning the nature and sources of this phenomenon, to which we return below.
This could arise if the CA set out the factors it would measure, the data it would use to measure these, and the calculations it would make, and if firms could costlessly access exactly the data the CA would use in its particular case and perform the calculations before it decided to take the action.
In contrast to the case of Partial Legal Uncertainty (below), under NLU firms of different type may face the same probabilities of being allowed or disallowed (convicted). Though in certain contexts this will be an unrealistic situation nevertheless it serves to make the point that even though the CA is using an Effects-Based procedure there still could be no legal uncertainty and that variability of decision across otherwise identical firms does not necessarily imply that there is legal uncertainty.
More precisely, if there were fixed but unknown fractions of firms facing different types of legal uncertainty, and if these were random subsets of the population of firms, then the welfare rankings of legal standards and of information structures that we derive in Sect. 4 will go through. The only result that would change would be that the CA would set just one level of penalty—that which applies when there is what we call Complete Legal Uncertainty.
Since the parameters π and δ are constant throughout the paper, we have suppressed the dependence of \(\widetilde{\varphi }\) on them and focused solely on its dependence on the probability of being disallowed, which varies across legal standards and information structures.
Davis (2011, p. 1).
There are even greater differences also, apart from those mentioned below, to another even earlier strand in the Law and Economics literature that deals with important private litigation issues (not examined here) in situations where individuals do not know the extent to which other people are negligent though they know the average degree of negligence. Thus Ordover (1978) examines the implications of costly litigation for compliance in these contexts while Hylton (1990) extends the Ordover analysis by introducing judicial errors in assessing negligence, showing that these reduce the likelihood of not getting perfect compliance equilibria (and thus can increase, in this sense, welfare). As we have emphasized, the judicial errors, the implications of which are examined in Hylton, are not, as in most of the other Law and Economics literature mentioned in the text, the same as the legal uncertainty examined in this paper—and are neither necessary nor sufficient for the latter.
Note that interactions between the various differences in the assumptions mentioned here can also affect the results: e.g. it is easy to show that in Kaplow (1990), with a more general penalty structure the optimal structure depends on whether a total welfare or a consumer surplus substantive standard is assumed.
That is, they generate positive or zero (but not negative) harm.
An alternative way to put this is to say that Kaplow (1990) just deals with actions that in the terminology below, are presumptively illegal while we also have to consider presumptively legal actions. This also has serious implications for the results we get on optimal penalties under the different information structures.
An additional difference between the above papers and the present one is that we examine the important phenomenon of desistance, i.e. how delays in the authority’s procedures affects the outcomes. Agents’ anti-competitive actions will normally take some time before they create benefits and social harm and so the size of these accruing will depend critically on delays in the authority’s procedures, which therefore will affect the value of optimal sanctions (see also, Katsoulacos and Ulph 2013).
In this section, agents can be uninformed about whether their action is harmful and if they become informed they learn the true harm that is what the authority will determine if it undertakes an investigation.
The different issues examined in the two papers—demand for legal advice in Kaplow and Shavell (1995) versus competition law enforcement here—can be considered responsible for the differences in assumptions.
And not just with a comparison across information structures. While comparing different enforcement procedures was the subject also of Katsoulacos and Ulph (2009), as noticed above, in that paper the analysis was restricted to one information structure and only exogenous penalties.
See Katsoulacos and Ulph (2009) for an extensive analysis and discussion of the conditions under which an Effects-Based legal standard with Partial Legal Uncertainty welfare dominates Per Se.
See discussion in Sect. 4.1.2 above for the intuition of this result.
The fraction of Benign actions taken when there is No Legal Uncertainty will be the same as under Partial Legal Uncertainty only when there is complete administrative effectiveness.
This arises only if the action is Presumptively Illegal and the degree of administrative effectiveness is low.
This will arise either if the action is Presumptively Legal or if it is Presumptively Illegal but there is a sufficiently high degree of administrative effectiveness.
Throughout this discussion we are assuming that there are no constraints to optimally set penalties e.g. constraints due to legal principles, such as that of “proportionality”.
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Acknowledgments
We are grateful for the comments of three referees. Of course, all errors and ambiguities remain solely our responsibility. The research was undertaken as part of a research project on optimal enforcement procedures funded by the UK Economic and Social Research Council (ESRC) under grant RES-062-23-2211. It has been co-financed by the European Union (European Social Fund—ESF) and Greek national funds through the Operational Program “Education and Lifelong Learning” of the National Strategic Reference Framework (NSRF)—Research Funding Program: CoLEG.
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Previous versions of this paper have been presented at Seminars at the University of Sussex, September 2011; the Higher School of Economics, Moscow, April 2013; the MaCCI Workshop on Competition Policy, Speyer, 13–17 June 2011; at Workshops in the Office of Fair Trading and the French Competition Authority in January 2011; the CRETE Conference, Tinos, Greece, July 12, 2010, the Centre for Competition Policy Conference, Norwich, June 2012 and the EARIE Conference, Rome September 2012. We have particularly benefitted from the comments of Mathew Bennett, Amelia Fletcher, Kai-Uwe Kuhn, Massimo Motta, Volker Nocke, Martin Peitz, Anne Perrot, Michele Polo, Patrick Rey, Yossi Spiegel, Jean Tirole and Thibaud Verge.
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Katsoulacos, Y., Ulph, D. Legal uncertainty, competition law enforcement procedures and optimal penalties. Eur J Law Econ 41, 255–282 (2016). https://doi.org/10.1007/s10657-015-9504-1
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DOI: https://doi.org/10.1007/s10657-015-9504-1