Penalizing cartels: The case for basing penalties on price overcharge

In this paper we set out the welfare economics based case for imposing cartel penalties on the cartel overcharge rather than on the more conventional bases of revenue or profits (illegal gains). To do this we undertake a systematic comparison of a penalty based on the cartel overcharge with three other penalty regimes: fixed penalties, penalties based on revenue, and penalties based on profits. Our analysis is the first to compare these regimes in terms of their impact on both (i) the prices charged by those cartels that do form and (ii) the number of stable cartels that form (deterrence). We show that the class of penalties based on profits is identical to the class of fixed penalties in all welfare-relevant respects. For the other three types of penalty we show that, for those cartels that do form, penalties based on the overcharge produce lower prices than those based on profit) while penalties based on revenue produce the highest prices. Further, in conjunction with the above result, our analysis of cartel stability (and thus deterrence), shows that penalties based on the overcharge out-perform those based on profits, which in turn out-perform those based on revenue in terms of their impact on each of the following welfare criteria: (a) average overcharge, (b) average consumer surplus, and (c) average total welfare.     

The Chilean Anti-cartel Experience: Accomplishments and Challenges

Review of Industrial Organization - We evaluate the Chilean law and enforcement record in the area of cartels. We identify the high probability of cartel detection, severe sanctions for detected...     

Multi-Market Collusion with Demand Linkages and Antitrust Enforcement

This paper analyzes dynamic cartel formation and antitrust enforcement when firms operate in demand-related markets. We show that cartel prosecution can have a knock-on effect: bringing down a cartel in one market reduces profits and cartel stability and leads to the break-up of the cartel in the adjacent market. Cartel prosecution can also have a waterbed effect: disrupting a cartel increases cartel stability in the adjacent market and induces cartel formation in previously competitive markets. We discuss the impact of dynamic cartel formation on consumer surplus, explore antitrust spillovers, the optimal scope of antitrust interventions and cartel formation with local firms.     

Heterogeneous Investor Sentiment and Institutional Real Estate Investments

Commercial real estate investors differ in their sentiment due to factors such as market expertise, investment strategies and expectations about future market conditions. Focusing on the office market, we investigate whether investors with a multiasset investment focus such as pension funds or insurance companies rely on the sentiment of specialized real estate investors such as public REITs or private developers/owners as source of information in their investment decision‐making. Using disaggregated sentiment measures and vector autoregression (VAR) we find evidence that changes in REIT and private real estate investor sentiment lead to changes in institutional investor sentiment in the suburban office and office REIT market. Our findings suggest that institutional investors rely on the sentiment of specialized real estate investors to make real estate investment decisions. Our study contributes to the existing literature on sentiment in commercial real estate markets by emphasizing the heterogeneity of investor sentiment and introducing a disaggregated sentiment measure. We also contribute to the institutional herding literature.     

Fine-Tailored for the Cartel-Favoritism in Procurement

In this paper, we investigate the interaction between two firms, which are involved in a repeated procurement relationship modeled as a multiple criteria auction, and an auctioneer (a government employee) who has discretion in devising the selection criteria. Our main result is that favoritism substantially facilitates collusion. It increases the gains from collusion and contributes to solving basic implementation problems for a cartel of bidders operating in a stochastically changing environment. A most simple allocation rule where firms take turns in winning, independently of stochastic social preferences and firms’ costs, achieves full cartel efficiency (including price, production, and design efficiency). In each period the selection criteria is fine-tailored to the in-turn winner: the “environment” adapts to the cartel. This result holds true when the expected punishment is a fixed cost. When the cost varies with the magnitude of the distortion of the selection criteria (compared to the true social preferences), favoritism only partially shelters the cartel from the environment. We thus find that favoritism generally facilitates collusion at a high cost for society. Our analysis suggests some anti-corruption measures that could be effective in curbing favoritism and collusion in public markets. It also suggests that the much-advocated rotation of officials is likely to be counter-productive.     

Combining cartel penalties and private damage actions: The impact on cartel prices

In many countries antitrust enforcement by Competition Authorities through prosecution and the imposition of penalties is complemented in price-fixing cases by private damage actions, which should affect both cartel deterrence and the prices set by those cartels that do form. We show that the impact of combining penalties and damages on cartel prices is not clearcut, and depends on both the nature of the penalty regime and the way that damages are calculated. We demonstrate this by focusing on two ways of calculating damages that have been advocated in practice and two different forms of the widely used revenue-based penalty regime. When the simple form of revenue-based penalties is in force, the standard method of calculating damages worsens its harmful pricing effects, whereas the proposed alternative method of calculating damages can overturn them. When a more sophisticated form of revenue-based penalties is in operation, imposing damages will improve its beneficial pricing effects under both methods of damage calculation, but the alternative method is more effective. In all cases combining penalties and damages improves deterrence.     

Stable heterogeneous cartels

We define a nation of cartel stability which allows firms to perceive the impact of their actions on overall competitiveness in the market. We demonstrate that in an industry with linear demand and diverse linearly increasing marginal cost functions a stable cartel always exists. Furthermore, we examine uniqueness and size of such cartels as well as the impact of cost and demand conditions on their characteristics. In particular, we establish that the most efficient firms will be in the cartel while the less efficient ones will remain outside.     

Price staggering in cartels

In this paper we investigate the optimal organization of staggered price increases in cartels. Staggered price increases impose a cost during cartel formation as the price leader initially loses sales. We show that for intermediate discount factors, staggered price increases can only be sustained when the increase is neither too small nor too large. When a cartel executes two consecutive price increases, the choice between using the same leader or alternating leadership depends on the initial price level in the industry. We also discuss the choice between simultaneous and staggered price increases with an exogenous antitrust detection function, the allocation of price leadership with cost asymmetry, and the effect of product differentiation on price staggering.     

Reassessing board member allegiance: CEO replacement following financial misconduct

Research summary: We examine how board members' reactions following financial misconduct differ from those following other adverse organizational events, such as poor performance. We hypothesize that inside directors and directors appointed by the CEO may be particularly concerned about their reputation following deceptive financial practices. We demonstrate that directors more closely affiliated with the CEO are more likely to reduce their support for the CEO following financial misconduct, increasing the likelihood of CEO replacement. Enactment of the Sarbanes‐Oxley Act similarly alters governance dynamics by creating a greater expectation for sound corporate governance. We demonstrate our findings in U.S. public firms that restated their financial earnings during a 12‐year period before and after the passage of Sarbanes‐Oxley. Managerial summary: Given past concerns about lack of oversight by boards of directors leading to firm financial misconduct, we examine how the relationship between directors and CEOs may be altered in the face of such misconduct. We argue that directors most closely tied to the CEO (inside board members and board members appointed by the CEO), typically the most supportive of the CEO, may become most concerned about their own reputation following financial misconduct. We find that CEOs receive less support from these directors, a finding in contrast to past studies demonstrating that such board members tend to shield CEOs following poor performance. These findings are accentuated following the passage of the Sarbanes‐Oxley Act, which places greater responsibility on the CEO for the accuracy of financial reports. Copyright © 2015 John Wiley & Sons, Ltd.     

Collusion in a price-quantity oligopoly

In the context of an infinitely repeated oligopoly game, we study collusion among firms that simultaneously choose prices and quantities. We compare a price cartel with a price-quota cartel and analyze when and why firms prefer the latter to the former. Output quota may be required to solve coordination and incentive problems when market demand is sufficiently elastic. If market demand is sufficiently inelastic, then the cartel faces a trade-off between increasing prices and the amount of costly overproduction. We find that a price cartel prices consistently below the monopoly price to mitigate excessive production. In this case, a quota arrangement allows firms to avoid overproduction and to sustain the monopoly price. From a policy perspective, our findings suggest that an overall price increase in conjunction with more stable prices and market shares is indicative of collusion in industries where production precedes sales and outputs are imperfectly observable.     

Cartel sustainability in retail markets: Evidence from a health service sector

This paper studies the role of cost asymmetries and product differentiation on cartel sustainability by drawing data from a failed retail cartel. Unlike the extensive theoretical literature, little empirical evidence exists on these relationships. First, we analyze cartel compliance and find that players are more likely to comply when cost is symmetric and own cost is high. Next, based on a structural model and counterfactual experiments, we show that a cartel price that satisfies all cartel members does not exist. This result indicates an inherent difficulty of sustaining collusion in retail markets with heterogeneous players. We also show that firm heterogeneities, especially product differentiation rather than cost asymmetries, hinder collusion more. Finally, we derive the level of patience (or the discount factor) required for cartel sustainability when firms split profits based on the Shapley value.     

QUALITY DISCLOSURE AND COMPETITION*

We analyze costly quality disclosure with horizontally differentiated products under duopoly and a cartel, and characterize the effect of competition on disclosure and welfare. We show that expected disclosure is higher under a cartel than under duopoly, and the welfare comparison depends on the level of disclosure cost: when the disclosure cost is low, welfare is higher under a cartel than duopoly, but when the disclosure cost is high, welfare is higher under duopoly. In either market structure, disclosure is excessive in terms of total surplus, but insufficient in terms of consumer surplus.     

Investor Sentiment,Limits to Arbitrage and Private Market Returns

This article examines the relation between investor sentiment and returns in private markets. Relative to more liquid public markets, private investment markets exhibit significant limits to arbitrage that restrict an investor's ability to counteract mispricing. Using vector autoregressive models, we find a positive and economically significant relation between investor sentiment and subsequent private market returns. We provide further long‐horizon regression evidence suggesting that private commercial real estate markets are susceptible to prolonged periods of sentiment‐induced mispricing as the inability to short‐sell in periods of overvaluation and restricted access to credit in periods of undervaluation prevents arbitrageurs from entering the market.     

Stepping across for social approval: Ties to independent foundations' boards after financial restatement

Research Summary: Integrating research on independent philanthropy and organizational misconduct, we argue that affiliations with independent foundations provide social approval benefits for firms that restate their financials. We use a panel of S&P 500 companies from 2004 to 2011 to investigate the addition of foundation board ties by restating firms. CEOs of restating firms add more new foundation board ties than CEOs of non‐restating firms, while existing corporate philanthropy and greater corporate reputation diminish this effect. We also find that new ties to foundations boards influences media tenor for restating firms more than it does for non‐restating peers. Our study offers a nuanced analysis of the post‐crisis actions of restating firms relative to non‐restating peers and highlights the relevance of ties to nonprofit boards for corporate governance. Managerial Summary: Firms oftentimes fire their top executives in the aftermath of misconduct, but such response is itself disruptive for the firm's operations. Instead, we suggest that forging ties to independent foundations can help firms in such contexts without unsettling effects. Our results show that, after a restatement event, CEOs of misconduct firms are especially likely to join new foundation boards as trustees and thus seem to be aware of the benefits of these associations. CEOs from firms with existing in‐house philanthropy or a high reputation do not join as many new foundations' boards of trustees. We also find that new firm‐foundation links are promptly and positively evaluated by the media, thus helping misconduct firms regain social approval.     

Cartel birth and death dynamics: Empirical evidence

This paper examines how a gradual tightening of antitrust enforcement impacts cartels’ births and deaths. To avoid the inherent sample selection bias in prosecuted cartel studies, we use a unique dataset of Swedish legal cartels registered between 1946 and 1993. We compare estimates from a count model (considering only registered cartels) and a Hidden Markov Model (allowing for potentially unregistered cartels) to identify observed and hidden cartel dynamics. The count model suggests that strengthening antitrust enforcement has a deterrent effect, but the Hidden Markov Model suggests otherwise. Despite stricter competition laws and a credible threat of cartel prohibition, cartels continue to form, but do so undercover. Additionally, our results suggest that the strengthening of competition law has little impact on destabilizing existing cartels.     

Investor perceptions of CEO successor selection in the wake of integrity and competence failures: A policy capturing study

Research summary : Drawing on theory about signaling, sensemaking, and the romance of leadership, we extend inquiry on investors' perceptions of CEO succession following misconduct. Whereas past studies have treated misconduct monolithically, we examine failures of integrity and competence separately. Using a policy capturing methodology that isolates investors' decision making from potential confounds, we find that, following an integrity failure, investors perceive outside and interim successors positively but inside successors negatively. Following a competence failure, investors perceive outside successors positively but are ambivalent toward inside and interim successors. Our findings indicate that whether an act of misconduct was an integrity failure or a competence failure, and what type of successor the firm chooses, are important considerations when using CEO succession as a means to restore investor confidence. Managerial summary: Business headlines regularly feature episodes of organizational misconduct, such as product safety problems, environmental violations, employee mistreatment, and securities lawsuits, and their aftermath. In such scenarios, shareholders demand answers from the people at the top, even if those people were not directly responsible for the problem. As a result, companies often fire the CEO as a means to restore investor confidence. Does this work? It depends on the type of misconduct and who is the CEO's successor. Following a competence failure, investors welcome the appointment of an outsider, but they are indifferent to inside and interim successors. Following an integrity failure, shareholders greet outside and interim CEO successors favorably while frowning on the promotion of insiders. Copyright © 2015 John Wiley & Sons, Ltd.     

The discontent cartel member and cartel collapse: The case of the German cement cartel

We hypothesize a particular source of cartel instability and explore its relevance to understanding cartel dynamics. The cartel instability is rooted in the observation that, upon cartel formation, the relative positions of firms are often fixed which may lead some growth-conscious members to be discontent. This incongruity between a cartel member's allocated market share and its desired market share may result in systematic deviations and the eventual collapse of the cartel. This hypothesis is then taken to the German cement cartel of 1991–2002. We argue that Readymix was such a discontent cartel member and, using a rich pricing data set, are able to characterize how Readymix deviated, how other firms responded, and how it led to the collapse of the cartel.     

Market Power and Incentives to Form Research Consortia

It is well known that instability is a limit to the formation of cartels, and that some synergies are required to give cartel members an advantage over outsiders. In this paper, we explore theoretically the linkage between cost-reduction alliances (like research joint ventures) and the formation of cartels. The former have negative external impacts on outsiders, while the latter have positive external effects on outside (independent) competitors. We find that when the decisions to join both are made simultaneously the cartel can be profitable and stable for a smaller number of members than previously found for cartel formation alone by Salant et al. (1983, Quarterly Journal of Economics 98, 185–199). This result follows both for open membership and exclusive membership rules, and suggests a possible anticompetitive impact of research joint ventures.     

The impact of the 2002 reform of the EU leniency program on cartel outcomes

The objective of this study is to empirically assess whether the 2002 reform of the EU leniency program, which brought the EU leniency policy much closer to the US policy, has increased the European Commission’s capability to destabilize cartels while making prosecution more efficient. More specifically, relying on a difference-in-difference approach, we estimate the impact of the 2002 reform on cartel duration, fines before and after applying leniency reductions and duration of investigation. We find that the 2002 reform decreased cartel duration by about 87 percent, but did not significantly affect the other outcome variables. Thus, our findings seem to suggest that the 2002 reform has improved the cartel-destabilizing effect of the EU leniency program, without enhancing however its effectiveness in prosecuting cartels.     

An oligopoly model of ocean liner shipping

In this paper I develop a simultaneous equations oligopoly model of the regulated international ocean liner shipping industry. The firms act as a cartel to determine price jointly and then set their own quality levels to maximize individual profits. The cartel does not attain monopoly profits, because each conference member myopically determines quality without regard for overall cartel profits. The results indicate that an increase in the number of firms in the cartel will increase both cartel price and quality level. An increase in price will also lead to an increase in quality level.I would like to thank Professors Alamarin Phillips, Robert Summers, and Bruce Allen for their helpful comments on earlier research for my dissertation in the Economics Department of the University of Pennsylvania on which this work is based. I am especially grateful to Professor Lawrence J. White for his encouragement and valuable suggestions at various stages of my work.