Printer Friendly

Contractual governance in trucking: Maislin v. Primary Steel and the undercharge crisis.


One of the great tragedies in life, Oscar Wilde warned in Lady Windermere's Fan, is having one's fondest wish come true. It is a lesson the nation's shippers may ruefully appreciate: Initially strong proponents for trucking deregulation, they now face potentially staggering financial liabilities as an unanticipated consequence of the motor carrier competition they advocated.

The current crisis was triggered by a combination of the greater complexity of truck rates following deregulation, a sharp increase in the incidence of bankruptcy among carriers no longer sheltered from competitive market forces, and a key 1990 Supreme Court decision on "undercharge" claims filed against shippers by bankrupt truck firms. In Maislin v. Primary Steel, the Court was forced to choose between the "filed tariff doctrine" and the "negotiated rates policy" as the basis for deciding carrier-shipper rate disputes. Holding the filed tariff doctrine to be controlling, the Court opened a floodgate for legal claims of billions of dollars against shippers.

After briefly reviewing the filed tariff doctrine, the negotiated rates policy, and the Court's opinion in Maislin, this paper will analyze the structure of post-deregulation contracting in the trucking industry, utilizing the transactions-cost framework developed by Williamson and by Klein, Crawford and Alchian. The current shipper crisis, and the impact of Maislin on contractual governance in the field, will then be examined.


Filed Tariff Doctrine

The filed tariff doctrine dates back to 1887, when the Interstate Commerce Act (ICA) was enacted. The ICA requires motor carriers to file their rates in a tariff with the Interstate Commerce Commission (ICC). It also stipulates that a "carrier may not charge or receive a different compensation for . . . transportation . . . than the rate specified in the tariff" (4, p. 2762). The ICA allows the exception that "unreasonable" rates are not enforceable, even if filed. The Court had adhered to the doctrine for many years, citing the danger of discrimination as a primary rationale for the doctrine's strict application.

Negotiated Rates Policy

Enactment of the Motor Carrier Act of 1980 (MCA) opened the door for the ICC to modify the classic filed tariff doctrine. The MCA reduced barriers to entry and increased competition, and a common response was for carriers to enter into agreements with shippers involving "point-to-point" rates that covered specific origin-destination combinations. The negotiated point-to-point rates were generally lower than the published tariff rates.

The MCA did not eliminate the requirement that all rates (including negotiated rates) be filed with the ICC. The ICC, wishing to promote competition, altered its regulations to allow rate decreases to go into effect as quickly as a day after they were filed. The relative speed of rate changes, when coupled with their high volume (hundreds are negotiated daily) has created a situation in which it is extremely difficult for shippers to determine what, in fact, the legal filed rate is on each of the many routes over which they ship. Exacerbating the situation, the ICC is not currently equipped to facilitate verification of rates on a timely basis.

Recognizing the difficulty in determining the correct rate and the changed nature of the industry under deregulation, the ICC "addressed complaints by shippers that motor carriers were quoting lower rates not filed with the ICC and then billing shippers at the higher filed rates" (6, p. 631). The ICC issued a ruling, Negotiated Rates I, which established what came to be called the "negotiated rates" policy. The decision held that the rule in deciding undercharge claims was to be: ". . . whether collection of undercharges based on the rate contained in the filed tariff would constitute an unreasonable practice and, if a negotiated rate is found to exist, whether this amount is all the carrier should be permitted to collect". This was seen as a substantial expansion of the concept of an unreasonable rate contained in the ICA; carriers and shippers alike relied on the decision, continuing to transact transportation based on negotiated rates, regardless of whether these rates were contained in a properly filed tariff.

The Maislin Decision

In Maislin Industries v. Primary Steel, the Supreme Court ruled on the validity of the ICC's negotiated rates policy. In that case, Quinn Freight Lines, a subsidiary of Maislin Industries, had negotiated rates to carry freight for Primary Steel at a discount from the filed tariff rates. From 1981 to 1983 Quinn billed Primary for shipments at these lower rates. Although Primary believed that Quinn would file the rates with the ICC, Quinn never did so.

In 1983, Maislin filed for bankruptcy. Its bankruptcy trustees subsequently filed an undercharge claim against Primary for nearly $200,000, representing the difference between the negotiated and filed rates on all shipments during the disputed period. The ICC ruled in favor of Primary, ruling collection of the tariff rate to be unreasonable under its negotiated rates policy. The Court overturned the ICC's ruling, holding that Primary was liable for the higher rate under the filed tariff doctrine, despite finding evidence that the lower rates were the result of a contractual agreement, with "offers, acceptances, and approvals by the involved parties".

The majority in Maislin relied on the Court's long tradition of strict application of the filed rate doctrine, rejecting the ICC's interpretation of the ICA which would declare a filed rate unreasonable if a carrier has negotiated a lower rate with a shipper. The majority also rejected the argument that Congress had implicitly authorized the negotiated rate policy with passage of the MCA. Dissenting, Justice Stevens presciently argued that "the only consequence of today's misguided decision is to produce a bonanza for the bankruptcy bar".


In Transaction-Cost Economics, Williamson develops a framework that characterizes transactions based upon the level of uncertainty, the frequency of recurrence, and the level of specific investment associated with those transactions. In Vertical Integration, Appropriable Rents, and the Competitive Contracting Process, Klein, Crawford, and Alchian analyze the major factors affecting the potential for opportunism in contractual relations. This section examines contracting in the motor carrier industry from the perspective developed in these two articles.

Specific Investment

The heart of Williamson's approach to contracts is the principle that the degree of transaction-specific investment is a prime determinant of contractual governance structures. In the absence of specific investment, classical market governance -- characterized by standardized transactions on the spot market -- will prevail. Under classical market governance, conditions are such that an ongoing relationship between buyer and seller is not necessary to ensure successful transactions. In contrast, bilateral governance relies on long-term relationships, while unified governance (vertical integration) completely removes the transaction from the market, in order to promote efficient transactions. Only with some degree of specific investments do these structures arise, as dictated by frequency and uncertainty.

In the motor earner industry, it might seem at first blush that investment is relatively standardized. With a few exceptions,(1) a truck is a truck. Most shipments are carried by one of a few types of tracks, which all carriers use. It is not likely that a motor carrier would be unable to liquidate or continue to use its vehicles at nearly the same price if any given shipper reneged on a long-term contract.(2) Another large investment in physical capital is required by less-than-truckload (LTL) shippers, who must build terminals in many locations for the purpose of consolidating shipments.(3) By their very nature, these terminals are suited to transactions involving many shippers. Physical capital is not transaction-specific in the trucking industry.

The lack of specific physical capital, however, does not rule out the possibility of the presence of specific investment. Williamson emphasizes the importance of specific investment in human capital. There is no reason to believe that a semi operator drives less effectively for one shipper than for another, but the actual negotiation of discount rates requires specific investment in human capital. Deregulation is the source of this specific investment. Prior to the MCA, rates were essentially fixed. The negotiation of rates was simple: Read the tariff and pay the rate shown. The advent of deregulation changed the negotiation process dramatically. Freed to operate as contract carriers, motor carriers were no longer barred from entering into reduced-rate agreements with individual shippers. Often through the use of point-to-point rates, carriers began to charge contract shippers 5-70% less than the general tariff rate.

Negotiations regarding these discounts are not costless, however. Large sums of money are at stake, contingencies must be specified, and rates must be determined for all relevant routes. The labor cost of these negotiations can be quite high.(4) Also, the investment in these negotiations is completely transaction-specific. A rate determined through such negotiations is valid only for a particular shipper, shipping with a certain carrier, over the specific route covered by the contract. The cost of negotiations may generate enough specific investment to characterize investment in the industry overall as being mixed, rather than completely standardized or highly idiosyncratic.


In his analysis of contractual governance, Williamson emphasizes the role of uncertainty when investments have a sufficient level of specificity: "Whenever investments are idiosyncratic in nontrivial degree, increasing the degree of uncertainty makes it more imperative that the parties devise a machinery to 'work things out' -- since contractual gaps will be larger . . . as the degree of uncertainty increases". Accordingly, increasing the degree of uncertainty increases the benefits of unified or bilateral governance structures, whenever some degree of specific investment is present.

One source of uncertainty relevant to contracts between shippers and carriers is likely to be fuel prices. Since these are easily and accurately observable to both parties, we would not expect large difficulties to arise in specifying contractual provisions to accommodate changes, and fuel prices would probably be not a major force pushing the industry away from classical market governance.

An increasingly important source of uncertainty, however, is the possibility that a carrier will go bankrupt. Since deregulation, the failure rate for motor carriers has far outstripped that for all industries. In 1979, the failure rate for motor careers was 27.2 per 10,000, compared to the all industry rate of 28.0 per 10,000. By 1985, the trucking rate was 191.1 compared to 115.0, and 1543 motor careers went bankrupt in that year. The bankruptcy of a carrier can pose serious difficulties for a shipper, even without undercharge problems. The shipper faces the costs of recovering shipments in transit and of finding a new carrier on short notice (often at higher rates). Large shippers may face difficulties finding a carrier with enough unused capacity to absorb the extra shipments. In the interim, revenue may be lost due to the interruption in product movement.

Using Williamson's framework, we can predict that this uncertainty will affect market governance only when investment is specific. If searching for another carrier is a low- or no-cost proposition, uncertainty should not change the tendency toward classical market contracting. In the presence of specific investment, however, this uncertainty increases the likelihood of bilateral or unified governance. Another source of uncertainty is the difficulty in determining the correct legal rate.(5) The effects of uncertainty with respect to rates will be discussed in the last section.

Frequency of Transactions

Williamson's work also highlights the role of transactional frequency in determining the governance structure that will prevail. He concludes that, regardless of the level of specific investment, "occasional transactions . . . will not support a transaction-specific governance structure," while recurrent transactions will do so in the presence of specific investment.

Williamson's analysis should be applied not on an aggregate level, but rather on a transaction-specific level. A given shipper may ship hundreds of shipments daily, but what matters is how often it ships on a given route. Frequency is likely to vary substantially across different routes, within routes on a seasonal basis, or within routes over time as sales patterns and plant capacities change. These variations in frequency can cause the preferred system of governance to vary as well.

To see that this is the case, imagine a simple firm, Wid-Star Manufacturing, with three noncontiguous pieces of property. One is the plant that manufactures the final good, "widgets;" one is the plant that makes a key component of widgets, "wids;" and the third is the corporate headquarters, where neither wids nor widgets are made. Also assume that Wid-Star has several large customers, including Jeers, Blue Value Hardware, and Small-Mart, along with numerous smaller customers. It then becomes a simple matter to determine which routes will be high frequency transactions to Wid-Star. Given some level of uncertainty and an investment of a mixed nature, we would expect to find that as frequency decreases, market governance becomes more likely.

Every widget made requires the shipment of a wid from the wid plant to the widget plant, so this is likely to be the highest frequency route. The three largest customers each have large distribution centers that Wid-Star ships to, so these routes will also be heavily used. On these routes, we would almost certainly expect bilateral governance in the form of long-term relational contracts. As Wid-Star adds major customers or plants, routes that had been less frequent may receive enough increased traffic to cause a change to bilateral governance as well. Similarly, we would expect a move away from bilateral governance on a route if shipments became less frequent due to the loss of a customer or a plant closing.

The smaller customers do not have distribution centers, so even if Wid-Star ships many widgets to a given customer, the stores are spread out in many locations. Any negotiated rate is customarily negotiated only for a specific route (since tariffs are only filed for specific routes). The frequency of shipments from Wid-Star to individual retail stores is likely to be much lower than to the distribution centers of larger customers. On these routes, we might still observe long-term contracting in some cases, but classical market governance would be more likely, especially for the most infrequent customers.

Finally, some routes could be classified as highly infrequent. The best example of this would be shipments of sample widgets to corporate headquarters or trade shows. In these cases, the occasional nature of the transaction would preclude the negotiation of a contract rate. Classical market governance would be expected.


In their analysis of competitive contracting, Klein, Crawford, and Alchian highlight the key role of "opportunism" and suggest numerous factors affecting the potential for it. Two factors that are most clearly relevant to the motor carrier industry are the problems of ex-post small numbers, and low levels of anticipated growth for potential cheaters. Both forms of opportunism can be expected to arise in situations where recurrent transactions and mixed investment create quasi-rents and facilitate the use of long-term, relational contracting.

Although the motor carrier industry is characterized by low concentration (in 1987, the eight largest firms accounted for only 37% of the market), the negotiation of discount rates can create a problem of ex-post small numbers. A shipper may choose to negotiate with any one of many carriers that would meet its needs, but once the contract is established, it would be costly to abandon it and negotiate with another carrier. In effect, a degree of ex-post monopoly power is created which, in turn, enables a quasi-rent to be captured. In the absence of an adequate contract (explicit or implicit) offering a premium stream to discourage cheating, this rent may be exploited by either party.

The problem of low future growth in demand for the product of potential cheaters is mentioned only briefly by Klein, Crawford, and Alchian. They simply point out that reputational effects are a strong deterrent to opportunistic behavior when a potential cheater expects his business to grow rapidly in the future. The opposite should also be true -- a firm that expects little or no future business is not concerned with reputational effects or premium streams. As such, the more informal deterrents to opportunism are not likely to be of any use. This is of particular significance in an industry where operating margins are razor thin and bankruptcies are frequent.(6)

Conclusions on Industry Structure and Governance

In the absence of a systematic analysis of contracts from a representative cross-section of shippers and carriers, it would be unwise to make sweeping generalizations about the correspondence of the above predictions with actual contracts in the industry. On the other hand, certain facts are documented in the transportation literature which support the predictions for governance outlined above. Where I have not come across patterns in the literature, I will test my predictions against the contracts made by carriers with Mead Corporation, whose contracts seem to be fairly typical. The risk here is that my predictions will have been biased in favor of supporting what I have observed at Mead, so it may be best to view the results of this exercise as illustrative.

The prevalence of long-term contracts rather than spot contracts is well documented. The outcry of shippers after the Maislin decision would not have occurred if shippers had been paying tariff rates all along; estimates of potential outstanding undercharges run as high as $32 billion. This supports the prediction that specific investment in human capital will cause some form of long-term contracting to replace spot contracting to some degree.

The above analysis also predicts that the likelihood of market governance is less where frequency of shipments on a particular route is high. This agrees with my working observations: At Mead, the Products Division has seven plants, each with a sizable warehouse. Mead pays discount rates on all shipments between these plants. Mead also generally pays discount rates when shipping to its largest customers. Other shipments generally are shipped under the tariff rates, especially those that are highly infrequent, such as shipments to trade shows.

The existence of opportunistic behavior is observable both in the literature and my own experience. Undercharge claims filed after a contract has been negotiated are clearly opportunistic. The fact that these are almost entirely filed by insolvent or borderline carriers suggests that the problem of low expected growth is at work.


Shippers complained that Maislin was unfair and inefficient, while most solvent carriers faced a dilemma: "should a carrier collect the undercharges and risk the loss of future business from the shipper"? The effects of Maislin do not appear to be very large, primarily because the court was unable to remove the uncertainty surrounding rates.

To see this, remember that undercharge claims could be filed successfully before Maislin. Under the negotiated rate policy, it was possible the ICC would find that no valid negotiated rate existed, and would award the undercharges to the carrier. In any event, there is some expected probability that a given case will be successful. This probability of the carrier winning a claim will be referred to as |P.sub.w~.

Additionally, when discounts are given from the tariff rate and then not properly filed, we would not always expect to see an undercharge claim filed by the carrier due to the prospect of losing business. The probability that a claim is filed will be called |P.sub.c~. We would expect |P.sub.c~ to vary positively with the expected award to the carrier from an undercharge claim, |P.sub.w~D, where D is the difference between the negotiated and tariff rates, and negatively with legal fees (F) and the discounted present value of the loss in future profits (|L.sub.|Pi~~) occurring due to the shipper withdrawing business. This would yield the following:

|P.sub.c~ = ||Alpha~~ |(|P.sub.w~D) - (|L.sub.|Pi~~ + F)~ (1)

where |Alpha~ is positive. An increase in the level of discounts or the probability of winning will result in a higher probability of claims being filed; an increase in legal fees or expected loss of profits will decrease the likelihood of undercharge claims. For simplicity, I assume that the relationship is linear.

When relying on negotiated rates, shippers face an expected value function that includes |P.sub.c~. The shipper receives additional gain (over and above the benefit he would receive by shipping at the tariff rate) equal to D. This is offset by the costs of uncertainty inherent in negotiated rates, namely |P.sub.c~|P.sub.w~D, which gives the expected value of loss through undercharge claims. An additional cost is that of negotiations (N) needed to receive the lower rate. Since these costs are spread out over the length of the contract, the per-unit cost of negotiation decreases with time if no breach occurs. Also, the total cost of negotiation is likely to be invariant with respect to frequency of shipments on a given route, so it follows that the per-shipment cost of negotiations will be less on high-frequency routes.

The shipper, then, has expected benefits, E(B), as follows:

E(B) = D - |(|P.sub.c~|P.sub.w~D) + N~ (2)

Substituting for |P.sub.c~ and simplifying yields:

E(B) = D - |Alpha~|(|P.sub.w~D).sup.2~ + |Alpha~|L.sub.|Pi~~|P.sub.w~D + |Alpha~F|P.sub.w~D - N (3)

The Maislin case increased only the probability that a carrier would win an undercharge claim, |P.sub.w~. To evaluate the effects of an increase in |P.sub.w~ on E(B), take the partial derivative of E(B) with respect to |P.sub.w~, which yields (assuming |Delta~N/|Delta~|P.sub.w~ = 0):

|Delta~E(B)/|Delta~Pw = |Alpha~D(|L.sub.|Pi~~ + F - 2|P.sub.w~D (4)

Since everything remaining is unambiguously positive, we can see that increasing the probability that a carrier will win an undercharge claim will reduce the net benefit to shippers if the product of the discount and the probability of winning is greater than the sum of the loss in profits to the carrier and the carrier's legal fees.

What, then, is the net result? Undercharge claims will increase, and shippers will move away from reliance upon long-term contracts, only when the discount is extremely high relative to the future gains expected by the carrier. This is most likely to be the case at the end of a contract or when a carrier becomes bankrupt, since expectations for future profits are very low. The problem for shippers is that Maislin did not remove the uncertainty of whether or not a carrier would file a claim, but only changed the value of the probability.

The effect of Maislin on the governance structure is to change the threshold values at which long-term contracts become favored over spot contracts. The cost to shippers of entering discount contracts increased with Maislin. Long-term contracts may still be useful on frequent routes, but marginal cases that might have facilitated long-term contracts before Maislin will be less likely to do so now. Vertical integration of the freight function may be an increasingly attractive option for larger shippers, but the presence of complex record-keeping requirements and the fact that investment is only partially specific argue against its widespread integration.

Aside from abandoning long-term contracting in favor of classical market governance or vertical integration, relatively easy solutions are at hand. By relaxing its electronic tariff filing requirements, the ICC could facilitate timely verification of filed rates. Shippers would then be in a position to demand that negotiated discounts be filed, reducing |P.sub.c~ substantially. Alternatively, Congress could amend the MCA to reinstate the Negotiated Rates Policy. Under that policy, as long as the parties had indeed reached an agreement (which is currently no defense to an undercharge claim), the shipper would know that the negotiated rate was the legal one, greatly reducing |P.sub.w~. Either way, the opportunity for opportunistic undercharge claims would decrease enormously.


Analysis of the motor freight industry reveals it to be characterized by mixed investment. Although physical investment is standardized, the human investment associated with the rate negotiation process is substantial and highly specific. The regulatory structure of the industry has given rise to uncertainty regarding which rates are legal. The frequency of transactions varies both over routes and over time for a given shipper and carrier.

The combination of these factors causes governance within the industry to vary accordingly: Shipments on high-traffic routes are more likely to be covered by a negotiated discount contract than by a standard, full-price tariff. The existence of these long-term contracts and the cost of their negotiation create a quasi-rent and the potential for opportunism in the form of undercharge claims, filed after good-faith negotiations resulting in a discount.

Maislin v. Primary Steel presented the Court with an opportunity to remove the uncertainty surrounding negotiated rates, but it did so only in a legal sense. Legally, all now know that the filed rate is the true rate. The structure of the market, however, and the advantages to carriers of negotiating discounts with shippers kept the uncertainty intact even after Maislin. While shippers no longer face the question of whether an unfiled rate will be upheld, they still face questions of whether a rate has been filed and whether a carrier will attempt to collect undercharges.

The post-Maislin shipper will, under the right conditions, still have an incentive to negotiate discount contracts in the face of uncertainty. Despite the impassioned protests of shippers, the decision will probably only change the structure of contractual governance in marginal cases: Where the benefits of entering a long-term contract were previously only slightly greater than the costs, they will now be somewhat less.

Legislative initiatives from shippers may succeed in eliminating rate uncertainty. Proposals currently before Congress would modify the filed rate doctrine to recognize good-faith negotiations as a defense to undercharge claims. Until then, uncertainty will remain one of the costs of bilateral governance in the motor carrier industry.


1. Refrigerated trucks and car carriers would be more specific than the basic panel trailer, but even these can be used by many different shippers.

2. When a long-term contract takes the form of a dedicated fleet arrangement, trucks may be painted with the logo of the shipper. This practice may reduce the resale or reuse value of the truck, since it would first need to be repainted, but the cost of repainting is relatively low compared to the cost of a semi trailer.

3. LTL carriers pick up many small shipments from different shippers and consolidate them before sending them to terminals where the shipments are split up again. This is in contrast to truckload carriers, who take an entire trailer of goods from point A directly to point B.

4. For example, the Corporate Logistics department at Mead Corporation employs two managers and two analysts just to negotiate and verify freight rates. Mead is a pulp and paper products company with headquarters in Dayton, Ohio and operations throughout the United States.

5. To see that this applied even before Maislin, see (1, p. 57).

6. The average operating margin (revenue -- expense/revenue) for the motor carrier industry from 1980 to 1987 was 3.58%. Prior to deregulation, it was 5.17%. The ICC has traditionally held 7% to be a reasonable margin. As noted above, 1543 carriers were bankrupt in 1985 (2, pp. 269, 271).


Calderwood, J. "Attack of the Rate Sharks." Transportation and Distribution, 28 (August 1987), 57.

Dempsey, P. "Running on Empty: Trucking Regulation and Economic Theory." Administrative Law Review, 43 (1991), 253-319.

Klein, B., Crawford, G. and Alchian, A. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process." Journal of Law and Economics, 21 (1978), 297-326.

Maislin Industries, U.S., Inc., et al. v. Primary Steel, Inc., 110 S.Ct. 2759 (1990).

McGinley, L. and Machalaba, D. "Fight Over Freight." Wall Street Journal, 73 (16 June 1992), A1, A8.

Murphy, D. "Maislin Industries, U.S., Inc. v. Primary Steel, Inc.: What Happened to Deference?" Case Western Reserve Law Review, 41 (1991), 627-641.

Rosenfeld, I., Schultz, J., and Winter, D. "Shippers Lick Wounds, Seek Relief After High Court Undercharge Ruling." Traffic World, 222 (14 July 1990), 7-9.

Sacasas, R., Munter, P., and Sanders, G. "Unwanted Assets? Motor Carriers and Auditors in a Post-Maislin World." Transportation Journal, 31 (1991), 51-57.

Schulz, J. "Shippers Beset by Undercharges Urge Repeal of 'Filed-Rate' Doctrine." Traffic World, 229 (16 March 1992), 20-21.

Williamson, O. "Transaction-Cost Economics: The Governance of Contractual Relations." Journal of Law and Economics, 22 (1979), 233-261.
COPYRIGHT 1993 Omicron Delta Epsilon
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Title Annotation:Maislin Industries Ltd.
Author:Smith, Brian R., II
Publication:American Economist
Date:Mar 22, 1993
Previous Article:A demand system for a gambling market: on the relative efficiency of restricted estimators for singular systems of equations.
Next Article:Sector-specific unemployment and corporate income tax incidence: a geometric exposition.

Related Articles
Contractual governance in trucking: a comment.
Voicenet, Inc. Announces Letter of Intent Which Contemplates the Acquisition of Substantially All of the Assets of Voice Synergies Inc.
Human Services, Education Top Houston's Charitable Causes, Greater Houston Community Foundation Survey Shows.
Greater Houston Community Foundation Seeks Aid in Viral Marketing Campaign for Gulf Coast Ike Relief Fund.

Terms of use | Copyright © 2017 Farlex, Inc. | Feedback | For webmasters