ECN 3103

INDUSTRIAL ORGANISATION

1

Semester 1, 2016

6. Collusion and Cartel Policy

Mr. Sydney Armstrong

Lecturer 1

The University of Guyana

Introduction

Definition (Collusion)

Collusion is when some or all firms in a market coordinate their

prices and quantities. This coordination is typically done with the

intent of raising price and earning higher profit.

“Cartels are cancers on the open market economy ..." [Mario Monti,

former European Commissioner for Competition, Sept 2000]

-“... negotiation between competitors may facilitate the supreme evil

of antitrust: collusion." [Supreme Court Justice Antonio Scalia,

Verizon Communications, Inc. v. Law Offices of Curtis V. Trinko

LLP, 2004]

-cartels are per se illegal in most countries2

Legal Practice of Defining Collusion

- explicit collusion: coordination through direct communication

occurs when firms directly communicate about price, market

allocation, sales quotas, and other information pertinent to

coordinating prices and quantities.

- legal status: always illegal

-tacit collusion: coordination without direct communication

when a less competitive outcome is achieved through mutual

understanding among firms; can also involve price leadership,

signaling using market instruments such as price, and any

other method not involving direct communication

-legal status: generally legal3

- price fixing = collusion can be without explicit agreement

(=tacit)

- collusion requires (credible) threat of punishment (not

actual punishment!)

- collusion can achieve monopolistic outcome

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Facts about (Detected) Cartels

- some studies estimate cartels controlled 40% of world trade

between 1927 and 1938

- in 1997 developing countries imported $81.1 billion of goods

from industries which had seen a price-fixing conspiracy

during the 1990s

- these imports represented 6.7% of imports and 1.2% of GDP

in developing countries

- FTC in US and European Commission have increased efforts

of prosecution

- after 1997 FTC has prosecuted international cartels worth

$8 billions of goods annually obtaining $1.2 billions in

criminal fines

-some more facts on cartels follow

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Market Conditions conducive to Collusion

Which industry characteristics facilitate or hinder collusion?

concentration

firm asymmetry

demand evolution: growing/declining industry

technological progress

product differentiation

frequency of interaction

multi-market contact

demand fluctuations

market transparency

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Market Concentration

in many countries competition authorities merger test includes

check if merger substantially increase the risk of collusion

among the remaining firms in the industry

the more firms, the harder it is to sustain a cartel

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Empirical evidence on the effect of concentration is mixed

Levenstein and Suslow (JEL, 2006): “no simple relationship

between industry concentration and the likelihood of

collusion".

Fraas and Greer (JIE, 1977): median number of firms in an

industry with a cartel is 8

why might the empirical evidence be mixed?

data is based only on convicted cartels with explicit collusion

when there are small number of firms, firms may be able to

tacitly collude

as number of firms increases, tacit collusion becomes more

difficult so there is more explicit collusion

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Firm Asymmetry

types of asymmetries: cost, capacity, historical market share, producttraits, product lines, financial status, willingness to collude

-impact on the set of feasible collusive outcomes

cartel stability requires inducing compliance from the firm with the

strongest propensity to cheat

may require redistributing cartel profit

may require having a firm to remain outside of the cartel

impact on the selected collusive outcome

lower cost firms want a lower collusive price

firms with more capacity want a bigger market share

how can cartel profit be “redistributed" to induce compliance?

market allocation (e.g., sales quotas)

firms charge different prices (with more sales and profit going tothe lower priced firms)

monetary transfers (e.g., inter-firm sales)

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asymmetric factors make collusion harder to sustain.

Demand Evolution

are fast growing or declining industries more conducive to

collusion?

collusion easier to sustain in growing industries, harder in

declining industries

industry growth increases future rewards for colluding today

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Market Transparency

recall the challenges associated with internal cartel stability

1 coordination

2 monitoring

3 punishment

information is essential to

1 firms being able to coordinate their prices and quantities

(future price intentions and exchange of current cost and demand data allows to choose profit-maximising collusive allocation)

2 monitoring compliance with the collusive outcome (historical disaggregated data common to all firms allows compliance checks)

3 punishing when there is evidence of non-compliance (allows targeted punishment of deviator) 13

Facilitating Practices

-facilitating practice is an activity that makes collusion more

likely or more effective, either by making coordination easier or

making it easier to sustain a collusive agreement

agreement among competitors to adopt a facilitating practice

may be prosecuted either as an anti-competitive agreement in

and of itself or as circumstantial evidence of price fixing

examples of facilitating practices

1 meeting competition clauses

2 most favoured customer clauses

3 information exchange of individual firm sales

4 announcements of future price changes involving minimum

prices

5 delivered or basing point pricing

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Meet The Competition Clauses

-MTC: seller promises that if buyer finds better price

elsewhere he would match this better price

-they can either charge a low price (L) or high price (H)

-consider price equilibrium without MTCs and two MTCs

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- MTC: whenever firm has high price while rival has low price,

high price firm reduces its price

- MTC clause destroys firms incentive to undercut rival because

rival is committed to follow price cut

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Most-Favoured Customer Clauses

seller engages to guarantee a buyer the same conditions

offered to other buyers

-retroactive MFC: buyer will be offered refund if future buyers

will be paying a lower price

CASE: GE/Westinghouse

Two biggest producers of turbine generators; 1963 GE

announced that if sold at any time below its book price all

customers of the last six months would get the same discount

paid out; they hired accounting firm to monitor them; soon

after Westinghouse did the same thing.

-What is the effect of this on pricing equilibrium of previous

example?

suppose current industry price is high

suppose when lowering the price, a company would have to refund previous customers a total amount of 2

- although price cut allows firm to steal market share from rival, it also means refunds to old customers

weaker incentive for price cuts and MFC can sustain collusion prices for turbine generators invariant from 1963 to 1975 until US DOJ intervened and firms had to give up the MFC clause 18

Facilitating Practices and Cartel Prosecution

to establish that some firm activity is a facilitating practice

which should be prohibited:

1 Did the firms act independently or collectively in adopting

this practice?

2 Does the common adoption of this practice promote anti-

competitive conduct?

3 Does this practice have any pro-competitive effects and, if so,

are they exceeded by anti-competitive effects?

- facilitating practices not per se prohibited but they may

trigger further investigation by competition authority 19

Competition Policy towards Cartels

Three stages in fighting cartels

1 Discovery (customer reports, whistleblower, leniency

programs, dawn raids, economic analysis)

2 Prosecution (standard of proof)

3 Penalization (corporate and individual fines and damages)

we look at these stages in reverse order

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Penalization

The Laws: Cartels are illegal!

- the very first law against cartel was the Sherman Act (1890) in the US

Sherman Act Section 1:

“Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal."

Sherman Act Section 2:

“Every person who shall monopolize, or attempt to monopolize, or

combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony, and, on conviction thereof, shall be punished by fine not exceeding $100 million if a corporation, or, if any other person, $1 million, or by imprisonment not exceeding ten years, or by both said punishments, in the discretion of the court."

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Prosecution

Standard of Proof

-prosecution of cartels requires hard evidence of a CAU (contract, agreement or understanding)

-in principle: tacit collusion legal, explicit collusion illegal

-tacit collusion (or absence of hard evidence) plus facilitating practices might be sufficient for prosecution

-firms use explicit collusion when gains from coordination and information sharing outweigh risk of prosecution

-this seems a rather weak standard of proof: can/should we expand domain of illegal collusion? 22

Discovery

in practice, how are cartels detected?

- Stainless steel - Buyers complained to the EC about the rapid increase in prices

-Lysine - An employee of ADM divulged the existence of a cartel and became an FBI informant.

-Sodium gluconate - Defendants in the lysine and citric acid investigations informed the authorities.

-Monochloroacetic acid - Clariant alerted European and American authorities to price fixing involving the Hoechst chemicals business that it had recently acquired.

we focus on the two mechanisms to detect and desist cartels

1 economic analysis

2 leniency programmes 23

1 Economic Analysis

-identify differences in market behaviour between suspected and unsuspected firms

-screening: (i) structural (identifying industry traits) or (ii) behavioural (identifying collusive patterns)

-problem with structural approach: produces too many false positives

behavioural approach:

is the collusive model better than competitive model?

is there a structural break?

- for example, we have a pretty good idea about the typical cartel price path

1 cartel formation is preceded by price decline.

2 transition phase in which price gradually rises

3 stationary phase in which price variance is low 24

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Problems with behavioural approach

-data intensive when data is hard to get

-data and method sensitive reduce court proofness

-can lead to higher legal costs

-potential for type I or type II errors of enforcement

- often successfully used to explain data from convicted cartels

- predicting cartels from suspected firms is a different story

- economists have a hard time to detect cartels on their own!!!

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2 Leniency Programs

Definition (Leniency Program)

A leniency program offers reduced penalties to corporations and/or individuals involved in collusion, in exchange for cooperating with enforcement authorities.

- has become major weapon in fight against cartels, used in Vitamins, Elevators, Lysine and so on

- information from leniency applications often forms basis for “dawn

raid investigation”

originated in criminal law, first introduced in 1978 in US, successfully reformed in 1993

since 2003 in Australia (reformed in 2009)

since 1996 in Europe (reformed in 2002), since 2006 in Japan, 2002

in Korea 28

Leniency Programs in comparison:

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Conditions for admission into leniency program

-corporation took prompt and effective action to terminate

participation

-provides full, continuing and complete cooperation that

advances investigation

-confession is truly corporate act (for corporate leniency)

-firm makes restitution to injured parties where possible

-did not coerce other parties in activity or was ring leader

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Miller (2009) finds that cartel formation and discovery has

decreased after the introduction of the leniency

programme in the US:

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