Principal agent relationships in competition policy

1. Principal agent relationships in competition policy John FingletonCEO, OFT February 2012, Paris

2. Overview Two main areas where principal agent relationships affect competition policy • Supply side issues • To what extent should principal agent relationships fall outside of competition law? • Demand side issues • Do principal agent relationships raise particular problems for the well functioning of markets?

3. Principal Agent Issues • Principal-agent issues are inherent in many organisational structures: • Labour – employer and employees. • Franchises – franchisor and franchisee. • Regulation – regulator and regulated company • Investors – shareholders and executives • Issues arises when the principal can not directly observe effort of the agent. • The more distant the relationship, the bigger the principal agent issue may be.

4. Principal Agent Relationships • Different organisation structures may attempt to minimise these issues through different methods: • Use of incentive contracts and vertical restraints in order to align upstream and downstream incentives: • Commissions paid on sales by downstream. • Restraints on who downstream can sell to and where. • Contractual obligations regarding quality of services. Agency relationship Use of vertical restraints Wholesaler relationship Vertical integration Low Downstream party’s degree of independence from upstream High

5. Demand side issues

6. Consumer decision making • Consumers decision making open to biases from ways in which products are presented. • Framing of prices makes a difference. • Ranking of prices makes a difference. • Concern when incentive relationships between the intermediary and sides of the market are not clear. • Particularly difficult in sales of experience or credence goods. • Four examples of OFT work.

7. Example One: Estate Agents Instruction to sell Property Information Offer passed on Offer made • OFT market study into estate agents. • Two sided market between buyers and seller. • May also have incentive contracts with mortgage brokers and surveyors and other complementary service providers. • Multiple responsibilities may create conflicting incentives – which may distort advice provided to customer and hence market outcomes.

8. Example Two: Car insurance • OFT market study into Private motor insurance. • Insurers may have additional relationships with repairers and hire car companies. • Provide ‘credit hire replacement vehicles’ to customers who are in accident (and not at fault). • Some evidence of specific lists of ‘approved repairers’ with different prices for third party repairs. • Referral fees from personal injury specialists to insurers for identifying potential claims. • Party who pays may not be the same as the party who benefits – creating misalignment of incentives – particularly if beneficiary receives referral fee.

9. Example Three: Mobility Aids • OFT examined the market for mobility aids • NHS procures mobility aids from various companies. • Public is then provided mobility aids by NHS. • NHS incentives skewed towards cheaper upfront prices at expense of whole life cost due to budgetary timing issues. • Purchasing department/budget not same as maintenance department and budget. • Result that customers may not get what they want, and NHS may spend more than necessary. • Note: • Given difficulties in the privately bought market it is not entirely clear that customers themselves would necessarily make better decisions if they purchased themselves.

10. Example Four: Price Comparison Sites • Key drivers of competition on consumer side is the accessing and assessing of competing offers. • Price comparison sites can play a key role in this by facilitating both the access and assessment of offers. • However information may be distorted if sites have other incentives which are not clear to consumers. • If site is owned by one of the firms they are promoting. • Sites may not contain all offers, or only those which have paid to appear on the site. • Sites may accept payments to promote certain products above other products. • In such cases comparison sites may hinder the competitive process more than benefiting it.

11. Conclusions on demand side • Principal agent relationships may give superficial impression of competition. • Principal agent issues may be particularly common in intensely competitive markets. • Less about anti-competitive behaviour and more about poor competitive equilibria. • Advocacy and consumer policy may be more important tool than competition policy.

12. Supply side issues

13. Economics of Agency Exception • From an economic point of view, competition law should strive to be organisationally neutral • Firms should be free to choose the most efficient structure and should not have incentives to vertically integrate versus other contractual relationships if the outcome is the same. • If the upstream and downstream firms are structured such that they are exactly analogous to a vertically integrated firm, then any vertical agreements within such a structure will have no worse an impact than any internal agreements within a vertically integrated company. • Provides economic rationale behind treatment of ‘Genuine agency’ relationships in competition law.

14. Economics of Agency Exception • Economic view implies two elements for consideration to ensure both no competition problems and organisational neutrality: • If answer to first is no, and second is yes, then any agreements between upstream and downstream will not create a competitive problem. Would the creation of a vertically integrated firm between the downstream and upstream pose a problem for competition? • Does the Agency agreement create a relationship analogous to a vertical integrated firm?

15. Agency Exception • Key legal question is if Principal-Agent relationship should be treated as the equivalent of single undertaking. • If there is a single economic unit for competition law purpose, there is no agreement between two undertakings – and therefore Article 101 does not apply to certain restrictions relating to the sale of goods or services by the agent on behalf of the principal. • Note that a firm may not be considered a ‘Genuine agent’ but may still be an agent for contract law purposes. • BUT: Genuine Agency exemption is limited in scope: • Restrictive agreements between principal and agents that do not relate to the sale of goods or services by agent on behalf of principal (e.g. exclusivity agreements upstream or downstream), do not escape 101(1).

16. Rationale for Agency Exception • Legal and economic views consider similar questions to determine whether a ‘Genuine Agency’ agreement will be harmful: • Is the Principal-Agent relationship analogous to a single economic unit and such may be treated as if they are single vertically integrated entity? • Are there other elements of the Principal-Agent relationship unrelated to the sales of goods or services by the agent, that harm competition (e.g. exclusivity)? • Sometimes difficult to disentangle. • Fact that an agent can impose certain restrictions on a principal relating to the principal’s commercial strategy (e.g. MFN clauses) may be an indication it is not a “Genuine Agent”.

17. What makes a Genuine Agent? • What factors may be important? • the allocation of risks between principal and agent, including risks relating directly to the contract between principal and agent as well as risks arising from market-specific investments and other risks; • whether there are relationships between a single agent and multiple competing principals or multiple overlapping relationships between several competing principals and agents; • factors that affect the bargaining strength of the agent, • pricing structures and the relative degree of control over pricing and commercial policy decisions generally

18. What is at stake? • Highly important: • Don’t want firms to simply restructure agreements as agency relationships in order to bypass competition law. • However don’t want to penalise or increase regulatory burden of efficient organisation structures. • Potential area for work in the future.

19. Thank-you John Fingleton