Like every other turn in this long case, the tentative settlement to United States v. Microsoft has generated controversy. Critics of the settlement, including many of Microsoft's competitors, argue that the proposed accord does not go far enough in punishing the company for perceived wrongdoings.

Reviewing the case as an economist leads me to a very different conclusion: For a number of reasons, the settlement is preferable to additional litigation. First, it is a compromise between the disputants that reflects the reality that continuing the trial would put the government case at risk and expose Microsoft to an uncertain and potentially more costly outcome. Second, it would reduce the considerable business uncertainty that now plagues the high technology sector. Third, the proposed settlement fully addresses the Microsoft actions that the U.S. Court of Appeals confirmed to be anticompetitive when it reviewed the original decision by District Court Judge Thomas Penfield Jackson. Indeed, the settlement includes some Microsoft concessions addressing plaintiffs' concerns that were not supported by the appeals court. In this article, I will discuss those three points in more detail. My discussion will not include any analysis of the original case; one need not take a stand on the merits or weaknesses of the economic foundations of United States v. Microsoft in order to see the wisdom in accepting the two parties' agreement. All that is required is an acknowledgement of where the case rulings stand today. The proposed settlement addresses those rulings and offers a remedy that prohibits the acts that have been found anticompetitive.

Compromise that Reduces Uncertainty

Economic analysis suggests that, in disputes, compromise should be the rule rather than the exception. According to one of the basic tenets of economics, "when transaction costs are low, parties will voluntarily transact if a mutually beneficial transaction is possible." In fact, the vast majority of all legal disputes are settled.

Settlements of pending litigation generally represent a compromise that takes known information into account and offers advantages to both parties. If a settlement is not balanced, the option of continuing the litigation will appeal to one side and stall negotiations. Thus, the fact that Microsoft and the government reached an agreement after numerous unsuccessful attempts indicates that the proposed settlement is not a "victory" for Microsoft or the government, but a middle ground reflecting the facts of the case, the court rulings to date, and a recognition that continued litigation is a gamble for both sides.

Apart from satisfying the two parties directly involved, settlements are also commonly viewed as good for society. As University of California economist Carl Shapiro has explained, "Settlements of litigation generally are recognized to provide a number of private and social benefits. Private benefits include the avoidance of litigation costs and the resolution of uncertainty. Social benefits include savings on court costs and/or reduction of congestion in the court system."

Uncertainty in the High Tech Sector

The reduction in uncertainty would be a boon not just for Microsoft, but also for much of the high technology sector. Companies that produce complementary products, such as applications that run on the Windows operating system, are directly affected by the case. The government has recognized that fact; as Assistant Attorney General Charles James explained, "Lots of small software development firms want to work closely with Microsoft to get their products commercialized, and they do so in a way that produces good software."

A study of how past antitrust enforcement involving Microsoft affected the stock of 159 other computer technology companies suggests that the effect is far broader. George Bittlingmayer and Thomas Hazlett found that the share prices of companies in the computer sector moved with Microsoft's share price in response to antitrust enforcement actions aimed at Microsoft. The authors examined 54 incidents of federal antitrust enforcement action from 1991 through 1997 that altered Microsoft's business prospects, classifying those actions as either proenforcement or anti-enforcement, and then tying the public announcement of the actions to computer sector stock values. The researchers concluded, "investors appear to believe that antitrust enforcement increases the link between the fortunes of Microsoft and other computer firms." "Withdrawals from policy enforcement," they continued, "have been accompanied by positive shareholder returns throughout the computer sector."

Court of Appeals Decision

Some settlement critics chastise the agreement for failing to secure many of the penalties against Microsoft that the Jackson court had ordered. Those criticisms are misplaced; the settlement had to reflect the appeals court's subsequent decisions on which Microsoft practices were anticompetitive and which were not. As New York University economist Nicholas Economides noted, "The remedy has to be based on [the appeals court ruling]. It should not punish Microsoft for things it was not found guilty of." Expanding on that point, Assistant Attorney General James explained:

People look at the Jackson decree, and then look at our decree, and perceive that it is weaker or compromised. I fundamentally disagree with that. The Jackson decree was premised on these liability findings that didn't continue in the case after the Court of Appeals ruling. Second, the Jackson opinion did not ever undergo a true litigation process. There are a number of issues that would have been hotly contested. Finally, there were a number of things that would have been ineffective in the context of the software industry as we find it now. Looking at our decree from the standpoint of the case that emerged from the Court of Appeals, we think that, in many respects, it is certainly equal to and perhaps superior to the result that likely would have emerged in litigation.

In particular, the appeals court vacated the Jackson finding that Microsoft's inclusion of the Internet Explorer Web browser in Windows was illegal per se. It also reversed Jackson's ruling that Microsoft took anticompetitive actions to obtain a monopoly in Web browsers. While the appeals court did agree that Microsoft holds a monopoly in PC operating systems and has taken some anticompetitive actions to maintain (but not initially to gain) that monopoly, many of the specific charges were narrowed. In fact, the decision vacated Jackson's remedy because, among other things, the appeals court "drastically altered the scope of Microsoft's liability."

The proposed settlement is, in my opinion, based on the "limited ground of liability" that the appeals court upheld. First, it directly addresses all of the conduct that the appeals court found anticompetitive. For example, the court found that Microsoft acted illegally in preventing PC manufacturers from deleting end-user access to Internet Explorer. The settlement explicitly gives computer makers that right- not just for Internet Explorer but also for many other software categories falling under the settlement's definition of"middleware." Similarly, the appeals decision found that Microsoft's exclusive arrangements with Internet Access Providers (IAPs) hampered distribution of competing Web browsers and were illegal. The proposed settlement broadly prohibits Microsoft from requiring lAPs or other companies to distribute Web browsing or other kinds of software exclusively or in any fixed percentage.

Second, the agreement calls for information disclosures by Microsoft that go far beyond the behavior identified by the appeals court as anticompetitive. For example, by requiring the company to disclose software interfaces and related technical information, the settlement would make it easier for software developers to create new middleware products that operate in the Windows environment. That requirement would prevent Microsoft from keeping secret information that is normally considered proprietary - information that might give internally developed software a competitive edge.

Finally, the proposed decree contains stringent enforcement provisions. It creates an independent three-person technical committee with broad, on-site review powers. It requires Microsoft to offer uniform license terms to the 20 largest computer manufacturers, thereby preventing the company from sidestepping other provisions of the settlement through discounts and promotional deals. It gives the government authority to seek criminal and civil contempt sanctions in the event that Microsoft violates the accord. And it grants the court the discretion to extend the five-year term of the order by two years if Microsoft breaks the rules.

Conclusion

In the end, both Microsoft and the government made concessions in order to reach a compromise because they realized that there are costs and risks to continuing litigation. Finding that such a compromise serves the public interest does not require a complete re-hashing of the original charges and arguments made in United States v. Microsoft. In fact, one need not take a stand on the merits of the original case at all. A far better approach is to review the record as it stands today, taking into account the appeals court decision and the uncertainty created by the fact that the remaining proceedings will be conducted before a new district court judge. Such a review reveals that the proposed settlement is preferable to additional litigation, and is in the public interest.

Robert Hahn is a resident scholar at AEI.