Violations and Competition

For years, the Environmental Protection Agency and companies have been settling enforcement cases that do not involve criminal charges. These out-of-court settlements involve a company agreeing to pay a fine set by EPA and to carry out any special requirements that the agency sets, such as auditing corporate compliance with environmental standards. In contrast, federal judges set fines in criminal cases after hearing testimony from expert witnesses. Money paid for all enforcement penalties goes to the U.S. Treasury.

The fines EPA proposes for settlements are designed to punish a company based on how serious the violation was and to recoup any economic benefit the business gained from its noncompliance. For the past 20 years, the agency has used two measures of economic benefit: the costs that a company avoids or the costs that it delays by not complying with an environmental rule. This financial benefit might stem from activities such as failing to maintain pollution control equipment or to file required paperwork.

EPA has considered broadening these measures of economic benefit of violations by adding a third category called "illegal competitive advantage." One example of this, according to EPA, is selling products that are banned. Another, the agency says, is a firm that is not obeying laws and thus gains a larger portion of the market by selling its products at a lower cost than its competitors that are complying with regulations.

Industry groups are upset with EPA's plans to recoup illegal competitive advantage through settlement fines, saying most of the agency's arguments don't make good economic sense (C&EN, Feb. 26, 2001, page 32). But agency enforcement officials have pushed forward with the idea. To help settle the issue, EPA has sent the plan to its Science Advisory Board (SAB).

On Aug. 5–6, an SAB panel of economists pored over the agency's proposed justification for collecting fines to offset a company's illegal competitive advantage from violations. The economists expressed skepticism about much of the agency's rationale on illegal competitive advantage.

The committee agreed that changes in a company's profits is the primary factor EPA needs to watch in determining whether a company has made an economic gain from a violation, said A. Myrick Freeman III, chairman of SAB's Illegal Competitive Advantage Economic Benefit Advisory Panel. Freeman, a research professor of economics at Bowdoin College, Brunswick, Maine, tells C&EN that for many enforcement cases, the extra profits associated with violations come from avoided or delayed compliance with environmental rules.

Panel members endorsed one of EPA's examples of illegal competitive advantage: a business selling an illegal product such as a banned pesticide. Such noncompliance could boost a company's profits, and it would be appropriate for EPA to offset these financial gains through fines, the panel found.

But any situations other than avoided or delayed compliance and selling banned products require a more involved analysis to determine whether a company gained economically and if so, by how much, Freeman said.

Members of the panel were particularly critical of EPA's plans to calculate fines based on a company's increased market share that is allegedly due to a violation. This is the same issue industry groups have attacked most fiercely.

"Increased market share does not necessarily translate into dollars," said panelist W. Michael Hanemann, professor in the department of agricultural and resource economics and public policy at the University of California, Berkeley. In calculating the economic benefit of a violation, changes in market share are not useful, he said.

Freeman said determining changes in market share can be difficult--and identifying if environmental violations were the reason for the shifts is even harder.

An industry coalition, which includes the American Chemistry Council, presented its own analysis of EPA's plan to the SAB panel. It included a critique of the market share issue. The report from the Manufacturers Ad Hoc Group said most companies expand their market share when they can, regardless of whether they are in compliance with environmental regulations. Plus, the report said, "most firms do not need savings from noncompliance to finance their competitive behavior in the marketplace." In addition, many manufacturers have a number of product lines, making it more complicated for EPA to identify or demonstrate any connection between market share gains and environmental violations, it said.

The SAB panel is expected to complete a report this fall on the EPA plan to use fines to offset the illegal competitive advantage of violations.