TACIT COLLUSION IN OLIGOPOLIES AND REGULATED INDUSTRIES Zur Erlangung des akademischen Grades eines Doktors der Wirtschaftswissenschaften (Dr. rer. pol.) von der Fakultät für Wirtschaftswissenschaften am Karlsruher Institut für Technologie (KIT) genehmigte DISSERTATION von Niklas Horstmann B. Sc. Tag der mündlichen Prüfung: 20. Mai 2016 Referent: Prof. Dr. Jan Krämer Korreferent: Prof. Dr. Karl-Martin Ehrhart Karlsruhe, 2016 Acknowledgements I am deeply grateful to my advisor Prof. Dr. Jan Krämer who always knew when to encourage and when to challenge me. He has not only been my mentor but also has become a dear friend. I am also indebted to Prof. Dr. Christof Weinhardt for the opportunity to pursue my scientific ambitions. My sincere thanks go to my co-advisor Prof. Dr. Karl-Martin Ehrhart for inspiring comments as well as to Prof. Dr. Kay Mitusch and Prof. Dr. Martin Ruckes for serving on the board of examiners. My sincere appreciation goes to all my colleagues. In particular, I thank Marc Adam for satirical references, Christoph Flath for informative exchanges on politics, Felix Fritz for working weekend chats, Johannes Gärttner for entertaining conversations, Anuja Hari- haran for exciting insights into Indian culture, Philip Köhler for his infectious cheerful- ness, Tobias Kranz for passionate debates, Ewa Lux for making my time at the institute even more memorable and for proofreading this thesis, Marius Müller for diverting discussions, Claudia Niemeyer for her joviality, Thomas Setzer for his dry sense of hu- mor, Daniel Schnurr for close and long-term collaboration, Alexander Schuller for his cooperative nature, Philipp Ströhle for brief glimpses into other research areas, Timm Teubner for constructive feedback, and Lukas Wiewiorra for helpful advice. I thank all colleagues with whom I had the pleasure to collaborate in academic self- administration. Moreover, I gratefully acknowledge financial support from Deutsche Forschungsgemeinschaft and Karlsruhe House of Young Scientists. I thank Prof. Dr. Marc Bourreau for fruitful cooperation during my research stay at Télécom ParisTech. Finally, I express my heartfelt gratitude to those who are most important to me: my family and friends. They encourage me in everything I do, help me to reflect myself, and remind me of the multiplicity of life. I owe them more than words can describe. i Abstract Detection and prevention of collusive behavior are primary concerns of regulatory and antitrust authorities. This includes the exposure of explicit collusion, i.e., cartels, as well as the avoidance of tacit collusion in order to create competitive markets. In an effort to acquaint regulators with market structures and firm behavior that facilitate implicit co- ordination among competing firms, this thesis investigates principle characteristics of oligopolistic markets with respect to their propensity to collude tacitly. These main fea- tures are (i) strategic interactions of few competitors, (ii) multimarket contact between those firms, and (iii) vertically related upstream and downstream markets. The market characteristics are investigated theoretically and empirically with a focus on economic laboratory experiments. Considering the lack of field data on tacit col- lusion due to the difficulties in detecting collusive behavior, experimental economics constitute a complementary research method which bridges the gap between theory and field evidence. In particular, economic laboratory experiments are well suited to systematically study the factors that may lead to tacit collusion in spite of the restrictive assumptions of theory or the deficiency of internal validity in real-world data. As groundwork for the investigation of oligopoly characteristics, part one of the thesis reports on analyses of the experimental methodology itself. Its potential with respect to regulatory policy advice in general is assessed in a literature review that results in guidelines for corresponding experimental designs. In particular, the survey spans the spectrum of experiments by classifying them into those aiming for external validity by implementing regularities of a specific industry and those targeting internal validity by considering the most simplistic laboratory environment. A key design element of any experiment is the mode of timing. The vast majority of experiments consider discrete iii time although continuous time may be argued to be a more realistic alternative. There- fore, both modes of timing are evaluated in an oligopoly competition experiment in which tacit collusion is found to be higher under discrete time than under continuous time. This finding emphasizes the implications of an experimenter’s choice of timing. Part two of the thesis is dedicated to theoretical and empirical analyses of the interac- tions of market structures and tacit collusion. First, the effect of the number of firms on tacit collusion is investigated by a meta-analysis of extant oligopoly experiments and by two experiments with symmetric and asymmetric firms. By systematic variation of the number of firms as well as the mode of competition, all analyses show that contrary to prominent belief the competitiveness of an industry does not strictly increase with the number of competitors. In fact, triopolies and quadropolies are found to be equally competitive, which bears important ramifications for merger control and ex ante reg- ulation of oligopolies. Second, a theory of conglomerate firms’ price setting behavior is developed that explains under which circumstances multimarket contact facilitates tacit collusion compared to single market contact. The theory builds on firms’ abil- ity to communicate collusive intentions solely through their price setting behavior and on the conjecture that such price signaling can be conducted more efficiently under multimarket contact. The findings suggest that limiting conglomerate firms’ possibil- ity to engage in price discrimination across geographically segmented markets may effectively reduce tacit collusion. Third, tacit collusion is also investigated in an en- vironment of vertically related markets. In an industry in which wholesale access for a non-integrated reseller is provided by two vertically integrated firms, a laboratory experiment reveals that wholesale competition may facilitate tacit collusion, yielding wholesale and retail prices even above the monopoly level. Whereas regulation pre- venting a margin squeeze fails to decrease prices, a simple price commitment rule at the wholesale level is found to substantially reduce tacit collusion. These results in- dicate that consumers may be worse off under a wholesale duopoly with unregulated competitive wholesale provision relative to the case of a wholesale monopoly. Alto- gether, these findings highlight the vital importance of research on competition policy and of regulation itself in safeguarding competition. iv Contents 1 Introduction1 1.1 Motivation.................................... 4 1.2 Research questions............................... 7 1.3 Structure of this thesis ............................. 10 I Regulation in the Lab 13 2 Experimental Economics for Regulatory Policy Advice 15 2.1 Objectives .................................... 17 2.2 Key variables .................................. 22 2.3 Literature review ................................ 24 2.3.1 Laboratory experiments maximizing external validity . 25 2.3.2 Laboratory experiments maximizing internal validity . 43 2.4 Observations................................... 55 2.5 Discussion.................................... 66 3 Sequences of Decision Making in Experiments and Tacit Collusion 69 3.1 Motivation.................................... 70 3.2 Timing in experiments............................. 72 3.2.1 Classification of discrete and non-discrete time experiments . 73 3.2.2 Review of non-discrete time experiments.............. 75 3.3 Experiment.................................... 79 3.3.1 Oligopoly competition......................... 80 3.3.2 Measuring competitiveness...................... 82 3.3.3 Repeated games in discrete and continuous time.......... 83 3.3.4 Procedures................................ 85 3.4 Results...................................... 87 3.5 Discussion.................................... 92 II Market Structures and Tacit Collusion 97 4 Number of Competitors and Tacit Collusion 99 4.1 Motivation.................................... 100 4.2 Meta-analysis .................................. 102 4.2.1 Experimental designs ......................... 102 4.2.2 Measuring competitiveness...................... 104 v Contents 4.2.3 Results.................................. 107 4.3 Experiment with symmetric firms....................... 113 4.3.1 Oligopoly competition......................... 113 4.3.2 Procedures................................ 114 4.3.3 Hypotheses ............................... 114 4.3.4 Results.................................. 117 4.4 Experiment with asymmetric firms...................... 121 4.4.1 Asymmetric oligopoly competition.................. 122 4.4.2 Procedures................................ 122 4.4.3 Hypotheses ............................... 125 4.4.4 Results.................................. 126 4.5 Discussion.................................... 131 5 Price Discrimination and Tacit Collusion 137 5.1 Motivation.................................... 138 5.2 Experiment.................................... 139 5.2.1 Design.................................. 139 5.2.2 Procedures................................ 140 5.3 Results .....................................