The Market Power Model of Contract Formation: How Outmoded Economic Theory Still Distorts Antitrust Doctrine

Transaction cost economics ( TCE ) has radically altered industrial organization\u27s 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\u27s 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\u27continuing 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 \u27force trading partners to enter exclusionary agreements. Most notably, courts have held that a monopolist\u27s use of such power to obtain an exclusionary agreement violates § 2 of the Sherman Act, without any additional showing that the agreement produced economic harm. Following similar logic, courts enforcing § 1 of the Act have banned tying agreements obtained by firms with market power, reasoning that sellers used their power to \u27force 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 \u27participation 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\u27 increasing economic sophistication. This Article locates the origin of these doctrines and the market power model in price theory\u27s 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\u27s 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\u27 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