Industrial Organization ( st term)

Transcription

1 .... Industrial Organization ( st term) Collusion & Cartels Dr. S. Farshad Fatemi Graduate School of Management and Economics Sharif University of Technology October 2, Dr. S. Farshad Fatemi Industrial Organization ( st term)

2 .. Collusion and cartel stability What is collusion and how can it arise? What features of an industry make collusion more, or less, likely to occur (and be sustained)? - Number of firms? - Homogeneous or differentiated goods? - Tight or excess capacity? - Symmetric or asymmetric firms? - Observability? What is the impact on consumers? How can collusion be detected? 17 Dr. S. Farshad Fatemi Industrial Organization ( st term)

3 .. Types of collusion Collusion: firms in the same industry acting together to achieve better outcomes than they can do individually - At best, may achieve monopoly price and output, and divide monopoly profit between themselves - Generally worse for consumers and for society as a whole - Typically illegal 18 Dr. S. Farshad Fatemi Industrial Organization ( st term)

4 .....Types of collusion Cartel: An institutionalized form of collusion, involving explicit (horizontal) agreement - Highly illegal: Some countries (e.g. US, UK) have possible criminal penalties Tacit collusion: accommodations reached without formal agreement 19 Dr. S. Farshad Fatemi Industrial Organization ( st term)

5 .. Explicit cartels US trusts: explicit price-fixing (or output-setting or market-sharing) cartels in 19th century (E.g. railroad operators) Sherman Act 1890: prohibited trusts (hence anti-trust) and monopolization of trade Measures adopted in other countries much later Explicit cartels are highly illegal Criminal penalties possible (e.g. UK Enterprise Act 2002) Some open international cartels: OPEC (oil), De Beers (diamonds) Secret cartels: vitamins producers, art auction houses 20 Dr. S. Farshad Fatemi Industrial Organization ( st term)

6 .. Tacit collusion Can firms reach a more favourable outcome without explicit agreement? Would expect a price-setting duopoly to do better than the competition If game is played repeatedly, will firms raise prices? - Example: Finitely repeated Bertrand game 21 Dr. S. Farshad Fatemi Industrial Organization ( st term)

7 .. Reaching a tacit agreement Relatively straightforward for Homogeneous goods / Similar production costs / Stable industry demand and costs Products are differentiated - How to decide price (or output level) for each one? - Non-collusive outcome is less harmful Firms have different costs - Higher cost firm(s) must be induced to produce less: side payments Industry shocks - Need to reset prices: price leadership may help 22 Dr. S. Farshad Fatemi Industrial Organization ( st term)

8 .. Improvements and extensions Infinitely repeated Bertrand model has a number of simplifications and limitations Improvements - Finite game and incomplete info: KMRW (1982) - Less severe punishments: Abreu (1986) stick and carrot Many extensions have been developed - Detection lags - Stochastic demand: Rotemberg & Saloner (1986) - Imperfect monitoring: Green & Porter (1984) - Capacity constraints: Brock & Scheinkman (1985) - Asymmetries between firms: Compte, Jenny & Rey (2002) 23 Dr. S. Farshad Fatemi Industrial Organization ( st term)

9 .. Finite game with incomplete information Backward induction result seems silly - Big difference in result between games with a large number (but finite) rounds and an infinite number of rounds - Surely a game with very many rounds can sustain collusion, at least for a time e.g. Axelrods experiments with finitely repeated PD - Tend to see collusion early on in the game which breaks down towards the end Way out of the paradox: introduce incomplete information 24 Dr. S. Farshad Fatemi Industrial Organization ( st term)

10 .. Kreps, Milgrom, Roberts and Wilson (JET 1982) Finite game with incomplete information - One player does not know the type of its rival - Player 1 thinks player 2 may be a committed trigger strategist and assigns a small probability α to this event - If 2 ever defects, this probability is updated to 0 If the number of remaining stages (s) is sufficiently large, collusion may be sustained Need to check players incentives 25 Dr. S. Farshad Fatemi Industrial Organization ( st term)

11 .. Stick and carrot punishment Trigger strategy is grim: no forgiveness, no reversion More realistic to suppose that firms punish cheating for a short time then revert to collusion Abreu (JET 1986): optimal symmetric strategy involves - Stick: punishment period with high output and very low prices (worse than reversion to Nash eq. outcome) - Carrot: return to collusion Punishment must be credible - Firms may not return to play collusively, thus punishment cannot be too severe - If a firm cheats during punishment phase, this takes place for another period 26 Dr. S. Farshad Fatemi Industrial Organization ( st term)

12 .. Detection (or reaction) lags Suppose that defection is not detected for 2 periods - Collusion is harder to sustain (requires higher δ) if price cutting is harder to detect Facilitating practices - Market transparency, e.g. publicly posting prices - Information exchange, e.g. through trade associations - Meet the competition clauses, which induce customers to police rivals pricing 27 Dr. S. Farshad Fatemi Industrial Organization ( st term)

13 .. Stochastic demand: Rotemberg & Saloner (AER 1986) In each period, demand may be low (D 1 ) or high (D 2 ), with prob. 1 2 Firms learn demand state, then simultaneously choose prices Incentive to cheat is greatest when current D is high (D 2 ) Implications: - Stochastic demand makes collusion harder to sustain - Price-cutting likely during booms - Could alter the collusive agreement by setting a price below the monopoly level during periods of high demand - Reduces incentive to cheat in these periods - Prices move counter-cyclically 28 Dr. S. Farshad Fatemi Industrial Organization ( st term)

14 .. Imperfect monitoring: Green and Porter (1984) Quantity-setting oligopoly Asymmetric information: firms do not observe rival behaviour (q) Demand fluctuates randomly, also unobserved Market price depends on total output and demand Thus, observation of a low price is a noisy signal - Could mean someone has defected or - Simply that demand is low Equilibrium strategy - Produce share of monopoly output q, until price falls below a trigger price - Then produce more than q for T periods (punishment phase), before reverting to q 29 Dr. S. Farshad Fatemi Industrial Organization ( st term)

15 .. Implications of imperfect monitoring Fully collusive outcome cannot be sustained Observe price wars in slumps, not booms (Opposite outcome to Rotemberg & Saloner) Price wars are necessary part of cartel discipline; Even though no cheating in fact occurs in eq. Collusion is harder to sustain if demand is very uncertain - Trigger price is carefully calculated to overcome incentive to cheat while minimizing unnecessary price wars - Greater uncertainty raises the cost from wasteful price wars Punishment is costly to implement, as q increases while p decreases (Free-rider problem in implementing this if more than 2 firms) 30 Dr. S. Farshad Fatemi Industrial Organization ( st term)

16 .. Capacity constraints Brock and Scheinkman (REStud1985): model with exogenous capacity constraints - n firms - Each has fixed capacity, k - Constant marginal cost c up to capacity k - Linear demand - Look for SPE in trigger strategies, to sustain collusion at p m 2 conflicting effects on collusion - Less incentive to cheat as cannot supply whole market demand - But ability to punish cheating is weaker Result: increasing number of firms, n, has a non-monotonic effect on the sustainability of collusion 31 Dr. S. Farshad Fatemi Industrial Organization ( st term)

17 .. Asymmetries between firms: Compte et. al (2002) Repeated Bertrand game with asymmetric capacity constraints Sustainability of collusion depends on - Capacity of largest firm: determines incentive to cheat - Aggregate capacity of the other firms: determines ability to punish When aggregate capacity is low, asymmetry hinders collusion - Largest firm has strong incentive to cheat - Rrivals ability to punish is limited When aggregate capacity is large, asymmetry helps collusion - Punishment is effective and collusion can be sustained 32 Dr. S. Farshad Fatemi Industrial Organization ( st term)

18 .. When is collusion most likely? Smaller number of firms - Easier to reach agreement / coordination - Less incentive to cheat and seize whole market Existence of (some) spare capacity Symmetric firms: costs, products, capacities - Easier to reach agreement; side payments unnecessary - Homogeneous goods mean Bertrand outcome is very harmful Observability - Price cutting is readily observed (transparency, facilitating practices) - Reaction lags are short - Demand is stable and observable 33 Dr. S. Farshad Fatemi Industrial Organization ( st term)

19 .. Collective dominance in merger control Suppose a horizontal merger reduces the number of firms but does not result in monopoly / dominance Competition authorities may nonetheless be concerned that merger could increase the likelihood of collusion (Does it create collective dominance?) Examine industry features to assess likelihood of collusion - Resulting level of, and increment to, Herfindahlindex - More sophisticated assessment of costs, capacities and incentives E.g. Compte, Jenny & Reys assessment of merger between Nestle and Perrier (bottled water sector in France) - Industry practices, e.g. price transparency, contracts 34 Dr. S. Farshad Fatemi Industrial Organization ( st term)

20 .. Detecting collusion Explicit cartel: look for documentary evidence - Meetings, papers, etc: search powers and dawn raids - Whistle-blowing: leniency measures Tacit collusion: detection is harder Industry conduct - Conscious parallelism : but there are other reasons why firms may change prices at the same time, e.g. common cost shock - Estimate firms reactions to one anothers price changes - High responsiveness = collusive behaviour (punishment strategies) Industry performance (Prices: compare with costs; Profits: compare with cost of capital) 35 Dr. S. Farshad Fatemi Industrial Organization ( st term)

21 .. Woodpulp: burden of proof Tacit collusion investigation involving producers of woodpulp Features - Price parallelism - Highly visible price pre-announcements - Rising prices, unrelated to cost changes, with increasing stocks - Cost differences not reflected in prices European Commission ruled this was concerted behaviour But ECJ overturned this on appeal, citing other explanations parallel conduct cannot be regarded as furnishing proof of concertation unless concertation constitutes the only plausible explanation;... At very least, Commission must show that behaviour cannot be explained by normal conditions of competition 36 Dr. S. Farshad Fatemi Industrial Organization ( st term)

22 .. EU policy towards cartels and collusion Article 81 of EC treaty: 1. The following shall be prohibited as incompatible with the common market: all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition... - This is followed by some particular prohibitions: price fixing, limiting production or investment, sharing markets, discrimination between customers, imposing unrelated conditions - 81(2): Prohibited agreements are automatically void - 81(3): Exceptions for agreements which are efficiency-enhancing, e.g. improve production or distribution, promote technical progress 37 Dr. S. Farshad Fatemi Industrial Organization ( st term)

23 .. Explicit cartel: Vitamins (1999, 2001) Secret, price-fixing cartel, operated Jan 1990 Feb Fixed prices of vitamins used in foodstuffs e.g. bread, milk, cereal - Total value of transactions affected was $5 bn Cases brought in US (1999) and EU (2001) Hoffman-La Roche (Swiss) - Fined $500m (US) and e462m (EU): believed to be the largest ever corporate fine in any sort of case - Worldwide marketing director of H-LR, Dr Sommer, pleaded guilty in exchange for a $100,000 personal fine + 4 months jail BASF (German): fined $225m (US) and e296m Rhone-Poulenc (now Aventis following merger with Hoechst) - Escaped fine in US in exchange for supplying evidence; fined in EU 38 Dr. S. Farshad Fatemi Industrial Organization ( st term)

24 .. Tacit collusion: White Salt (1986) Investigation by UK Competition Commission into pricing behaviour Two major producers of salt in the UK - British Salt: 45% of market, lower cost producer - ICI: 50% of market Competition concerns - Parallel pricing: price changes always matched over previous 10 yrs - In the previous 5 years ICI had led on all price changes - Pre-notification of price changes (by letter): parties claimed this was necessary as they traded a small amount of salt with one another! - Prices had risen faster than in other industries - High returns on capital: 50% for ICI, 30% for BS (though falling) - [NB: figures around 10-15% might be considered reasonable] 39 Dr. S. Farshad Fatemi Industrial Organization ( st term)

25 .....Tacit collusion: White Salt (1986) Features of the salt industry - Homogenous product - Declining market: 30% fall in production Barriers to entry Large economies of scale: small scale entry suffers significant cost disadvantage Large excess capacities: BS 75% utilisation, ICI 65% utilisation( figures) Use of long-term contracts foreclose a large part of the market Legal barriers to entry: Cheshire County Council (where the best salt deposits are located) is unlikely to grant any new development licenses due to environmental considerations - Limited imports: high transport cost relative to the value 40 Dr. S. Farshad Fatemi Industrial Organization ( st term)

26 .....Tacit collusion: White Salt (1986) Analysis of the market - Several factors that might support tacit collusion Highly concentrated market (effective duopoly) High barriers to entry Information sharing Capacity for retaliation strategy - Some evidence that it might be occurring Parallel pricing Rising prices despite falling demand Excessive returns on capital - CC ruled that tacit collusion was occurring In particular, criticized BS for following ICIs pricing rather than (as the lower cost producer) putting greater competitive pressure on ICI Imposed form of price control, with prices linked to BSs costs 41 Dr. S. Farshad Fatemi Industrial Organization ( st term)

27 .. Rees (1993) analysis of White Salt Examined the data to test for tacit collusion Concluded that - Given firms capacities, the threat of punishment was credible and would sustain collusion - Though the result was not joint profit-maximizing as this would require BS (with lower costs) to produce at full capacity and make side payments to ICI 42 Dr. S. Farshad Fatemi Industrial Organization ( st term)