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On Collusive Behavior Models of Cartel Formation, Organizational Structure, and Destabilization Dissertation CORE Metadata, citation and similar papers at core.ac.uk Provided by Elektronische Publikationen der Universität Hohenheim On Collusive Behavior Models of Cartel Formation, Organizational Structure, and Destabilization Dissertation zur Erlangung des akademischen Grades Doktor der Wirtschaftswissenschaften (Dr. oec.) an der Fakult¨at fur¨ Wirtschafts- und Sozialwissenschaften der Universit¨at Hohenheim vorgelegt von Julia Fischer – 2011 – Die vorliegende Arbeit wurde im Jahr 2011 von der Fakult¨at f¨ur Wirtschafts- und Sozialwissenschaften der Universit¨at Hohenheim als Dissertation zur Erlangung des akademischen Grades Doktor der Wirtschaftswissenschaften (Dr. oec.) angenommen. Dekan: Professor Dr. Dirk Hachmeister Erster Berichter: Professor Dr. Ulrich Schwalbe Zweiter Berichter: Professor Dr. Justus Haucap Tag der letzten m¨undlichen Pr¨ufung: 21. Oktober 2011 Contents List of Figures III 1 Introduction 1 1.1 MarketImperfections. .. .. 3 1.2 Collusive Behavior . 4 1.3 AntitrustEnforcement . .. .. 6 1.4 LifeCycleofCartels ....................... 9 1.4.1 CartelFormationStage. 10 1.4.2 Cartel Stability Stage . 12 1.4.3 Cartel Destabilization Stage . 14 1.5 Outline............................... 16 2 Cartel Formation 20 2.1 TheCartelFormationSupergame . 21 2.2 Application ............................ 26 2.2.1 LinearDemand ...................... 26 2.2.2 GeneralDemandFunctions . 38 2.3 Summary ............................. 45 3 Organization of Cartel Communication 47 3.1 TheModel............................. 48 3.1.1 Definitions......................... 49 3.1.2 Tacit Collusion . 51 3.1.3 Explicit Collusion . 51 3.2 Stability.............................. 56 3.2.1 General Stability of Cartels . 57 3.2.2 Pairwise Stability of Cartel Networks . 58 3.3 LinearDemand .......................... 60 3.3.1 Critical Patience of Players . 61 3.3.2 NetworkTypes ...................... 63 3.3.3 Discussion......................... 65 I CONTENTS II 3.4 Summary ............................. 70 4 Destabilizing Collusion in Vertical Structures 71 4.1 TheModel............................. 72 4.1.1 Double Marginalization . 74 4.1.2 Collusive Equilibrium . 75 4.1.3 Non-Linear Pricing Schemes . 77 4.2 DownstreamCollusion . .. .. 78 4.2.1 Optimal Price-Quantity Combination . 79 4.2.2 DiscountSchemes. .. .. 87 4.3 Non-Collusive Behavior Downstream . 91 4.3.1 Optimal Price-Quantity Combination . 92 4.3.2 DiscountSchemes. .. .. 95 4.4 Summary ............................. 97 5 Conclusion 99 A Restrictions for Sequential Cartel Formation 103 B Characteristics of the Critical Discount Factor 105 B.1 CourseoftheCriticalDiscountFactor . 105 B.2 Restricting Players in Cartel Networks . 106 C Solution of the Optimization Problems 107 Bibliography 109 List of Figures 2.1 ParametersforCartelFormation . 29 2.2 Price Dynamics for n =4Firms................. 33 2.3 Price Dynamics for n =5Firms................. 33 2.4 ConsumerSurplus......................... 37 3.1 NetworkStructures .. .. .. 50 3.2 Discount Factors in Networks with Fixed Link Costs . 66 3.3 Discount Factors in Networks with Fixed Cohesion Parameter 67 4.1 VerticalMarketStructure . 73 4.2 Double Marginalization in a Vertical Structure . 76 4.3 All-Units vs. Incremental Discount Schemes . 79 4.4 Optimal Price-Quantity Combination . 84 4.5 Discount Schemes to Destabilize Collusion . 89 III Chapter 1 Introduction Actions of antitrust authorities in prominent cartel cases, such as the unan- nounced inspections conducted by the European Commission in various firms of the e-book publishing sector in March 2011 or the fines looming against chocolate producers in Germany, are often reported by the media and have regularly attracted public attention in recent years. A discussion about car- tels, however, is not only held in the public but also in the scientific world in the research field of industrial organization. The strategic interactions of firms and the problems arising in markets with imperfect competition are analyzed within this field. Usually, the problems discussed in this strand of literature are analyzed by conducting partial analyses of markets where the concept of perfect competition fails to explain several aspects, such as in markets where the firms behave collusively. In these markets, the underlying assumption in perfect competition of firms’ price-taking behavior is not sat- isfied, therewith the allocative effects of prices are suspended, and the firms are able to increase their profits by colluding. The aim of this thesis is to gain a better understanding of the impact of collusive behavior on prices and the incentives that drive collusive behavior. In economic literature, it is generally accepted that collusive behavior causes welfare losses, and therefore agreements about prices, quantities, quotas, market shares, etc. are prohibited per se in almost all jurisdictions. That is why these agreements are not enforceable by law; nevertheless, cartels exist in many markets. Thus, there have to be other aspects than legal enforceability that contribute to stabilizing cartels. Many of these aspects are understood, however, we believe, more work is necessary to better understand these incentives. In most of the economic literature, the modeling of the stability of car- tel agreements is based on pure monetary incentives. In general, it is as- sumed that cartel members face a situation which corresponds to a prisoner’s 1 CHAPTER 1. INTRODUCTION 2 dilemma. In this interpretation a cartel member has two options: Either the respective cartel member decides to stick to collusive behavior or the con- sidered firm deviates from the collusive agreement, which corresponds to the firm’s individual maximization of its profit given the others still behave collusively. As the situation corresponds to a prisoner’s dilemma, the respec- tive firm is better off by deviating than by colluding. As all participating firms face these incentives to deviate and cartel agreements are not enforce- able by law, the cartel is not stable unless the cartel members have another way to enforce their agreements. The possibility to achieve enforceability arises if the firms interact repeatedly and the cartel members value payoffs in future periods high. By making the decisions whether to stick to collusive behavior repeatedly, the cartel members are able to punish firms that deviate from collusive behavior in future periods by, e.g., not colluding in the future and therefore decreasing all firms’ profits, but most importantly decreasing the deviator’s profits. Through these punishing mechanisms, the interacting firms might be able to stabilize their agreements. There are few other approaches to cartels in the economic literature, which will be discussed later in this chapter. Nevertheless, collusive behavior is not fully understood so far as there are aspects that are not yet covered by the literature. These aspects are inter alia, the instruments given to an- titrust authorities’ that have changed in recent years, and research has not fully covered the new aspects arising from these changing conditions for car- tel members. Furthermore, the organizational structure within cartels and its influence on cartel stability is not discussed so far in the standard cartel literature. A reason for specific forms of the cartels’ organization, i.e. the structure with whom the cartel members communicate and agree to specific behavior, might be due to the stability considerations of the cartel members. The exact form of cartel structures, however, might not only be influenced by stability arguments but also by the process of how a cartel was formed; the formation process might contribute to intensifying the communication between particular members. The focus of this thesis, therefore, lies on im- proving the understanding of the incentives in different stages of the life cycle of a cartel, namely the cartel formation stage, the stage where a cartel acts profitably, and the stage where the collusive behavior ends, the destabiliza- tion stage, to improve the theoretical background for understanding firms’ collusive behavior. From an antitrust authority’s perspective, it is important to understand the incentive structure of cartel members for various reasons. First, a better understanding of the incentives for collusion might allow for the distinction between markets, where firms are rather likely to explicitly collude and oth- ers, where the risk of cartelization is low. Second, the success of fighting CHAPTER 1. INTRODUCTION 3 cartels depends substantially on the antitrust authorities’ effective use of their instruments. A better understanding of collusion by antitrust authori- ties might contribute to an improvement in the decisions on which markets to closely monitor and where to intensify the actions taken in order to prevent or detect collusion and how to best apply the instruments in the presence of the antitrust authorities’ budget constraints. 1.1 Market Imperfections In our analyses of firms’ behavior, we consider markets which exhibit various imperfections that, in consequence, lead to market prices above the perfectly competitive levels. This is due to the very restrictive assumptions of perfect competition, which are often violated in reality. We will only discuss a few market imperfections in detail that arise by relaxing some of the strict as- sumptions of the perfect competition concept; these are of great importance for the analyses conducted in this thesis and respond to the assumptions of the firms’ price-taking behavior and, closely related to this, the
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