Regulation Collusion PDF

2.B Cartels 2.B. Cartels A. Should we merge into a single firm? DECISIONS WITH NEGATIVE B. Should we form a secret cartel? IMPACTS ON C. Should we try to maintain high...

2.B Cartels 2.B. Cartels A. Should we merge into a single firm? DECISIONS WITH NEGATIVE B. Should we form a secret cartel? IMPACTS ON C. Should we try to maintain high prices? CONSUMERS UNDER THE SCRUTINY OF COMPETITION AUTHORITIES ATREX BULVA 49 What do we study in this section? 1. Formation and stability of cartels 2. Detecting and fighting collusion 50 Cartel formation 3 alternative processes Firms decide simultaneously whether or not to participate in a single cartel 1st stage: Cartel participation decision → Determines number of decision-makers 2nd stage: Competition on the market Endogenous formation of cartels in a sequential way “1st” stage: Firms propose, sequentially, which cartel to form; those that refuse make a new proposition → Several cartels may form “2nd” stage: Competition on the market Bilateral market-sharing agreements “I stay out of your market if you stay out of mine” 51 A simple game with 3 firms Model Two-stage game 1st stage: Choose to participate to the cartel (Y) or not (N) 2nd stage: Set quantity (cartel = 1 decision-maker) Market conditions Inverse demand: # = ? − 6 Same constant marginal cost for all firms: 7 Cartel formation has no impact of production cost! Set ? − 7 = 1 Equilibrium profits (per decision-maker) Monopoly , ! = 1/4 Duopoly , ) = 1/9 Triopoly , * = 1/16 52 A simple game with 3 firms – Quantity game &+ " 3 firms in cartel / 0 independent firm → 1 !+ 3 = = $ "# &, " " 2 firms in cartel / 1 independent firm → 1 !+ 2 = = /1 -./ 2 = 1 0 = # ", 1 " 0 or 1 firm in cartel / 3 independent firms → 1 -./ 1 = 1 / = 53 "2 A simple game with 3 firms – Cartel game Equilibrium with 3 firms in cartel? Condition: No firm prefers to stay independent 0 0 : DE 3 ≥ : FGH 2 ⇔ 01 ≥ I NO Equilibrium with 2 firms in cartel? Condition 1: Independent firm doesn’t want to join cartel → OK Condition 2: Cartel firms don’t prefer to stay independent 0 0 : DE 2 ≥ : FGH 1 ⇔ 0J ≥ 0K NO Equilibrium with no firm in cartel? Condition: No independent firm wants to join cartel → OK 54 Generalization to ! firms First stage A cartel with ! firms is formed, with 1 < ! ≤ % Or, all firms stay independent (! = 1) Second stage ! < % → Cournot game played by cartel & % − ! independent firms So, 9 − : + 1 decision-makers ! = % → Monopoly choice of quantity Same market conditions as before (K = = − '; MC = :) Equilibrium profits per decision-maker if ) decision-makers: $−= 1 := 1 !+1 55 Generalization to ! firms – Equilibrium Conditions for cartel with 7 firms at equilibrium Internal stability: No firm in the cartel wants to ‘leave’ the cartel If firm ‘stays’, ( firms in cartel; if it ‘leaves’, only ( − 1 firms in cartel ( firms in cartel → ) − ( + 1 decision-makers ( − 1 firms in cartel → ) − (( − 1) + 1 decision-makers 9 ≥ : ≥ 3 → All terms are negative → NO 9 > : = 2 → −(9 − 2)& − 2 9 − 2 + 1 = −9& + 29 + 1 < 0 for all 9 > 2 → NO 9 = : = 2 → 0 + 0 + 1 ≥ 0 → OK 56 Generalization to ! firms – Lesson Simultaneous formation of cartel Consider the formation of a single cartel on a Cournot market with homogeneous goods and constant marginal costs. If there are at least three firms in the industry, all firms remain independent. If there are just 2 firms in the industry, the 2 firms form a cartel. 57 Generalization to ! firms – Intuition “Better to be out than in” The formation of the cartel induces positive externalities on the firms outside the cartel (higher market price). All firms prefer to free-ride on the public good provided by cartel members. 58 Generalization to ! firms – Extensions Partial and stable cartels may form if … Firms produce horizontally differentiated goods Competition and free-riding incentive are relaxed. ® It is possible to find stable cartels comprising not all firms but a strict subset of them (if goods are sufficiently differentiated). Cartel is formed in a sequential way Firms can commit to stay out of the cartel. ® At equilibrium, first firms remain independent and free-ride on cartel that the last firms will eventually form. Stable cartels may exist! 59 Illustration of cartels’ instability 60 Illustration of cartels’ instability (2) 61 Detecting and fighting collusion Looking at possible high price-cost margins is not sensible ⇒ Evidence of wrongdoing must be found. Method 1. Direct investigation Communication is central to collusion. It might leave significant pieces of evidence Permanent records of meetings or agreements Telephone conversations may have been tapped. ⇒ This can be used to detect collusion. Method 1. Encourage informing Competition authorities have designed policies to encourage cartel members to bring evidence to the authorities. Leniency & Whistleblowing 62 Difficulties in detecting collusion 4 methods to detect collusion 1. Is the firm’s behaviour consistent or not with properties or behaviour that are supposed to hold under a wide class of competitive models? Screening 2. Are there structural breaks in the firm’s behaviour? 3. Does the behaviour of suspected colluding firms differ from competitive firm’s behaviour? If only a subset of firms in the industry colludes and they can be identified a comparison can be directly carried out. Verification Otherwise one can resort to comparison across markets and across periods. 4. Which model (competitive or collusive) better fits the data? 63 Difficulties in detecting collusion (2) All 4 methods suffer from 2 general problems. 1. Necessary data to identify firm’s behaviour are not available (cost is often unobservable). 2. Firms have an incentive to misreport private information. Authorities are likely to suffer from the so-called indistinguishability theorem ® Firms misreport cost information to make prices appear as resulting from competitive - and not collusive - behaviour + Problems of results interpretation Even if needed data are available, estimation of firm’s behaviour may be extremely sensitive to model specifications. 64 Leniency and whistleblowing programmes To obtain evidence for the existence of cartels and collusion, competition authorities introduced… Corporate leniency programmes Reduced sentences for firms that cooperate with the authorities and provide evidence for the existence of a cartel Whistleblowing programmes Shielding individual informants from criminal sanctions Results of law enforcement Make cartels less stable Break-up existing cartels Prevent the formation of cartels n - issio - c omm pean m/ euro rtel/ ia.co -ca ets med s-trading ark ond :/ / w ww.m -over-b s k http raboban fines - 65 2.C Tacit collusion 2.A. Tacit collusion A. Should we merge into a single firm? DECISIONS WITH NEGATIVE B. Should we form a secret cartel? IMPACTS ON C. Should we try to maintain high prices? CONSUMERS UNDER THE SCRUTINY OF COMPETITION AUTHORITIES ATREX BULVA 67 What is tacit collusion? ‘Meeting of the minds’ between colluding firms No explicit agreement, no communication The collusive outcome may emerge at the equilibrium of a non-cooperative game. The analysis of ‘tacit agreements’ is also highly relevant for explicit agreements. Cartels are inherently unstable (even when firms meet and discuss). Punishments cannot be legally binding. A cartel is more stable if collusion is individually rational for each member. 68  Tacit collusion is more challenging to detect Correlated price movements can give a hint. Example. Gas stations in Germany (2015) Price increases, usually started by Aral or Shell. If Aral begins, Shell follows in 90% of the cases after exactly 3 hours. Vice versa if Shell begins. Esso usually follows 3-6 hours after the first firm raised prices. Jet usually follows after 5h and sets a price of one cent per litre below the others. But parallel price movements are no proof! Why? Costs (e.g. crude oil) or demand (e.g., increases before holidays) might evolve similarly across firms. Competition authorities need hard evidence of price fixing (see 2.A) 69 See: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3795206 A model of tacit collusion Model 2 firms sell a homogenous good Cost of production: constant marginal cost :. At each period M = 1, 2, … , O, firms repeat the same “static” game. Profits in the static game At the Nash equilibrium: , % If both firms choose the collusive action, each firm gets , + = , ! /2. With / % = monopoly profit If one firm chooses the collusive action and the other firm optimally deviates, this firms gets , ) By definition: , ) > , + > , % Example: Bertrand competition , + = , ! /2, , ) ≅ , ! , , % = 0 70  Tacit collusion. Finite time horizon ? = finite number → Firms know when competition stops. We can use backward induction to determine the subgame-perfect equilibrium of the repeated game. Period O → Firms play according to the Nash equilibrium of the static game; they obtain the corresponding profits. Period O − 1 → The strategies firms choose don’t affect the future profits ⇒ They play according to the Nash equilibrium of the static game and obtain the corresponding profits (same as in O). And so forth up to Period 1. If competition is repeated over a finite number of periods, firms play according to the (unique) Nash equilibrium of the static game in each period. Tacit collusion cannot emerge. 71 See: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3795206 Tacit collusion. Infinite time horizon Firms don’t know when the competition will stop. Firms must always care about the future consequences of their current choices. → Some strategies may allow firms to sustain collusive outcomes over time. Example. Grim Trigger Strategy A firm starts by choosing the action that maximises total profits. It keeps on choosing this action as long as both firms have done so in all previous periods. ® “Cooperation phase” If one firm deviates, deviation ‘triggers’ the start of the “Punishment phase”. Firms choose the action that corresponds to the Nash equilibrium of the static game. 72 Tacit collusion. Infinite time horizon (2) When is the grim trigger strategy part of a SPE? At any period M, firm " must find it optimal to play the strategy if it expects the firm P to play it as well. Period @ is in the punishment phase. Firm P plays the Nash equilibrium action now and forever. ⇒ Firm " can’t do better than playing this action as well. ⇒ Equilibrium Period @ is in the cooperation phase. Firm P plays the collusive action now. Trade-off for firm " Immediate gain from deviation (1 0 > 1 3 ) Future losses due to firm P’s punishment (1 + < 1 3 ) Depends on: magnitude of 1 0 − 1 3 and 1 3 > 1 + + firm’s discount factor 73 Tacit collusion. Infinite time horizon (3) Period @ is in the cooperation phase (continued) Present discounted value if firm " follows the grim trigger strategy: Present discounted value if firm " deviates: Equilibrium (deviation is not profitable) if and only if Discounted long Short term term losses gain Firms have a sufficiently large discount factor (they put sufficient weight on future profits). 74 Tacit collusion. Infinite time horizon (3) Lesson If a competition game is repeated infinitely, any profit level between the Nash equilibrium profit and the monopoly profit can be supported in a subgame-perfect equilibrium if the discount factor is sufficiently large. Application. Bertrand competition - ≥ 2 firms, constant and identical marginal cost Profits: : S = : T /9, : U ≅ : T , : E = 0 Tacit collusion can be sustained if and only if: The minimum discount factor is increasing in ). Tacit collusion is harder to sustain the larger the number of firms in the industry. 75 Factors facilitating tacit collusion What we already know Other factors Repeated competition over an Symmetric firms infinite horizon. It is harder for asymmetric firms to Tacit collusion cannot merge if “agree” on collusive prices or competition ends at some known production quotas. date. Frequent interaction High discount factors (patience) It makes deviation less profitable. Firms must value future profits Market transparency sufficiently to make the threat of Greater transparency makes it future punishment effective. easier to detect deviations and Small number of competitors trigger the punishment. The more numerous competitors Meet-the competition clauses are, Contractual commitments not to the more patient they must be. lower prices Also true under Cournot competition Most-favoured customer clause 76 Merger and tacit collusion Coordinated effects of mergers A merger may increase the incentives for the remaining firms to engage in tacit collusion. Contrasting impacts on the sustainability of collusion. The merger ¯ the number of firms in the market ® Tacit collusion becomes easier to sustain. The merger may increase the symmetry among the remaining firms. ® Tacit collusion becomes harder to sustain. If synergies, the merged entity may become a more efficient producer than the outside firms. In differentiated goods industries, the merged entity may own a more extensive set of brands. 77 Merger and tacit collusion (2) This may affect the evaluation of merger remedies. Example. Nestlé-Perrier proposed merger Pre-merger Proposition 1 Proposition 2 Proposition 3 Perrier 36% Nestlé + 53% Nestlé + 38% Nestlé + Perrier Perrier Perrier -Volvic - Volvic - other brands BSN 23% Nestlé 17% BSN 23% BSN 38% + Volvic Others 24% Others 24% Others 24% Refused because Refused because dominant position coordinated effects Accepted 78