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Estimating Monopoly Power with Economic Profits
U.C. Davis Bus. L. J. (2010)
  • Michael A. Williams
  • Kevin Kreitzman
  • Melanie S. Williams, California State University, Northridge
  • William M. Havens
Abstract

Monopolization and attempted monopolization are prohibited by section 2 of the Sherman Act. Proving the existence of monopoly power, however, is problematic. While direct evidence is sometimes available, more often courts rely on indirect—and sometimes highly disputed—evidence that firms have obtained or attempted to obtain monopoly power. Courts have been reluctant to rely on direct evidence of supra-normal profits as proof of monopoly power because (1) accounting profits as recorded in firms’ financial statements differ from economic profits, which fundamentally determine whether a firm as monopoly power, and (2) short-term, supra-normal profits are not, by themselves, evidence that a firm has monopoly power.

However, using a discounted cash flow approach for firm valuation (the Miller-Modigliani “MM” framework) a dynamic estimate of a firm’s economic profits over an extended period of time, either for individual lines of business or for the firm as a whole, can be estimated using the firm’s transaction records. When transaction records are unavailable, analysts can reverse-engineer them using the firm’s financial accounting records. The implications of this analysis are important: rather than relying on indirect methods of estimating the degree of a firm’s market power in a given market (with such heavily litigated issues as market definition and the characterization of high market shares and barriers to entry), analysts can instead examine a firm’s financial records to generate direct evidence of monopoly power in one or more of the markets in which that firm competes. Since an analysis based on the MM framework permits a reverse engineering of accounting records to determine market power, and since both private and publicly traded companies maintain such records in the ordinary course of business, determining whether a firm has a monopoly power in a given market will be more reliable and straightforward.

Keywords
  • antitrust,
  • market power,
  • Sherman Act,
  • economic profits,
  • accounting
Disciplines
Publication Date
2010
Citation Information
10 U.C. Davis Bus. L. J. 125 (2010).