As I noted in a post last month, the Ninth Circuit recently threw out an antitrust challenge to cable operators’ refusal to provide cable channels on an a la carte, rather than bundled, basis.  (Josh also had some insightful comments on the Ninth Circuit’s Brantley decision.)  In my post, I promised that I would later explain how channel bundling, which permits cable operators to price discriminate and extract greater consumer surplus, may nonetheless benefit consumers by expanding output.  Having just finished incorporating a number of helpful comments Herbert Hovenkamp gave me on a forthcoming tying/bundling article (more about that later!), now seems like a swell time to return to the topic of cable bundling.

Read the full piece here. 

In a recent Dealbook post, Steven M. Davidoff complains that Delaware’s business judgment rule is too lenient.  Davidoff contends that “[a] Delaware court is not going to find [directors] liable no matter how stupid their decisions are. Instead, a Delaware court will find them liable only if they intentionally acted wrongfully or were so oblivious that it was essentially the same thing.”  He then asserts that a commonly heard justification for this lenient approach — that it is required in order to induce qualified individuals to serve as directors — is “laughable.”

Prof. Davidoff’s pithy summary of the Delaware business judgment rule seems accurate, and I share his skepticism toward the argument that the rule is justified as a means of inducing highly qualified directors to serve.  I disagree, though, with his insinuation that the Delaware approach is unjustified.  The rule makes a great deal of sense as a means of aligning the incentives of directors (and officers) with those of shareholders.

Under Delaware’s business judgment rule, courts will abstain from second-guessing the merits of a business decision — even one that appears, in retrospect, to have been substantively unreasonable — as long as the directors acted honestly, in good faith, without any conflict of interest, and on a reasonably informed basis (i.e., they weren’t “grossly negligent” in informing themselves prior to making the decision at issue).  Courts treat the rule as quasi-jurisdictional, insisting that they simply will not hear complaints about the substantive reasonableness of a decision as long as the prerequisites to BJR protection are satisfied. 

One frequently hears two justifications for this deferential approach.  First, courts sometimes seek to justify it on grounds that they are not business experts.  Second, as Prof. Davidoff observes, directors and officers often defend it on grounds that it’s needed to prevent qualified directors from being scared off by the prospect of huge liability for good faith business decisions that turn out poorly.  

Neither justification works very well.  Courts routinely second-guess the substance of decisions in areas where they lack expertise and might, by imposing liability, dissuade qualified individuals from offering their services.  Consider, for example, medical malpractice.  Courts aren’t medical experts, yet they routinely second-guess the substance of good faith, reasonably informed treatment decisions.  And they do this with full knowledge that malpractice judgments dissuade qualified doctors from providing their services.  (Remember President Bush’s concern that malpractice verdicts were dissuading gynecologists from “practic[ing] their love with women all across this country”?)  There must be something more to the story.

Indeed, there is.  By insulating directors from liability for good faith, informed business decisions that turn out poorly, the business judgment rule encourages directors to take greater business risks.  This is a good thing, because directors and officers tend to be more risk averse than their principals, the shareholders.  I previously explained that point in criticizing Mark Cuban’s claim that shareholders and CEOs “have completely different agendas: Most chief executives want to hit a ‘home run’ — taking big risks for potentially big payoffs — while most mom-and-pop shareholders simply hope not to ‘strike out’ and lose their nest egg.”  I wrote:

… Stockholders would normally prefer corporate managers to take more, not less, business risk.

When it comes to managerial decision-making, rational stockholders prefer greater risk-taking (which is associated with higher potential rewards) for a number of reasons. First, stockholders have limited liability, which means that if a business venture totally tanks and creates liabilities in excess of the corporation’s assets, the stockholders are off the hook for the excess. Since stockholders are able to externalize some of the downside of business risks, they’ll tend to be risk-preferring. Moreover, stockholders are the “residual claimants” of a corporation — they don’t get paid until obligations to all other corporate constituents (creditors, employees, preferred stockholders, etc.) have been satisfied. In other words, they get nothing if the corporation breaks even, and they therefore would prefer that managers pursue business ventures likely to do more than break even. Finally, stockholders are able to eliminate firm-specific, “unsystematic” risk from their investment portfolios by owning a diversified collection of stocks. They therefore do not care about such risk (although they do demand compensation for bearing non-diversifiable, “systematic” risk). …

Compared to equity investors, corporate managers (including CEOs) tend to be relatively risk-averse. Unlike shareholders, they get paid even if the corporation breaks even, so high-risk/high-reward ventures are less attractive to them. In addition, they cannot diversify their labor “investment” so as to eliminate firm-specific risk (one can generally work only one job, after all). Managers therefore tend to prefer “safer” business ventures.

The need to reconcile risk preferences among corporate managers (directors and officers) and their principals (the shareholders) provides a compelling justification for Delaware’s business judgment rule.  Chancellor Allen clearly articulated this point in footnote 18 of the 1996 Caremark opinion:

Where review of board functioning is involved, courts leave behind as a relevant point of reference the decisions of the hypothetical “reasonable person”, who typically supplies the test for negligence liability. It is doubtful that we want business men and women to be encouraged to make decisions as hypothetical persons of ordinary judgment and prudence might. The corporate form gets its utility in large part from its ability to allow diversified investors to accept greater investment risk. If those in charge of the corporation are to be adjudged personally liable for losses on the basis of a substantive judgment based upon what persons of ordinary or average judgment and average risk assessment talent regard as “prudent” “sensible” or even “rational”, such persons will have a strong incentive at the margin to authorize less risky investment projects.

As Geoff has often reminded us, the optimal level of business risk is not zero.

Filed under: business, corporate governance, corporate law, law and economics

The Ninth Circuit recently issued a decision that pushes the doctrine governing tying in the right direction.  If appealed, the decision could provide the Roberts Court with an opportunity to do for tying what its Leegin decision did for resale price maintenance:  reduce error costs by bringing an overly prohibitory liability rule in line with economic learning.  First, some background on the law and economics of tying.  Then, a little about the Ninth Circuit’s decision.  

Some Background on the Law and Economics of Tying

Tying (or a “tie-in”) occurs when a monopolist sells its monopoly “tying” product on the condition that the buyer also purchase some “tied” product.  Under prevailing doctrine, tying  is per se illegal if: (1) the tie-in involves two truly separate products (e.g., a patented printer and unpatented ink, not a left shoe and a right shoe), (2) the seller possesses monopoly power over the tying product, and (3) the tie-in affects a “not insubstantial” dollar volume (not share) of commerce in the tied product market (e.g., $50,000 or so will suffice). 

Scholars from both the Chicago and Harvard Schools of antitrust analysis (including yours truly) have argued that this rule is too prohibitory and that tie-ins should be condemned only when they foreclose a substantial percentage of sales opportunities in the tied product market.  This sort of rule of reason approach, we maintain, would prevent liability for tie-ins that could not possibly be anticompetitive and would align tying doctrine with the liability rule governing tying’s close cousin, exclusive dealing.  The governing per se rule, we contend, is a relic of the days when courts believed that a monopolist could immediately earn two monopoly profits by tying in a separate product and charging both a supracompetitive price for that tied product and the monopoly price for its monopoly product.  This so-called leverage theory has been debunked.  (Consumers will view the supracompetitive tied product price as an increase in the price of the tying product, which will push the tying product price above the profit-maximizing level and cause the seller to lose profits.  In short, there is only one monopoly profit to exploit, and the seller can do so by charging its profit-maximizing monopoly price for the monopoly product alone.) 

A couple of years ago, Harvard Law’s Einer Elhauge published a much-discussed article arguing that we critics of current tying doctrine are wrong.  Prevailing doctrine, Elhauge argued, is appropriate because tie-ins can cause anticompetitive effects even if they do not occasion substantial tied market foreclosure.  In particular, a tie-in can permit a seller to price discriminate among consumers and thereby extract a greater proportion of the trade surplus for itself.  For example, in a variable proportion tie-in (one where there is no fixed ratio between the number of tying and tied units purchased, as when a buyer of a printer is required to purchase all his ink requirements from the printer seller), the seller can price discriminate by tying in a complement (ink) whose consumption corresponds to the degree to which consumers value the tying product (e.g., consumers who most value the printer likely buy lots of ink).  By lowering the price of the tying product (the printer) from monopoly levels and charging a supracompetitive price for the tied product (the ink), the seller can effectively charge higher prices to consumers who value the tying product more, thereby capturing more surplus for itself.  Elhauge argues (incorrectly, as I show in this article) that this is an anticompetitive effect.

A second form of “anticompetitive” price discrimination, Elhauge contends, may result from fixed proportion tie-ins of products for which demand is not positively correlated.  George Stigler provided the classic example of this dynamic in his discussion of the Loew’s case, which involved the block booking of feature films (i.e., selling the films only in packages). 

Suppose, for example, that a firm has two customers, A and B; that A values product X at $8,000 and product Y at $2,500; and that B values product X at $7,000 and product Y at $3,000.  (For simplicity’s sake, assume that the marginal cost of both products is zero.)  If the firm were to sell the products separately, it would charge $7,000 for X and $2,500 for Y, and it would earn profits of $19,000 ($9,500 x 2).  By tying the products together and selling them as a bundle, the seller can charge a total of $10,000 per customer, an amount less than or equal to each customer’s reservation price for the package, thereby earning profits of $20,000.  While each consumer is charged the same amount for the package, the pricing is in some sense discriminatory, for the seller effectively discriminates against A, the low-elasticity X buyer, on A’s purchase of X and against B, the low-elasticity Y buyer, on B’s purchase of Y.  (This is because, absent the tying of X and Y, A would have enjoyed surplus of $1,000 on X but no surplus on Y, and B would have enjoyed surplus of $500 on Y but no surplus on X.)  By engaging in this sort of price discrimination, the seller may enhance its profits for, as Judge Posner explains, “When the products are priced separately, the price is depressed by the buyer who values each one less than the other buyer does; the bundling eliminates this effect.”

According to Elhauge, the sort of price discrimination/surplus extraction occasioned by “Stigler-type” tying, like the price discrimination resulting from a variable proportion “metering” tie-in, is anticompetitive and justifies the prevailing liability rule against tying.  In a subsequent post, I will explain why Elhauge is wrong and why Stigler-type price discrimination is output-enhancing and thus procompetitive.  For now, though, let’s consider the Ninth Circuit’s recent case, which rejected Elhauge’s view.

The Ninth Circuit’s Recent Brantley Decision

Brantley, et al. v. NBC Universal, Inc., et al., involved a challenge by cable television subscribers to T.V. programmers’ practice of selling cable channels only in packages.  The plaintiffs, who preferred to purchase individual channels a la carte, maintained that the programmers’ policy violated Sherman Act Section 1.  As the Ninth Circuit correctly recognized, the arrangement really amounted to tying, for the programmers would sell their “must have” channels only if subscribers would also take other, less desirable channels.  (Indeed, the practice is closely analogous to the block booking at issue in Loew’s, where the distributor required that licensees of popular films also license flops.)

The district court dismissed plaintiffs’ first complaint without prejudice on the ground that plaintiffs failed to allege that their injuries (purportedly higher prices) were caused by an injury to competition.  Plaintiffs then amended their complaint to include an allegation “that Programmers’ practice of selling bundled cable channels foreclosed independent programmers from entering and competing in the upstream market for programming channels.”  In other words, plaintiffs alleged, the tying at issue occasioned substantial tied market foreclosure.

After conducting some discovery, plaintiffs decided to abandon that theory of harm.  They prepared a new complaint that omitted all market foreclosure allegations and asked the court to rule “that plaintiffs did not have to allege that potential competitors were foreclosed from the market in order to defeat a motion to dismiss.”  Defendants again sought to dismiss the complaint.  The district court, reasoning that the plaintiffs had failed to allege any cognizable injury to competition, granted defendants’ motion to dismiss, and plaintiffs appealed.

Given this procedural posture, the Ninth Circuit starkly confronted whether, as Elhauge maintains, the price discrimination/surplus extraction inherent in Stigler-type bundling is an “anticompetitive” effect that warrants liability.  In affirming the district court and holding that plaintiffs’ claims of higher prices were not enough to establish anticompetitive harm, it effectively held, as I and a number of others have urged, that there should be no tying liability absent substantial tied market foreclosure.

This holding, while correct as a policy matter, seems to conflict with the Supreme Court’s quasi-per se rule.  That rule assigns automatic liability if the tie-in involves multiple products (it did here), the seller has monopoly power over the tying product (it did here), and the tie-in involves a not insubstantial dollar volume of commerce in the tied product market (it did here).  Thus, the Ninth Circuit has provided the Supreme Court  with a perfect opportunity to revisit the liability rule governing tying. 

I for one am hoping that the Brantley plaintiffs appeal and that the Supreme Court agrees to take the case and reconsider the prerequisites to tying liability.  If it does so, I predict that it will overrule its Jefferson Parish decision, jettison the quasi-per se rule against tying, and hold that there can be no tying liability absent substantial foreclosure of marketing opportunities in the tied product market.

Filed under: antitrust, economics, error costs, law and economics, markets, price discrimination, regulation, Supreme Court, tying, tying

Sprint, perhaps the most vigorous opponent of the proposed AT&T/T-Mobile merger, has been extolling the values of competition lately.  Last Thursday and again today, the company ran full-page ads in the Wall Street Journal featuring the following text (which was apparently penned by Helen Steiner Rice):

Competition is everything.

Competition is the steady hand at our back, pushing us to faster, better, smarter, simpler, lighter, thinner, cooler.

Competition is the fraternal twin of innovation.

And innovation led us to offer America’s first 4G phone, first unlimited 4G plan, first all-digital voice network, first nationwide 3G network, and first 4G network from a national carrier.

All of which, somewhat ironically, led our competition to follow.

Competition is American.  Competition plays fair.

Competition keeps us all from returning to a Ma Bell-like, sorry-but-you-have-no-choice past.

Competition is the father of rapid progress and better value.

Competition inspires us to think about the future, which inspires us to think about the world, which inspires us to think about the planet, which inspired us to become the greenest company among wireless carriers.

Competition has many friends, but its very best is the consumer.

Competition has many believers, and we are among them.

Competition brings out our best, and gives it to you.

Sprint — All. Together. Now

The current ad is a bit more artful, though less amusing, than Sprint’s last print ad (scroll down), which was quickly pulled after it raised the ire of the (hyper-sensitive) transgender community.  That ad addressed the AT&T/T-Mobile merger more directly, stating that “the deal is bad for consumers who would see higher prices, less innovation, and two companies controlling 80 percent of wireless revenue.”

Now I’m all for competition, undoubtedly the best regulator out there, but I’m suspicious of Sprint’s claim that its opposition to the AT&T/T-Mobile merger is based on a desire to ensure vigorous competition.  Sprint, you see, benefits if the proposed merger leads to the predicted parade of horribles.  Higher prices occasioned by a Verizon/AT&T “duopoly” (Sprint’s term) means Sprint can charge more for its services or win business from the “duopolists” by underpricing them.  If the duopolists get fat and lazy and slow their innovation, as Sprint predicts, Sprint won’t have to work as hard to attract customers.  In short, most of the purportedly anti-consumer aspects of the AT&T/T-Mobile deal are pro-Sprint.

Why, then, is the company fighting this merger so vigorously?  Well, there are a couple of possibilities.  One is that Sprint is concerned that the merged AT&T/T-Mobile will be particularly good at offering customers product/service/price combinations that they find attractive.  If that’s the case, then Sprint is ultimately worried that the deal will enhance, not reduce, competition.  Alternatively, Sprint may be worried that an AT&T/T-Mobile combination will reduce competition in the sale of inputs needed to provide wireless service, making it more difficult for Sprint to access the facilities it needs to do its business.  That might be a genuine anticompetitive harm from the merger.

Sprint would do well to clarify its complaint.  When it lauds the value of competition generally and complains about things like higher consumer prices and reduced innovation (effects from which it would benefit), it loses credibility.  Give it to us straight, Sprint.

(Josh’s much more sophisticated thoughts on the proposed merger are here.)

Filed under: antitrust, economics, law and economics, markets, mergers & acquisitions, wireless

I’ve been in a blue funk since last Tuesday, when my home institution, the University of Missouri Law School, fell into the third tier in the U.S. News & World Report annual ranking of law schools. Since the rankings began, Missouri has pretty consistently ranked in the 50s and 60s. Last year, we fell to 93. This year, to 107. That’s pretty demoralizing.

It’s completely ridiculous, of course. On the metrics that really matter (academic reputation, student quality, bar passage, etc.), we do pretty well — near the top of tier 2 (schools 50-100). With respect to scholarly productivity, our faculty ranks sixth among law schools outside the top fifty. We do less well with employment, but that’s largely because (1) we don’t manipulate the numbers, as many schools do, and (2) many of our graduates go into prosecution and public defense, where hiring decisions are not made until after the bar examination. Where we really get beat up is on expenditures per “full-time equivalent” student. Last year, we ranked 173 out of 190 on that measure. In my view, that means we’re efficient — we get a heck of a lot out of our financial resources. According to U.S. News, though, the fact that we spend less money educating our students means that the quality of our educational offering must be sub-par. Non sequitur, anyone?

Despite the stupidity of the U.S. News rankings, they matter. We will have a harder time attracting top students next year. In the past, we’ve been able to attract sharp students that were accepted at, say, Iowa, Illinois, or Washington University because our tuition (especially in-state tuition) is much, much lower. Given all this talk of higher education bubbles and the widespread questioning of whether law school is really worth the steep price, this should be an ideal time for Missouri to exploit its low tuition. Unfortunately, that’s tougher to do when you’ve fallen into the U.S. News third tier and prospective students, who don’t yet realize the insanity of the rankings metrics, wrongly perceive that you’re selling a shoddy product. We may also have a harder time attracting high-quality faculty, though this fall’s outstanding class of entrants (two John Roberts clerks, a Jose Cabranes clerk, and an outstanding Virginia J.D./Ph.D) will surely help on that front. We Missouri professors may even have a harder time placing our scholarship, given that the third-year law students who select articles for publication tend to evaluate scholarship, in part, on the basis of the author’s “prestige” as measured by the ranking of her home institution.

So what should we do? If I were dean, I believe I would simply opt out of U.S. News. I’m serious. We know the rankings are a joke, and they’re actually hurting us. I would simply refuse to fill out the magazine’s survey form and then take out explanatory ads, on the day the 2012 rankings were released, in the New York Times and Wall Street Journal. Reed College has taken this sort of principled stand in the U.S. News college rankings and has gotten loads of favorable media attention.  I believe its stance has actually boosted its excellent reputation.

Of course, if a school fails to fill out the U.S. News form, the magazine will simply incorporate a somewhat punitive “estimate” of the uncooperative school’s data, so its ranking may be artificially depressed. But at this point, what do we at Missouri have to lose?  We’re already down to 107!  Anyone who does the slightest bit of investigation will see that Missouri Law — one of the oldest law schools west of the Mississippi River, the flagship public law school in a fairly populous state with two significant legal markets, the home of a productive faculty that also cares deeply about teaching — is not what participants on the Princeton Review’s old message board used to call a “Third Tier Toilet.” If we opt out of the rankings (a decision U.S. News will have to note), readers will surmise that our low ranking results from our decision not to play with U.S. News. Right now, they think there’s something wrong with Missouri, not with the screwy rankings system. Our opt-out would at least draw attention to the stupidity of the ranking metrics.

Of course, this move would entail significant risk. As it did with Reed College, U.S. News would likely adopt punitive estimates of the data we refused to provide, causing us to fall further in the rankings. Readers might not notice the disclaimer that we refused to return our survey and that our ranking is therefore based on estimated data. The media (mainstream and other) might not draw as much attention to our bold stand as I expect they would. While I think it would take a perfect storm for an opt-out strategy to tarnish our reputation even further, such storms do occasionally occur.

We could reduce the riskiness of our strategy if we could persuade some other law schools — perhaps other low-tuition, efficient schools that find themselves similarly disadvantaged by the rankings’ inapposite focus on expenditures per student — to withhold data from U.S. News. This would require U.S. News to include more “based on estimated data” asterisks, which would reveal the punitive nature of the magazine’s estimates and undermine confidence in the flawed ranking system.

But would this sort of concerted strategy run afoul of the antitrust laws? Initially, I thought it might. After all, what I’m contemplating is essentially an agreement among competitors to withhold information from a publication that tends to enhance competition among those very rivals. Moreover, the cooperating rivals would be withholding this information precisely because they think the competition stimulated by the publication is, to use the old fashioned term, “ruinous.”  It smells pretty fishy.

The more I think about it, though, the less troubling I find this strategy. The fact is, the methodology underlying the U.S. News rankings is so unsound that the rankings themselves are misleading.  And the misrepresentations they convey actually hurt a number of schools like Missouri.  I believe we who are unfairly disadvantaged by the U.S. News methodology could, without impunity, bind together in an attempt to undermine the flawed rankings.  Indeed, it is in our individual competitive interests to do so.

So how would a court evaluate a boycott of U.S. News by a group of law schools that perceive themselves to be disadvantaged by the magazine’s ranking methodology (say, less expensive, more efficient law schools with low per-student expenditures)?

First, the court would likely determine that the agreement not to participate in the ranking survey is ancillary, not naked.  As Herb Hovenkamp has explained, “[a] serviceable definition of a naked restraint is one whose profitability depends on the exercise of market power” (i.e., on a constriction of output aimed at artificially raising prices so as to enhance profits).  The agreement I’m contemplating makes perfect business sense apart from any exercise of market power. Each law school that would participate in the agreement is personally injured by the screwy rankings scheme, and each has an independent incentive — regardless of what other schools do — to refrain from participation. The participating law schools, it is true, would prefer to have others join them, but that is not because they are seeking to exercise market power; rather, they realize that the message their non-participation will convey (i.e., that U.S. News’s rankings methodology is nonsense) will be stronger if more schools join the boycott.

Since the restraint I contemplate is ancillary, not naked, it would be evaluated under the rule of reason. Indeed, any court that sought to utilize a less probing analysis (per se or quick look) would have to confront the Supreme Court’s California Dental decision, which held that a pretty doggone naked restraint among competing dentists was entitled to a full rule of reason analysis because it could enhance competition by reducing fraudulent advertising.

Under the rule of reason, the arrangement I’m contemplating would likely pass muster. Because widespread misinformation among consumers reduces the competitiveness of a market, an effort to reduce such misinformation, even a concerted effort, is pro-, not anti-, competitive.  Because the “agreement” aspect of my contemplated restraint increases the degree to which the arrangement undermines the misleading, competition-impairing U.S. News rankings, it enhances the restraint’s procompetitive effect. 

So what do others think?  Am I underestimating the antitrust risk of this strategy?  The business risk?  My TOTM colleagues from Illinois and George Mason, both of which do quite well under the U.S. News formula, probably have little personal interest in these musings.  But I suspect others do.  What do you think?

Filed under: antitrust, cartels, Education, law school, universities

If you’re currently a law professor and you’re thinking you might want to change schools (because, for example, your school continued its precipitous slide in the law school rankings . . . more about that later), you’d better hop on the phone. Today is your last day to snag a visiting offer from another law school. (You’ve already missed the deadline for procuring a permanent offer. That was March 1.)

The competing law schools, you see, have agreed to limit competition amongst themselves for law professor talent. Pursuant to the Association of American Law Schools’ Statement of Good Practices for the Recruitment of and Resignation by Full-Time Faculty Members, the law schools have pledged to “make an[y] offer of an indefinite appointment as a teacher during the following academic year no later than March 1 and of a visiting appointment no later than March 15.”

If this arrangement strikes you as legally suspect, congratulations. You know more about antitrust law than does the Executive Committee of the AALS. This arrangement is, quite simply, an unreasonable horizontal restraint of trade — not unlike an agreement among Ford, Chrysler, and GM that they will not poach engineers and designers from one another during the six-month period preceding the debut of new models. They’d no doubt love to adopt an agreement like that, but their lawyers would wisely counsel against doing so.

Members of the AALS, of course, contend that their little arrangement is fine. First, they insist it’s merely a “statement of good practices,” not an actual agreement, which is necessary to satisfy the “contract, combination, or conspiracy” element of Sherman Act Section 1. In addition, they maintain, it’s not an “unreasonable” restraint of trade. They’re wrong on both points.

As anyone who’s spent time teaching in a law school knows, law school administrators treat the hiring arrangement as though it is an actual agreement that binds them. They speed up recruiting to ensure that they make lateral offers before the cut-off dates. They talk to each other about the arrangement as though they recognize it as a common commitment.  Moreover, even if the arrangement were not the product of an express agreement, a reasonable factfinder would infer agreement from the fact that the law schools, in collectively adhering to the “good practice,” are engaging in consciously parallel behavior that would make no sense to adopt unilaterally (i.e., any law school that unilaterally adopted a policy of refusing to poach from its rivals after a certain date would hurt itself without procuring any economic benefit).  Thus, there is no question that the arrangement represents an antitrust “agreement” under prevailing legal standards.

The restraint is also unreasonable.  Most likely, the agreement would be deemed a “naked” restraint of trade.  Herbert Hovenkamp has written that “a serviceable definition of a naked restraint is one whose profitability depends on the exercise of market power.”  (The Antitrust Enterprise: Principle and Execution 112 (2005).)  If the participants in this agreement didn’t have market power — e.g., if only 20 of the nearly 200 law schools in the AALS adopted this policy — the policy wouldn’t really work.  An exercise of market power seems to be required for the arrangement to have efficacy, so the restraint is probably naked.  And if it’s naked, then it’s per se unreasonable and thus illegal.

But even if the arrangement is not naked, it would be condemned under a more probing analysis — either a “quick look” or a full-on rule of reason analysis.  Because it precludes law professors from procuring other offers when they’re most valuable to their existing employers (and thus in the best position to extract salaries approaching their actual worth), the arrangement systematically drives faculty salaries below the levels that persist in free competition.  This is especially galling because most law professors do not learn what they will be paid the following year until after the deadline for procuring another offer has passed.

The law schools would contend, of course, that this anticompetitive effect is outweighed by an important benefit: avoidance of the disruption that inevitably occurs when a professor resigns late in the spring term, after the fall schedule has been completed and students have selected courses.  There are at least two problems with that argument.

First, the argument really amounts to an assertion that vigorous competition among schools for professor talent is itself unreasonable because it leads to messy results.  The Supreme Court has rejected that line of argument in no uncertain terms.  In the Professional Engineers case, the Court condemned an agreement among engineers not to discuss price with potential clients, despite the engineers’ insistence that the agreement was necessary to prevent the shoddy design work that would result from low engineering prices.  The engineers’ public safety argument would not fly, the Court concluded, because “the Rule of Reason does not support a defense based on the assumption that competition itself is unreasonable.”  The Court explained that the Sherman Act is premised on “[t]he assumption that competition is the best method of allocating resources in a free market,” and it insisted that “[e]ven assuming occasional exceptions to the presumed [good] consequences of competition, the statutory policy precludes inquiry into the question whether competition is good or bad.”  Thus, the competing law schools can’t agree not to compete for labor just because doing so is hard.

Second, even if the policy at issue creates a good effect — reduced disruption from untimely resignations — there are less restrictive means of securing that end.  Each individual law school could negotiate resignation rules with its own professors.  For example, a law school could agree with its professors that they may not resign after Date X, and it could even bargain for a liquidated damages provision that would compensate it for any disruption occurring from breach.  Law schools would then compete with each other on this contract term — some would allow later resignations than others.  They could even have different resignation dates for different professors.  This sort of unilateral, non-collusive solution to the problem of untimely resignations would preserve competition for labor resources, causing them to be allocated more efficiently.

Of course, the members of the AALS know that they’re unlikely to be sued over this policy.  After all, any disgruntled law professors that brought suit over the policy would signal that they are prone to litigate and would thereby reduce their attractiveness as lateral candidates.  You’d think, though, that the AALS would show a little more respect for the law. 

Filed under: antitrust, cartels, law school

In recent years, antitrust scholars have largely agreed on a couple of propositions involving tying and bundled discounting. With respect to tying (selling one’s monopoly “tying” product only on the condition that buyers also purchase another “tied” product), scholars from both the Chicago and Harvard Schools of antitrust analysis have generally concluded that there should be no antitrust liability unless the tie-in results in substantial foreclosure of marketing opportunities in the tied product market. Absent such foreclosure, scholars have reasoned, truly anticompetitive harm is unlikely to occur. The prevailing liability rule, however, condemns tie-ins without regard to whether they occasion substantial tied market foreclosure.

With respect to bundled discounting (selling a package of products for less than the aggregate price of the products if purchased separately), scholars have generally concluded that there should be no antitrust liability if the discount at issue could be matched by an equally efficient single-product rival of the discounter. That will be the case if each product in the bundle is priced above cost after the entire bundled discount is attributed to that product. Antitrust scholars have therefore generally endorsed a safe harbor for bundled discounts that are “above cost” under a “discount attribution test.”

In an article appearing in the December 2009 Harvard Law Review, Harvard law professor Einer Elhauge challenged each of these near-consensus propositions. According to Elhauge, the conclusion that significant tied market foreclosure should be a prerequisite to tying liability stems from scholars’ naïve acceptance of the Chicago School’s “single monopoly profit” theory. Elhauge insists that the theory is infirm and that instances of tying may occasion anticompetitive “power” (i.e., price discrimination) effects even if they do not involve substantial tied market foreclosure. He maintains that the Supreme Court has deemed such effects to be anticompetitive and that it was right to do so.

With respect to bundled discounting, Elhauge calls for courts to forego price-cost comparisons in favor of a rule that asks whether the defendant seller has “coerced” consumers into buying the bundle by first raising its unbundled monopoly (“linking”) product price above the “but-for” level that would prevail absent the bundled discounting scheme and then offering a discount from that inflated level.

I have just posted to SSRN an article criticizing Elhauge’s conclusions on both tying and bundled discounting. On tying, the article argues, Elhauge makes both descriptive and normative mistakes. As a descriptive matter, Supreme Court precedent does not deem the so-called power effects (each of which was well-known to Chicago School scholars) to be anticompetitive. As a normative matter, such effects should not be regulated because they tend to enhance total social welfare, especially when one accounts for dynamic efficiency effects. Because tying can create truly anticompetitive effect only when it involves substantial tied market foreclosure, such foreclosure should be a prerequisite to liability.

On bundled discounting, I argue, Elhauge’s proposed rule would be a disaster. The rule fails to account for the fact that bundled discounts may create immediate consumer benefit even if the seller has increased unbundled linking prices above but-for levels. It is utterly inadministrable and would chill procompetitive instances of bundled discounting. It is motivated by a desire to prevent “power” effects that are not anticompetitive under governing Supreme Court precedent (and should not be deemed so). Accordingly, courts should reject Elhauge’s proposed rule in favor of an approach that first focuses on the genuine prerequisite to discount-induced anticompetitive harm—“linked” market foreclosure—and then asks whether any such foreclosure is anticompetitive in that it could not be avoided by a determined competitive rival. To implement such a rule, courts would need to apply the discount attribution test.

The paper is a work-in-progress. Herbert Hovenkamp has already given me a number of helpful comments, which I plan to incorporate shortly. In the meantime, I’d love to hear what TOTM readers think.

Filed under: antitrust, bundled discounts, economics, error costs, exclusionary conduct, law and economics, price discrimination, regulation, SSRN, tying

It’s pretty hard to cycle through the University of Chicago Law School (or at least it used to be back when I was a student) without gaining an appreciation for the extent to which markets, while subject to occasional failures, enhance human welfare by channeling resources to their highest and best ends. It’s also hard to spend much time at Chicago without coming to understand that government interventions, despite the best intentions of the planners, often fail, given planners’ limited knowledge (see, e.g., Hayek) and bureaucrats’ tendencies to act, like the rest of us, in a self-interested fashion (see, e.g., the public choice literature). Indeed, even left-leaning Chicagoans like Cass Sunstein, for whom I have tremendous respect, appreciate these ideas and therefore tend to advocate (somewhat) limited government interventions that are targeted at real market failures and that preserve space for private ordering. (See, e.g., Sunstein’s “libertarian paternalism,” which has occasionally been derided on this blog but is a far cry from the “paternalist paternalism” we’ve been seeing from the current Administration.)

When President Obama was elected, I hoped and expected that his time at Chicago would influence his policy prescriptions. It hasn’t done so. Not only did he push through two of the most market-insensitive and government-confident pieces of legislation in modern history (the stimulus and the health care law), but even his “move to the center” speech following a mid-term shellacking advocated central planning in the form of pick-the-winner “investments” in green technologies, high-speed rail, etc. His answer to economic stagnation isn’t sound money and the creation of institutions that permit entrepreneurs to flourish without fear of excessive regulation and confiscation. Instead, he wants government to step up and push America forward, as it did in the space race with the Russians: “This is our generation’s Sputnik moment!”

I’ve often wondered how Mr. Obama managed to spend so many years at Chicago without absorbing the ideas that seem to saturate the place. Richard Epstein offers an answer in today’s Wall Street Journal (which quotes an interview Epstein gave to Reason TV):

Reason: The economy has lost 3.3 million jobs, consumer confidence is half its historical average, and unemployment is 9 percent. To what extent is Obama responsible for this?

Richard Epstein: He’s not largely or exclusively responsible, but he’s certainly added another nail into the coffin. The early George Bush—I think he got a little bit better through his term—and Obama have a lot in common. Bush wanted a pint-sized stimulus program that failed and Obama wanted a giant-sized stimulus program that failed. Neither of them is a strong believer in laissez-faire principles. The difference between them, which is why Obama is the more dangerous man ultimately, is he has very little by way of a skill set to understand the complex problems he wants to address, but he has this unbounded confidence in himself.

Reason: So he’s the perfect Chicago faculty member.

Epstein: He was actually a bad Chicago faculty member in this sense: He was an adjunct, and we always hoped he’d participate in the general intellectual discourse, but he was always so busy with collateral adventures that he essentially kept to himself. The problem when you keep to yourself is you don’t get to hear strong ideas articulated by people who disagree with you. So he passed through Chicago without absorbing much of the internal culture.

So that’s it….

Filed under: markets, musings, politics

In a must-read op-ed in today’s Wall Street Journal, Yale Law’s Jonathan Macey weighs in on Goldman Sachs’s decision to allow only foreign gazillionaires — no Americans, regardless of their wealth or sophistication — to invest in new shares of Facebook.

Numerous observers have portrayed Goldman’s move as a “victory for the SEC.”  The New York Times‘ Dealbook called it “a serious embarrassment for Goldman.”  In reality, Macey contends, “[i]t is the SEC that should be embarrassed” for fostering a system in which, as Larry put it,  “the US securities laws exclud[e] US investors from investing in a US company in the US.”

Echoing a number of Larry’s observations, Macey explains:

Thanks to SEC regulation and the litigious atmosphere it fosters — not to mention Sarbanes-Oxley’s onerous burdens on corporate executives — the whole capital formation process is moving offshore. The U.S. share of total equity raised in the world’s capital markets is shrinking, while the number of U.S. companies listing their shares for trading exclusively in foreign markets has risen steadily for the past five years.

Macey then points a finger at the SEC’s overarching regulatory philosophy, which views investors — even rich, sophisticated ones — as needing governmental protection and displays scant regard for the unintended consequences of paternalistic limitations on the freedom of contract:

The SEC’s fundamental approach to regulation involves depriving investors of opportunities in order to protect them. This was not much of a problem in the immediate post-World War II period. Before Japan and Europe rebuilt, and before China emerged as an economic giant, the U.S. had the only large pools of investment capital in the world and dominated the financial scene. During this happy period of U.S. primacy, the SEC, along with most academics, took the rather ludicrous view that it actually deserved the credit for the primacy of U.S. capital markets. That world is long gone.

Still, according to the SEC, all investors large and small must be protected against the danger that they will succumb to a feeding frenzy of enthusiasm when given the opportunity to invest in a new deal. For example, the SEC rules governing the Facebook offering until Goldman pulled the plug include the requirement that the stock being sold “cannot be the subject of advertising, general promotional seminars or public meetings in connection with the offering.” The concern here is that publicity about a deal might, heaven forbid, create interest among investors. …

The investors who supposedly are being protected by the SEC’s rules here are not unsophisticated small investors. Goldman had limited the marketing of Facebook’s shares to the billionaires and large institutions that constitute its wealthiest clients.

Finally, Macey suggests that the Obama Administration, which has recently committed itself to ferreting out cost-ineffective regulations that “make our economy less competitive,” take a long, hard look at the “investor-protective” securities rules that drive capital overseas and prevent American investors from having access to the wealth-enhancing opportunities available to their European and Asian friends:

Ironically, the Goldman decision to move the Facebook deal offshore was announced just as President Obama was acknowledging in these editorial pages that “regulations do have costs” and saying that he would order a government-wide review to eliminate rules that cripple economic growth. That review should include the rules promulgated by the SEC, lest we continue to see U.S. capital markets fade into irrelevance.

If we ever get another President who believes that markets, while imperfect, generally work well, that government intervention often fails to make things better, and that regulations should be narrowly tailored to fix legimitate market failures, he or she should look hard at Prof. Macey for a spot on the SEC.