The market power model of contract formation: how outmoded economic theory still distorts antitrust doctrine.

• Author: Meese, Alan J.
• Position: Introduction to II. Price Theory, Workable Competition, and The 'Market Power' Model of Contract Formation D. Chicago's Elaboration and Internal Critique, p. 1291-1331

Transaction cost economics ("TCE") has radically altered industrial organization's explanation for so-called "non-standard contracts," including "exclusionary" agreements that exclude rivals from access to inputs or customers. According to TCE, such integration usually reduces transaction costs 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 once hostile to such contracts. Still, old habits die hard, even for courts of increasing economic sophistication. This Article critiques one such habit, namely, courts' continuing claim that firms use market or monopoly power to impose exclusionary contracts on unwilling trading partners. In so doing, the Article takes issue with both the Harvard and Chicago Schools of Antitrust, normally seen as antagonists, each of which has erroneously embraced the "market power" model of contract formation.

For the last several decades, courts have premised particular rules of antitrust liability upon the assumption that firms used 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 [section] 2 of the Sherman Act, without any additional showing that the agreement produced economic harm. Following similar logic, courts enforcing [section] 1 of the Act have banned tying agreements obtained by firms with market power, reasoning that sellers used their power to "force" buyers to enter such contracts. Finally, courts have invoked the market power model when holding that dealers or consumers can challenge unlawful agreements they have themselves entered and enforced, contrary to the common law doctrine of in pari delicto ("in equal fault"). Courts have reasoned that plaintiffs' participation in such contracts is involuntary, because defendants use market power to impose them. While modern courts sometimes consider evidence that such agreements produce benefits, they nonetheless assume that sellers employ market power to impose them and treat such coercive imposition as a harm coexisting with any efficiencies.

These doctrines survive to this day, along with the market power model of contract formation, despite courts' increasing economic sophistication. This Article locates the origin of these doctrines and the market power model in price theory's workable competition model, 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 imposed such contracts against the will of trading partners. Courts embraced this 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.

In the past few decades, TCE has emerged as a competing paradigm for evaluating non-standard contracts. Building on the work of Ronald Coase, practitioners of TCE argued that many such contracts, including those that "exclude" rivals, can reduce the cost of transacting, particularly anticipated costs of opportunism made possible by relationship-specific investments. While most practitioners of TCE have ignored the means by which such contracts are formed, Coase himself once indicated that such integration was "voluntary," albeit without elaboration. This Article elaborates on prior work by the author and others showing 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. While courts have sometimes invoked TCE's beneficial characterization of such agreements, they have not recognized the implication, examined here, that such contracts are purely voluntary, clinging instead to the decades-old conclusion that firms use preexisting market power to impose them.

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 impose 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 doctrines that depend upon the "market power" model of contract formation in favor of more direct analysis of the economic impact of challenged practices. This admonition cuts both ways. On the one hand, plaintiffs should not prevail or establish a prima facie case in monopolization or tying litigation simply by showing that a firm with power has "imposed" an exclusionary agreement. At the same time, recognition that voluntary exclusionary rights agreements can produce anticompetitive harm undermines the Chicago School claim that failure to establish preexisting market power should doom challenges to ties and other agreements scrutinized under [section] 1 of the Sherman Act. Second, and in the same vein, 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.

INTRODUCTION

More than a generation ago industrial organization witnessed a scientific revolution in the form of transaction cost economics (TCE). The transaction cost approach offered a radically different interpretation of various forms of contractual integration that economists and judges had previously condemned as anticompetitive. In particular, proponents of this new approach provided explanations for non-standard agreements, which constrained dealers or customers after a sale. These scholars contended that, while apparently anticompetitive, such agreements in fact often minimized the costs of relying upon an otherwise atomistic market to conduct economic activity and thereby enhanced economic welfare.

Not surprisingly, TCE has exerted a growing influence on antitrust doctrine over the past few decades, with courts invoking its beneficial account of various non-standard agreements to justify revision of doctrines once hostile to such contracts. Still, old habits die hard, even when courts of increasing economic sophistication articulate antitrust doctrine. This Article identifies and critiques one such habit, namely, the propensity of courts to characterize certain agreements as expressions of market or monopoly power "used" to impose contracts on unwilling trading partners. This habit, it will be shown, originated in neoclassical price theory, which two schools of antitrust thought ordinarily viewed as antagonists--Harvard and Chicago--embraced as a methodology for understanding how such agreements are formed.

For the last several decades, beginning in antitrust law's "inhospitality era," courts have premised particular rules of liability upon the assumption that firms with market power used that power to "coerce" or "force" trading partners to enter certain contracts, particularly contracts excluding rivals from portions of the market. Most notably, courts have held that a monopolist that "used" its power to obtain an exclusionary agreement thereby violated [section] 2 of the Sherman Act, without any additional showing that the agreement produced economic harm. Following similar logic, courts enforcing [section] 1 of the Act banned all tying agreements obtained by firms with the slightest market power, reasoning that sellers used their power to "force" buyers to enter such contracts. Like the "use" of monopoly power to impose exclusionary agreements, such "forcing" was unlawful per se, without any additional proof of harm.

The market power model of contract formation did more than influence substantive antitrust doctrine. The model also helped courts decide who can challenge unlawful conduct. In particular, courts have held that dealers or consumers can challenge unlawful agreements they have themselves entered and enforced. Although the common law doctrine of in pari delicto ("in equal fault") ordinarily prevented parties from challenging agreements they had helped negotiate, courts declined to invoke this bar, reasoning that participation by consumers and dealers in such contracts was involuntary, because manufacturers had used market power to impose such agreements against plaintiffs' will. Courts even applied this logic to non-exclusionary agreements such as resale price maintenance, which raised the prices dealers could charge consumers.

Applying the teachings of TCE, courts have modified or abandoned many doctrines announced during the inhospitality era. Nonetheless, doctrines based upon the market power model of contract formation survive to this day. For instance, the Supreme Court's most recent treatment of exclusionary contracts...