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October 06, 2014 Articles

The Role of the Economic Expert in Damages Analyses

Economists can provide analyses through the application of economic techniques.

By Robert Kneuper and James Langenfeld

Economists can be particularly useful as experts in complex damages matters. Economic experts are good at modeling the world "but for" the alleged illegal act, developing a theory of causation that links the acts to damage calculations, and separating the impact of the alleged acts from other market forces. As such, economic experts contribute at various steps in the process of developing economic expert testimony, including the formation of the theory of causation and assistance in discovery.

Selection of the Economic Expert
The first decision about the role of an economist in damages analyses is whether to use an economist or a financial/accounting expert. The answer to this question depends on a number of factors, including the nature and extent of the anticipated analysis of damages. An economist can offer certain key strengths as part of a damages analysis, including the ability to develop economic models of market outcomes that would likely have happened "but for" the alleged bad acts. Because economists are often trained at developing economic models of firm behavior under various conditions, economic theory can be particularly well suited toward predicting market outcomes in a "but for" world. Economists also typically have extensive training in quantitative methods, such as regression analysis, and can offer the ability to conduct rigorous statistical analyses and other data techniques in order to isolate the impact of the alleged "bad acts" from other factors.

In considering whether a particular economic expert is suitable to conduct the damages analysis for a case, the parties and counsel often weigh several key factors. First, they consider whether the potential economic expert has suitable education, training, and experience to perform the needed analysis and withstand any challenge to the expert's qualifications. Depending on the exact nature of the testimony, the expert will benefit from having (1) a graduate-level degree in economics or a closely related field, (2) testimonial experience, (3) publications in professional journals on relevant topics, (4) relevant experience in government, and/or (5) teaching experience at a university. Second, the economic expert should have appropriate technical skills and staff support to evaluate and analyze various types of important evidence, including potentially large and complex data sets that may be pertinent to the case. Third, for those cases involving an industry that requires substantial industry-specific knowledge and/or complex regulatory issues, it can be helpful for the economic expert to have knowledge of the industry and market in question. For example, certain industries such as health care, energy, telecommunications, etc., involve a rather complex industry and regulatory structure, so it can be advantageous for the economist to have some type of prior experience in those types of industries. Fourth, the economist should have sufficient objectivity to provide an independent expert opinion that the fact finder will perceive as useful and unbiased. For example, if an economic expert has previously taken positions contradictory to those that would be needed in the case, then the expert's objectivity might be questioned. Fifth, some consideration should be given to the economist's track record of any successes or failures in similar matters. Few experienced economists are always on the winning side of a matter or have never had any portion of their testimony excluded. However, one should consider the number of matters where relevant testimony has been given, and whether the expert has done poorly in a high percentage of those matters. Sixth, the most effective economic experts are excellent communicators and have the ability to explain complex economic analyses clearly and simply in writing and speech, so the court and the finder of fact can understand and evaluate the merits of the expert's opinions.

The following discusses the types of damages analyses that economist typically perform.

Damages Analyses
Measurement of damages typically proceeds from the improper acts or "bad acts" at issue in the case. Damages experts typically assume that such bad acts did occur. The primary areas of focus then become: (1) the impact of the acts on the plaintiff, and (2) the quantification of damages based on the impact. Accordingly, the damages expert typically assesses the likely effects of the defendant's allegedly improper acts by reconstructing what would likely have happened "but for" the acts. Because of their extensive training in economic modeling and statistical analyses, economists can provide useful and reliable analyses in each of these areas.

It is generally recognized that in demonstrating injury in fact, the plaintiff bears the burden of demonstrating that the defendant's allegedly bad acts in fact caused the plaintiff harm. A proper damages analysis, therefore, presents and substantiates a theory of causation that explains how the alleged acts affected the plaintiff. For example, in a breach of contract case, the damages expert would need to substantiate a theory of how the breach impacted the plaintiff. Establishing causation is an essential step in identifying the impact of the alleged acts.

Determining the relevant market characteristics in the actual and "but for" worlds is important to damages analyses, because damages to the plaintiff are estimated by the difference in actual and "but for" outcomes. For example, in a price-fixing case, a damages analysis typically compares actual prices paid by customers during the period of the price-fixing conspiracy against estimates of "but for" prices that would have been paid during that same period absent the conspiracy. Economists can play a key role in this type of modeling.

In other types of cases, such as breach of contract, the damages expert might opine on "but for" profits. For example, suppose that one firm sues another firm alleging breach of contract due to a failure to put forth commercially reasonable efforts in selling its product. In such a case, the damages expert would estimate the sales if the contract had been fulfilled. Using this estimate of the sales, the expert can then multiply the units by the profit per unit under commercially reasonable efforts, and then compare the difference between these "but for" profits and actual profits earned by the plaintiff. Again, economic modeling can be quite useful here.

The determination of "but for" prices, sales, or profits to quantify damages typically entails a combination of economic reasoning and analysis of available financial data to generate an economically reasonable estimate. There are a variety of economic techniques that can be used to estimate "but for" prices, sales, or profits.

One technique is the "before and after" (or "before and during") approach, which uses information on economic behavior before the allegedly improper acts to make inferences about likely economic behavior in the "but for" world that excludes the allegedly improper acts. In an antitrust case involving an allegation of reduced competition and higher prices, the damages expert may use historical prices or historical price trends in the market prior to the alleged reduction in competition as a benchmark to estimate prices "but for" the allegedly anticompetitive actions, controlling for other market influences as appropriate. Similarly, economists may use "during and after" or "before, during, and after" tests, using the period after the alleged illegal behavior as a benchmark to estimate "but for" prices. The "during and after" approach can be particularly useful when data on the period before the alleged anticompetitive behavior is not available.

In a case involving alleged damages due to a firm's false advertising campaign, a damages expert might look at the plaintiff's sales and profits during periods of time in which the alleged false advertising did not occur compared to periods of time when it did occur. Again, it is important that the expert control for other market influences that might also impact the firm's sales and profits.

Another technique is the "yardstick" approach, in which the damages expert makes use of potential comparable markets or industries in estimating "but for" outcomes. For example, in an antitrust case alleging reduced competition and higher prices, the damages expert could potentially use prices or price trends in comparable "competitive  markets" to estimate prices "but for" the allegedly anticompetitive actions.

One important consideration in making comparisons using either a "before and after" approach or a "yardstick" approach is to ensure that the market outcomes in the market of comparison are economically reasonable predictors of the likely outcomes in the "but for" market at the time of the allegedly improper acts. For that reason, it can be important that the damages expert analyze and compare the economic characteristics of the comparison market with the economic characteristics of the market in which the allegedly improper acts occurred. In particular, damages analyses must reasonably account for factors other than the allegedly improper acts that may be causing market outcomes in the market of concern (e.g., relatively high prices).

Various economic and statistical techniques also can be used to control for these other influences and isolate the economic impact of the allegedly improper acts. For example, economists typically use "benchmarks" or comparables as part of a damages analysis. These analyses usually compare the market outcomes from the alleged behavior to outcomes that are not affected by that behavior. The use of comparables is intended to control for many of the influences on a market that are not related to the actions at issue, and is referred to as a "natural experiment" analysis. That is, a natural experiment compares market outcomes associated with the firm or market of interest with those of other similar firms or markets that serve as a control group (unaffected by the behavior of interest). This type of analysis is reliable provided (1) the natural experiment (or benchmark) is sufficiently similar to the market or time period at issue, and (2) the existence of the allegedly illegal acts is a major difference between the benchmark and the market or time period at issue. As in other economic analyses, natural experiment analyses are only useful if (1) they reasonably fit the facts of the case, (2) they employ sound economic methodologies that are based on reliable information, and (3) the inferences are accurately drawn from an appropriate economic model and given other available evidence.

Another technique involves regression analysis, which is a formal statistical technique used to isolate the impact of different independent variables on a dependent variable. Statistical and econometric techniques, including in particular regression analyses, are particularly useful in separating the impact of an alleged anticompetitive act on market outcomes (such as pricing, profits, etc.) from the impact of several other influences. That is, when correctly implemented, econometric techniques such as regression analyses can isolate and measure the effect of a single explanatory factor on the economic outcomes that are relevant to the analysis.

The data are not always available for regression analyses, and there are other reliable techniques that can effectively isolate the potential impact of the allegedly improper acts. For example, there may not be enough observations in any one data set for a multiple regression analysis to be performed. However, there may be several sources of information that may serve as reliable benchmarks. An economist may be able to estimate damages by using a combination of these benchmarks, assuming the benchmarks consistently show a similar pattern and yield roughly similar damage figures.

An economic expert can play an integral part in estimating damages in a case. The expert needs strong credentials and analytical skills, and should be skilled in describing opinions and data analyses in terms that are understandable and persuasive to the court and finder of fact. Economists can play a key role in providing damages analyses by properly using economic techniques to estimate the impact of the alleged bad acts, including modeling prices, sales, or profits in a "but for" world in which the alleged bad acts did not occur. A theory of causation is essential to a proper damages analysis, and the economic expert can play a key role in developing such a theory and methodologies for quantifying damages. Economists use various techniques to model damages, including benchmarking, natural experiments, and statistical/econometric analyses. Accordingly, counsel should work closely with the expert to ensure that the expert bases his or her opinions on sound and pertinent economic theory, obtains reliable information and data needed to support those opinions, and applies sound economic models and analytical methods in a manner that accounts for pertinent case facts.

Keywords: litigation, expert witnesses, economic expert, damages analysis, "but for" outcomes, before/during/after approach, yardstick approach, natural experiment analysis, benchmarks, comparables, regression analysis

Robert Kneuper and James Langenfeld are with Navigant Economics in Washington, D.C., and Evanston, Illinois, respectively.

Navigant Consulting is a corporate sponsor of the Section of Litigation. Neither the ABA nor ABA entities endorse non-ABA products or services. This article should not be construed as an endorsement.

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