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Article Excerpt
In its landmark ruling in Illinois Brick Co. v. Illinois in 1977, the US. Supreme Court restricted standing to sue for recovery of antitrust damages to direct purchasers. However, antitrust damages are typically (in part) passed on to intermediaries lower in the chain of production and ultimately to consumers. We show that the Illinois Brick rule facilitates collusion. It allows an upstream cartel to shield itself from private damage claims by forwarding a share of cartel profits to its direct purchasers. These benefits dissuade the direct purchasers from exercising their exclusive right to sue for private damages. The cartel can achieve this by rationing inputs at low prices. Several U.S. antitrust cases show symptoms of "Illinois Walls."
1. Introduction
* Under Section 4 of the Clayton Act, victims of anticompetitive behavior can claim treble damages in civil actions. Antitrust overcharges upstream in longer vertical chains of production are typically (partially) passed on, affecting intermediary markets and ultimately consumers. As a result, determining the dispersed antitrust damages and to whom they accrue is complicated. Two Supreme Court rulings, Hanover Shoe Inc. v. United Shoe Machinery Corp. in 1968 and Illinois Brick Co. v. Illinois in 1977, have, however, significantly reduced the complexity of private antitrust damage claims. (1)
In Hanover Shoe, the defendant was United Shoe Machinery Corp., which had earlier been convicted of monopolization through long-term leasing contracts. United Shoe claimed that the plaintiff, Hanover Shoe Inc., one of its direct purchasers, had not in fact been injured by these anticompetitive contracts, because Hanover Shoe had been able to pass any price increases on to its own customers. The Supreme Court ruled against this defensive use of the pass-on argument, finding that it would unduly lengthen and complicate antitrust cases, dissipate private incentives to seek antitrust injury recovery, and undermine deterrence. As a result, a direct purchaser is entitled to claim damages to the extent it was overcharged on its input purchases, irrespective of whether it was able to pass the higher input price on to its customers.
In Illinois Brick the State of Illinois claimed, in conjunction with several hundred local governmental entities, to have been harmed by Illinois Brick Co. in a conspiracy to fix the prices of concrete blocks used in public construction projects. The plaintiffs argued that the antitrust overcharge on their contractors had been passed on to them. The Supreme Court disallowed this offensive use of the pass-on argument, thus setting a companion standard to Hanover Shoe. The plaintiffs were denied compensation and the precedent was set that only direct purchasers can seek recovery of damages from firms that violate federal antitrust laws.
Starting with the considerations leading up to the Supreme Court's vote itself, the Illinois Brick decision has been heavily disputed. (2) Whereas Hanover Shoe may allow parties to claim compensation for damages they did not actually sustain, Illinois Brick potentially withholds compensation to parties that did incur passed-on anticompetitive price increases. Immediately after the decision, bills to overrule Illinois Brick were proposed in both the Senate and House of Representatives--but never enacted.
An important legal base for Illinois Brick lies in a potential problem of multiple liability that Hanover Shoe created. Because direct purchasers are entitled to the full price increase on the total volume by the latter standard, the Court was apprehensive that allowing indirect purchasers standing as well could effectively expose defendants to an accumulation of damage claims.
The two decisions were further defended on economic grounds. In their testimony to the Senate, Landes and Posner (1979) took the view that the intent of Congress passing the Clayton Act with treble antitrust damages had first and foremost been to strengthen deterrence by creating a strong private channel of policing, alongside public enforcement. Illinois Brick should accordingly be judged under an efficiency criterion rather than concerns of fair compensation. Companies that purchase directly from a cartel are more likely to become suspicious of its existence and are better able to collect relevant evidence than indirect purchasers. Restricting standing to the direct purchasers therefore provides the best incentives to uncover cartels. At the same time, the rule prevents multiple individually litigated cases for the fragmented indirect purchaser damages caused by a single violation, which would create wasteful legal transaction costs. (3)
Later case law has somewhat relaxed the restrictions imposed on indirect purchasers. Since the 1981 Supreme Court decision in J. Truett Payne Co., Inc. v. Chrysler Motors Corp., parties that only deal with cartel members indirectly can nevertheless ask in a civil action for injunctions to break up the upstream cartel in state courts. (4) Also, in its 1989 decision in California v. ARC America Corp., the Supreme Court left it to the discretion of individual states whether or not to allow lawsuits by indirect purchasers. (5) As a result, the rules on antitrust standing vary across states, with presently a small majority allowing lawsuits by indirect purchasers under state law. (6) Support for the view that the Illinois Brick rule should be overturned is mounting, yet the rule remains an important constraint in U.S. private antitrust enforcement. (7)
In this article, we develop a new efficiency argument against Illinois Brick by showing that the rule can facilitate tacit collusion between suppliers. Under Illinois Brick, an upstream cartel can prevent private litigation as long as it assures that its direct purchasers downstream benefit more from the existence of the cartel than they can claim antitrust damages for. Illinois Brick is instrumental in making this possible. The cartel will typically reduce total welfare, yet often generates sufficiently large cartel profits to share with direct purchasers in return for their silence. By ruling out lawsuits by indirect purchasers, Illinois Brick enables the cartel to focus side payments on only the affected parties with standing to sue. The direct purchasers benefit with the cartel members at the expense of the rest of the chain of production and final consumers. The cartel is effectively shielded from exposure through private litigation by an "Illinois Wall" of direct purchasers.
We study conditions under which such Illinois Walls exist. The upstream cartel can imply its direct purchasers in various ways--ranging from hush money to grease the palms of key decision makers to overt money transfers between companies. (8) Yet, a scheme that abuses Illinois Brick has to satisfy a number of conditions. First, the cartel has to forward profits in excess of the direct purchasers' gain from bringing a civil action--which, because of treble damages, typically is a lot of money. Second, no direct purchaser should have an incentive to benefit from the side payments for some time first and then nevertheless bring a claim. Third, cartel profits net of these side payments must be larger than upstream competitive profits. Fourth, none of the upstream firms should benefit from defecting the cartel. Finally, the arrangement should not leave any evidence of the direct purchasers' involvement, because the Illinois Brick rule includes exceptions in which indirect purchasers can sue if it can be proven that the direct purchaser co-conspired. (9)
One compensation scheme that satisfies these constraints puts all direct purchasers on allocation at low input prices. That is, the upstream cartel sells a rationed amount of inputs to each of its direct purchasers. This creates an artificial scarcity on the downstream market, from which the direct purchasers benefit through high sales prices. Combined with low input prices, the allocation mechanism forwards part of the cartel profits to the cartel's direct purchasers. (10) The arrangement is tacit, simple, and covert. No money changes hands. The deal requires little or no communication and will in all likelihood leave few traces and no hard evidence, so that it can escape private litigation under the antitrust laws by indirect purchasers or consumers. Hence, the upstream industry is free to collude, constrained only by the risk of public prosecution or shareholder lawsuits, from which we abstract in this article.
Our analysis relates to a literature on incentive effects of private damage claims and their contribution to efficiency. Salop and White (1986) survey aspects and empirics of private antitrust enforcement. The authors view Illinois Brick as the courts "trimming plaintiffs' powers and strengthening defendants' powers ... so as to regain the desired overall balance" (p. 1039). Besanko and Spulber (1990) extend the position of Landes and Posner (1979) that private antitrust enforcement provides a more direct, and therefore better informed, enforcement channel, which enhances legal efficiency. Under asymmetric information, the efficiency of private litigation can be exploited through a sufficiently high damage multiple. Salant (1987) shows instead that increasing the damages multiple may raise market prices when firms incorporate the threat of private penalties in their objective functions. For this reason, Baker (1988) criticizes the private antitrust damage system when buyers are informed and foresee damage awards. In addition, Briggs, Huryn, and McBride (1996) identify an externality of private action on public litigation, as the threat of massive private follow-on litigation may delay efficient settlements in government prosecutions. In Harrington (2004a), it is shown how all former cartel members may noncooperatively price above competitive levels, knowing that a low post-cartel price level translates into large private antitrust damage claims.
The remainder of this article is organized as follows. In the next section, we model a vertical chain of production and formally define Illinois Walls. Section 3 analyzes sufficient conditions for the existence of stationary Illinois Walls. In Section 4, we establish that there is more scope for abuse of Illinois Brick the more competitive markets otherwise are. Section 5 surveys some antitrust cases that show symptoms of Illinois Walls. Section 6 concludes....
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