The Case of the Discredited Damage Study (1993)

One of the best ways to understand damage studies is to examine one t at doesn't work. John Leslie Livingstone, CPA, PhD, owner, Livingstone Associates, West Palm Beach, Florida, offers an example. CPAs frequently are engaged either by the plaintiff in a lawsuit to prepare a damage study or by the defendant to evaluate the plaintiff's study. This article takes CPAs through the steps of building a case and then determining what is wrong with it. The case is a hypothetical one adapted from a number of cases. Although fictitious, it is a realistic representation of an actual damage study. This article begins with a description of the plaintiff's damage study. CPAs with experience in this area should be able to detect some of the flaws in the study as they read about it. THE REDLED MINING CASE The Redled Mining Corp., Inc. is a tightly held, family-owned operator of a South Texas lead mine. The mine produces lead ore, which Redled converts into lead ingot and sells to gasoline refineries located in southern and eastern Texas. Less than 5% of Redled's sales are made to refineries outside Texas. Redled filed an antitrust suit alleging price fixing by its five largest customers, which it said conspired to fix and hold down the prices they were paying Redled lead ingot. Redled retained a firm of consulting economists to prepare testimony, including a damage study. The following discussion focuses on the lost-profits portion of the claim, which differs little, if at all, from lost-profits claims in other types of cases (such as breaches of contract, patent violations, trademark infringements, dealer terminations or price discrimination suits). Therefore, the study is quite generic and representative of a wide range of cases. THE BUT FOR TONNAGE A lost-profits damage study involves a financial projection that estimates what sales quantities would have been if the alleged price fixing had not taken place. This is a but for projection. The but for tonnage projection is shown in column E of exhibit 1 below. It was based on adjusting the actual tonnage using the index of petroleum production (IPP), which reflects national refinery output. The IPP has a base value of 100 (1981=100). It is important to understand how the index was used to adjust the actual tonnage. For example, consider the 1989 but for tonnage in column E. It was calculated as follows: Actual 1981 tonnage times 1989 IPP/1981 IPP, or: 1,609 times 124/100 = 1,995 The 1990 but for tonnage is: 1,609 times 128/100 = 2,060 Every year of the but for projection was based on the 1,609 actual 1981 tonnage, since the plaintiff alleged price fixing began to occur in 1982. Consequently, the but for tonnages 1982 through 1990 were estimated using the actual results of a single year, 1981, which might be considered too small a foundation to support a nine-year projection. A better approach would have been to use a three- or five-year average the base-year tonnage, compiled from the uncontaminated past years. THE BUT FOR AVERAGE PRICES To project actual prices without the price fixing, the economists made a but for adjustment using the UMWA (United Mine Workers of America) national index of average hourly wages. What do wages have to do with prices? Wages often are subject to COLA (cost of living allowance) adjustments, which are based on price levels as reflected in the consumer price index, example. In general, it is plausible wage rates and prices to move in parallel. The UMWA index was applied to the 1981 base year to compute the but for price. For example, the but for price shown in exhibit 1 (column K) 1985 is $3,159 per ton. It was calculated by multiplying the 1981 actual price of $1,938 by 163 divided by 100. Of course, the but for prices that are shown in exhibit 1 1982 through 1990 are higher than each year's actual price. …