Firms as Irrational Actors

The leadoff article in the Competition Policy International Journal‘s (paywall) recent “focus issue” on behavioral economics is a primer on the literature regarding systematically irrational behavior by firms and its implications for competition law and policy. The topic is in itself unusual, as the authors Mark Armstrong and Steffan Huck note, inasmuch as a large part of the research on sub-optimal decision making focuses on consumers. Firms, by contrast, are frequently presumed–especially by courts and policymakers–to be model rational actors. The results surveyed by the authors strongly suggest that this is very frequently not the case.

One example with significant practical consequences is the manner in which cartel formation deviates from theoretical models under the influence of different enforcement regimes. Game theory predicts the ineffectiveness of leniency programs, such as those employed by competition authorities in the US and Europe, under which lower penalties or complete amnesty are given to the first participant to turn in a price-fixing conspiracy. Theories postulate that leniency can even encourage cartel formation because rational participants can use it as an enforcement mechanism to punish cheaters. But experimental results have found lower prices and incidence of cartel formation under leniency. The reasons for these deviations from rational maximization are speculative, but the fact that they occur is highly relevant to the formulation of competition policy.

Similar results are also relevant to the emerging practice by US courts of evaluating and often dismissing antitrust complaints based on their facial “plausibility” without allowing any investigation of the actual facts underlying a claim:

Courts and regulators in some jurisdictions may not consider seriously conduct (such as predatory pricing, for instance) which does not appear to make “business sense” according to their judgment. Leslie reports that “if a plaintiff’s complaint describes a conspiracy that the judge concludes is irrational, then the court rules that the conspiracy must not have happened as a matter of law, regardless of the evidence presented by the plaintiff to support its claim.” In the light of the theories and evidence reported in this article, we suggest that a dogmatic attitude towards the pervasiveness of business rationality may lead to instances where harmful behavior goes unpunished.

I will be watching for how lawyers use the growing body of behavioral economic evidence in this area to oppose dismissal in antitrust cases, and whether courts will pay it any heed.

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