IN THE MATTER OF:

Porcelain-on-steel cookware from Mexico
(Continued)

IV. CONCLUSION

The Panel affirms the Commerce Department’s determinations with respect to all issues with the following two exceptions: (1) the Panel remands the issue concerning the error associated with product number 10158 for further proceedings not inconsistent with this opinion, and (2) the Panel remands the issue of the appropriate adjustment for rebated or uncollected value-added taxes with instructions for the Department to apply the tax neutral methodology approved by the Court of Appeals for the Federal Circuit in Federal Mogul v. United States, 63 F.3d 1572 (Fed. Cir. 1995). The Department shall provide the Panel with the results of this remand within 45 days of the date of this decision.

ISSUED ON APRIL 30, 1996

SIGNED IN THE ORIGINAL BY:

O. Thomas Johnson, Chairman

Victor Carlos Garcia-Moreno

Lewis H. Goldfarb

Kathleen F. Patterson

Alejandro Castaneda Sabido

Concurring Opinion On The Issue Of The Inclusion of Profit-Sharing In The Calculation Of COP & CV ¹

Joining in this Concurring Opinion on the issue of the inclusion of profit-sharing in the calculation of cost of production (COP) and constructed value (CV) are Panellists Alejandro Castañeda-Sabido & Victor Carlos García-Moreno (hereinafter "The Concurring Panel Members"). The Concurring Panel Members submit the following opinion and Appendix to express their finding that it would be reasonable from a profit maximization perspective not to include profit-sharing expenses in COP. Nevertheless, because the parties did not raise arguments using the profit maximization perspective, the standard of review afforded to the Panel does not allow for remand.

Analysis

The Concurring Panel Members find reasonable CINSA’s position that profit-sharing payments should not be included in costs of production (COP), utilizing the perspective of a profit maximizing firm. The Concurring Panel Members’ finding is analyzed below and in the Appendix. This analysis, however, was not raised by the Parties, and, thus, is not part of the administrative record upon which Commerce made its determination.

In accordance with the North American Free Trade Agreement (NAFTA), Annex 1903.2(1), "the Panel shall base its decisions solely on the arguments and submissions of the two Parties." Thus, the standard of review does not allow for remand. The Concurring Panel Members do not join in the decision of the Majority because they do not agree with the Majority’s economic analysis of profit-sharing payments. As discussed further below and in the Appendix, the Concurring Panel Members find that economic analysis from a profit maximization perspective supports the conclusion that the full amount of profit-sharing expenses would not be included in marginal cost, and, thus, in the pricing decision of the firm. Moreover, since one of the purposes of the home market cost/price test is to determine whether the price set by the firm recovered the costs of production, the Concurring Panel Members find that it would ² be reasonable for Commerce’s determination to reflect the firm’s decision-making process.

Part A. Characteristics of Profit-Sharing

As explained in the Majority decision, profit-sharing payments are "hybrid transfers of value." The Concurring Panel Members understand the profit-sharing expense as a contingent payment made by companies to employees based on the annual assessed profits of the firm. This contingent payment is similar to direct employee wages in that the payment is made to individuals involved in the production of the product. Unlike other employee wages and benefits, however, the profit-sharing payment will only be made if the company achieves a profit. In this respect, the profit-sharing expense also differs from the production costs of materials, fabrication, general expenses and packaging because these costs are incurred independently of whether the company works at an overall loss. ³ This aspect makes profit-sharing analogous to income tax and dividend payments because they are all contingent on the firm’s realization of a profit.

Profit-sharing is further likened to dividends because profit-sharing extends to the workers the economic risks that the company faces while operating in an uncertain environment. As stated by Commerce in its Opposition Brief, the risk-sharing aspect of dividends is a reason why dividends are not considered a cost of production. See Commerce Opposition Brief at 49.

In that case, the firm had to pay the profit-sharing allowance even if it did not make a profit. In contrast, CINSA only paid profit-sharing if the firm achieved a profit. Profit-sharing differs from dividend payments, as pointed out in the Majority decision, in that profit-sharing is a legal obligation and does not convey any ownership rights. The Majority decision also discusses CINSA’s argument that profit-sharing should be treated like income tax payments. The Majority agrees with CINSA that both profit-sharing and income taxes "constitute mandatory payments that are tied to a firm’s fiscal results." The Majority, however, distinguishes profit-sharing on the basis that it benefits workers and that it allows a firm to reduce fixed employee wages. This assertion was also presented in, Oil Country Tubular Goods From Austria, where Commerce asserted that, from an economic perspective, profit-sharing was directly related to wages and salaries. Id. 60 Fed. Reg. at 33,557. ⁴ To support the conclusion, Commerce claimed that because of profit-sharing, "[t]he company’s fixed wages are reduced allowing it to remain cost efficient in tough economic conditions." Id.

The Concurring Panel Members, however, find the claim that a firm can reduce wages because of profit-sharing, speculative and not supported by evidence on the record in the case at hand.

The Concurring Panel Members point out, however, that even though profit-sharing and corporate taxes have this indirect impact on marginal cost and prices, it does not mean that they should be included as part of COP. Regarding the give and take between wages and profit-sharing, they do not agree that the two payments are perfect substitutes from the worker’s perspective. Moreover, even though an institutional arrangement such as profit-sharing may reduce overall expenses, that does not mean that a profit-maximizing firm will allocate the expenses due to this arrangement as part of the marginal cost that affects their price-setting decision. The elements that are included in the firm’s marginal cost and price-setting decision will be discussed at length below and in the Appendix.

These different aspects of profit-sharing have made the expense a vague and somewhat problematic element for Commerce in the calculation of cost of production. Complicating matters further, Congress has not provided fixed standards or principles to instruct Commerce in its determinations or to guide the courts in their reviews.

Part B. Economic Argument.

The Majority decision asserts that, although both income taxes and profit-sharing payments affect marginal cost in a similar way, only profit-sharing is rightfully included in COP. ⁵

The Majority distinguishes profit-sharing stating that a rational firm will try to save on this expense, and, thus, on increased capital costs, by reducing the fixed wages paid to the workers with the promise of sharing profits with them. The Majority states:

"It is reasonable to assume that, rather than seeing its cost of capital and, ultimately, its marginal costs rise, a rational firm will attempt to keep its employee compensation levels at the market-clearing level, and will attempt to pass the cost of profit-sharing on to those workers who benefit from it - - rather than to the shareholders."

What the Majority refers to here as "employee compensation" includes the fixed wage and the so-called expected profit-sharing allocation.

The Concurring Panel Members respectfully disagree with the Majority’s assertion. The Concurring Panel Members’ criticisms of the Majority’s analysis on the effect of profit-sharing come from the supply side of the labor market and from the way profit-sharing enters into the firm’s decision-making process.

From the perspective of labor supply, the Concurring Panel Members do not agree that the contingent profit-sharing payments will perfectly substitute for fixed wages. It is not clear whether the workers will perfectly substitute a secure salary (fixed wage) for a contingent or expected payment (profit- sharing).

Unless workers are risk neutral, no perfect substitution will be present. Furthermore, the supply schedule of workers that would receive a fixed wage plus the contingent payment will be different than the supply schedule that would receive a pure fixed wage. If the labor supply schedule has some degree of elasticity and the demand for labor remains unaltered, a firm’s attempt to substitute contingent payments for fixed wages will imply a reduction in fixed wages, but also will imply a reduction in the market clearing employment and an increase in the so-called market clearing wage.

Assuming that the labor market faced by a firm is perfectly competitive, then the firm faces a perfectly elastic supply curve (i.e., the firm faces a competitive market in which it cannot have any impact), and there is no way in which the firm can reduce the fixed wages with the promise of sharing profits. The Concurring Panel Members do not agree that the supply schedule will remain constant after the workers have changed from a situation in which pure fixed wages were given to them to a situation in which part of their income is made contingent on uncertain events.

More fundamentally, the Concurring Panel Members disagree with the Majority’s characterization of the impact of the profit-sharing expense on the firm’s decision making process. The Majority concludes that the full amount of the expected profit-sharing payment is correctly included in COP. The Concurring Panel Members, however, find that this conclusion does not reflect the marginal decisions with respect to hiring labor for a profit maximizing firm that has to share profits. To illustrate this point, the Concurring Panel Members offer their own analysis of the decision-making process of a profit maximizing firm that shares profits.

A firm that does not share profits will hire an additional worker if the revenue that the firm expects to obtain from hiring the additional worker is larger than the extra costs that it will incur. Now, suppose that a firm has to share profits and faces the same decision with regard to hiring a worker. That firm has to share a certain percentage -say 10%- of its additional revenue that emerges because of the hiring of the additional worker. However, since the share is on profits, and since profits are calculated by subtracting costs from revenues, the effective cost of hiring the worker will also be reduced in the percentage in which the firm shares profits. Thus, there is no reason why a firm should have to consider expected profit-sharing as part of its marginal cost upon which production and pricing decisions are based. Any amount of profit-sharing will reduce revenues and costs in the same percentage. This analysis implies that a firm which shares profits and a firm which does not share profits will choose the same output and price.

The results of the analysis in the preceding paragraph assume that it is reasonable to study the price fixing decision from a short run perspective. As analyzed in the Appendix, if the long run perspective were to apply, it would imply that a firm could change all factor of productions at will, including capital. The Concurring Panel Members, however, find that the respondent did not have the ability to change its level of capital assets during the whole period of review, and, thus, it is reasonable to assume a fixed stock of capital. If the capital stock is fixed, the only way a profit maximizing firm can alter the level of production is by changing its level of labor employment.

Assuming that a firm may convince its workers to accept a lower fixed wage with the promise of sharing profits so that capital costs do not increase, there is no reason why a firm that maximizes profits needs to consider the expected profit-sharing payments as part of its marginal costs. Even in the long run, a firm that shares profits will lose on revenues, but will save in costs, and, thus, its impact is neutral in the pricing decision as long as capital is not mismeasured.

In the long run perspective, assuming that capital services are not accurately measured, then the savings in costs may be larger or smaller than the true cost of the capital services. In this case, profit-sharing is not fully neutral. In the case at hand, however, there is no record evidence that the capital services were mismeasured during the period of investigation. In fact, the Panel’s decision with regard to depreciation affirms Commerce’s determination which found that the revalued method of depreciation as used in the firm’s financial statements, reasonably reflected the depreciation expenses. Even assuming that capital has been mismeasured, in the short-run perspective, the mismeasurement does not imply that profit-sharing will affect the output and pricing decision.

If the firm can alter the level of capital and labor -the long run perspective- and if the capital costs are accurately calculated, the firm still does not have to worry about recovering the full amount of profit-sharing because it will still save on costs in the same percentage in which it loses on revenues, and, thus, the impact is neutral. Marginal cost would be determined by the fixed wage and by the rate of return on capital. If a firm succeeds in reducing its fixed wages allocation with the promise of sharing profits and maintains its capital costs at a constant level, the firm will face a lower marginal cost.

If capital costs are mismeasured and the firm is in the long run perspective, then the firm will still save on costs. However, the percentage on savings will be smaller than the percentage that it has to pay on revenues. Even in this case, unless the level of mismeasurement is excessive, most of the profit-sharing allocations will be automatically recovered without the need to alter the price. For example, if capital services are mismeasured at the 10 percent level; profit-sharing is ten percent; and if the firm increases its level of output in one unit -assuming for simplicity that price changes very little-then 10 percent of the additional revenues will be lost and the firm will also save 10 percent of the additional labor costs and approximately 9 percent of the additional capital costs. Although a small part of the additional capital costs are not saved, and this small part slightly changes marginal cost and prices, the magnitude is never at the full amount of profit-sharing. In other words, the firm does not need to alter the price dramatically since most of the profit-sharing expenses are recovered and marginal cost would only be changed slightly. As shown in the Appendix, this change is fundamentally determined by the level of mismeasurement of capital and not by the amount of profit-sharing.

The Concurring Panel Members find that there is no evidence in the record that shows that capital services have been mismeasured, and, thus, find it reasonable that from a profit maximizing perspective, profit-sharing should not be included as part of COP. The Concurring Panel Members also find reasonable that labor and other inputs -such as materials- were the only inputs that CINSA could alter in the period of investigation.

Under the latter circumstance, even if capital was mismeasured, profit-sharing will not have an impact on marginal cost and on the pricing decision. It is true, however, that if capital is being mismeasured and the firm is facing a long run situation, Several then profit-sharing may affect marginal cost, but this impact is not rightly incorporated by adding the profit-sharing allocation as part of the labor costs. Thus, the Concurring Panel Members find that the analysis from the profit maximization perspective does not support the Majority analysis and Commerce’s methodology.

The Concurring Panel Members conclude that if a profit maximizing firm shares profits, then it need not worry about including the full amount of profit-sharing in determining prices because the recovery of profit-sharing is automatic. The firm loses on revenues, but also saves on costs, even if not the full amount. From a profit maximizing perspective, the Concurring Panel Members find that the inclusion of profit-sharing would bias the cost/price test. Whatever the impact of profit-sharing on marginal cost, it is substantially reflected in fixed wages and the rate of return on capital.

In order to estimate what elements a firm would include in its price-setting decision, certain assumptions must be made as to how the firm behaves. One widely recognized assumption used be economists is that the aim of a rational firm is to maximize profits. This general assumption has been recognized by the administering authorities and by the reviewing courts. In USX ⁶ determinations from the International Trade Administration (ITA), also refer to profit-maximizing firms. See, e.g., Final Affirmative Countervailing Duty Determination: Cold Rolled Carbon Steel Flat-Rolled Products from Korea 49 FR 47,284 (December 3, 1984) (. . . "profit maximizing firms compete within that system, a marketplace exists and our benchmarks for identifying and valuing subsidies are prices in that market place"); Final Affirmative Countervailing Duty Determination: Certain Steel Products From Austria, 58 FR 37,217 (July 9, 1993) ("Privatized companies (and their assets) are now owned and controlled by private parties who are profit-maximizers.").

Corp. v. United States, the Court of International Trade (CIT) reviewed a decision by the International Trade Commission (ITC) which found negative material injury on domestic industry based upon a test, developed by one of the commissioners, which demonstrated that the foreign company had not engaged in predatory pricing. 12 C.I.T. 205, 682 F. Supp. 60 (Ct. Intl. Trade 1988). The Court remanded the decision, rejecting the Commissioner’s position that before finding material injury, the ITC must first find predatory pricing. Id. 682 F. Supp. at 66- 68. Nevertheless, the Court agreed ". . . that analysis from the point of view of rational profit-maximization is necessary in many situations . . ." Id. at 68. In another CIT decision, British Steel Corp. v. United States, the Court states, "The Department agrees that a profit-maximizing company should use the types of analyses suggested by the plaintiff in making its managerial decisions on these issues, . . ." 10 C.I.T. 224, 232, 632 F. Supp. 59, 66 (Ct. Intl. Trade 1986). The Court then goes on to question the reasonability of using such analyses on a per-project basis, but it does not question the profit-maximizing assumption. Id.

The Concurring Panel Members find it reasonable that Commerce calculate COP in the case at hand using the economic principle of profit-maximizing behavior. Since the purpose of the determination of sales at less than fair value is to assess whether the firm has engaged in an unfair trade practice, it is reasonable that Commerce evaluate the firm using the market principles by which firms operate. Moreover, since one of the ⁷ purpose of the home market cost/price test is to determine whether the price set by the firm recovered the costs of production, it is reasonable for Commerce to make the recovery analysis as the firm would, based on market principles.

SIGNED IN THE ORIGINAL BY:

Alejandro Castaneda-Sabido Victor Carlos Garcia-Moreno

Issued on April 30, 1996

Appendix to the Concurring Opinion Economic Analysis

The Concurring Panel Members’ reasoning can be better explained with the help of the following mathematical model. First, suppose that there are just two inputs, capital services and labor. If both are accurately measured, the profit function by including profit-sharing can be written in the following way:

II = (1-s)(pq-wl-rk)

If the firm wants to increase its level of output and sell one more unit, then it will have to buy more capital and labor services. The firm will increase production as long as marginal revenue exceeds marginal cost. In this example, the fact that firms share profits does not alter the decision to produce an additional unit. The firm will lose a certain percentage of the revenue, but that percentage will also be saved on costs.

Now suppose that capital is being mismeasured and only a certain percentage of capital is incorporated in the profit-sharing allocation. Call this percentage ( ( and assume that its value lies below 1, then the profits of the firm will be written in the following way.

II = (1-s)(pq-wl-( (rk) - (1- ( ( )rk

Using microeconomic analysis, the definition of "long run" is understood as a situation in which all inputs are subject to change. The Concurring Panel Members do not find that the long run perspective is the appropriate standard for the period of investigation in the case at hand, because their is no evidence on the record which shows that CINSA was able to adjust its capital stock at will during this period. Rather, the Concurring Panel Members find it reasonable to view the analysis by considering, as standard microeconomic analysis does, that the respondent had some level of inputs -such as the capital stock-which were inherited from past decisions, and, thus, that the short run profit function holds.

Under the short term conditions, the term k in the last equation is fixed. A firm which wants to produce more output has to hire more labor. By doing this, the firm increases its output and sales and loses a percentage of revenues because of profit-sharing, but the firm will also save on labor costs in the same percentage.

Thus, there is no reason to try to recover the profit-sharing allocation. The impact of profit-sharing is neutral, and the decision to price and produce is not affected by profit-sharing.

The conclusion of the Majority’s corporate tax analysis is that in a competitive capital market, the term r - capital services - will change. Comparing this with profit-sharing, the Majority states that a rational firm will reduce the fixed wages and will consider a labor compensation level that incorporates the expected profit-sharing payments, and moreover, that the labor compensation will stay at the same level at which the market cleared when the firm offered only a fixed wage. Here is where the Concurring Panel Members disagree. First, as economic analysis and the above profit function indicate, any additional unit of labor to be hired to increase production will be neutral. The firm will have to lose on revenue but it will also save on costs in the same percentage.

Thus, a rational profit-maximizing firm should not worry about recovering this allocation of profit-sharing, because the firm will recover it automatically. In other words, a firm that hires an additional unit of labor and loses a percentage of the additional revenues because of profit-sharing, will also save on marginal labor costs in the same percentage, and, thus, there is no reason to try to recover the profit-sharing allocation and the firm does not have to worry about maintaining its labor compensation at the former market clearing level.

Suppose that we are in the long term perspective (k is variable) and capital services are being mismeasured (( ( is less than 1), then the implicit price of capital has increased and the firm will choose relatively more labor. Marginal cost will depend among other things on the parameters ( (, the fixed wage w and the rate of return on capital r. The firm will lose on revenues by sharing profits and a lower percentage will be saved on cost since the new implicit price on capital, (1-( (s)r, is larger than the price of capital when the capital services are accurately measured, (1-s)r.

If capital services are mismeasured at the 10 percent level and profit-sharing is ten percent, then ( (=.9. Then, as analyzed above, only a small part of profit-sharing will not be recovered. This reasoning implies that the price will be altered only slightly, if at all. The impact of profit-sharing will be reflected in marginal cost and in the pricing decision, but only in the amount in which (1-( (s) differs from (1-s). Even in this case the effect on prices may be ameliorated by nonlinear considerations, such is the case of a Cobb-Douglas technology.

When capital services are mismeasured, the effect of profit-sharing on the pricing decision will depend fundamentally in the factor ( (. The inclusion of profit-sharing as part of the cost of production will not resemble this impact, and, thus, the impact of profit- sharing on the pricing decision will not be accurately depicted by adding profit-sharing as part of the cost of production. The inclusion of profit-sharing as part of cost of production will distort the cost/price test if the firm maximizes profits.

As the above reasoning illustrates, when capital is being mismeasured, profit-sharing does affect marginal cost, but this does not mean that the way it affects marginal cost is by including it as part of an extra wage added to the fixed wage term w. Profit-sharing affects marginal cost through the ( ( factor, and there is no reason to add profit-sharing to resemble the impact of this factor.

The Concurring Panel Members understand that Commerce, by adding profit-sharing to COP and applying the cost/price test, intends to show that the impact of profit-sharing has to be recovered in some way. However, as the model in this Appendix indicates, recovering the profit-sharing payments should not be a concern. If profit-sharing has any impact then that should be picked in the ( ( factor, and the terms r and w. The upshot of this economic analysis is that profit-sharing is not a significant issue in the pricing decision because a firm that shares profits and another that does not share will set almost the same price. Under Commerce’s current methodology (adding profit-sharing to COP), the home market cost/price test will be biased.

Thus, based upon economic assumptions such as profit-maximization, the Concurring Panel Members do not agree with Commerce’s methodology.

SIGNED IN THE ORIGINAL BY:

Alejandro Castañeda-Sabido Victor Carlos García-Moreno

Issued on April 30, 1996

¹ The following opinion is applicable to Commerce’s calculation 1 of both costs of production (COP) and constructed value (CV). According to the analyis, profit-sharing would be included in CV as an element of profit and not as an element of production costs.

² See 19 U.S.C. § 1977b(b), which provides: " . . . If the administering authority determines that sales made at less than cost of production— (1) have been made over an extended period of time and in substantial quantities, and (2) are not at prices which permit recovery of all costs within a reasonable period of time in the normal course of trade such sales shall be disregarded in the determination of foreign market value. . . ." [emphasis added] See also, 19 C.F.R. § 353.51(a). In addition, the regulation provides, "The Secretary will calculate the cost of production based on the cost of materials, fabrication, and general expenses, but excluding profit, incurred in production such or similar merchandise." Id., subsection ©.

³ Even though working at an overall loss, the firm will still make these payments as long as it can recover its variable costs.

⁴ The Concurring Panel Members agree with CINSA that Oil 4 Country Tubular Goods can be distinguished from the case at hand because in that case, the expense denominated "profit-sharing" was not exactly what is meant in the present case. Id. 60 Fed. Reg. at 33,557.

⁵ The Majority states, "Income taxes and mandatory profit-sharing payments are also alike in that both reduce a firm’s return on equity, thus increasing the firm’s costs of capital and, in time, the firm’s marginal cost."

⁶ The International Trade Commission (ITC), in making its 6 domestic injury tests, uses an economic model which assumes that firms optimize profits. The name of the model is Comparative Analysis of the Domestic Industry’s Condition (CADIC).

⁷ Congress has recognized the importance of the market 7 principles by providing a special procedure for calculating FMV in non-market economies. U.S.C. § 1677b© (1982); See also, S. Rep. No. 93-1298, 93^rd Cong., 2^nd Sess. 174, reprinted in 1974 U.S.C.C.A.N, 7186, 7311.