Determinants of Cartel Duration Margaret Levenstein Valerie Suslow

1. Determinants of Cartel Duration Margaret Levenstein Valerie Suslow ESRC Centre for Competition Policy University of East Anglia June 2009

2. AGENDA • Sample of Contemporary International Cartels • Determinants of Cartel Duration • Economic Theory • Empirical Results

3. International Cartel Prevalence • 1930s: • 30 to 40% of world trade controlled by international cartels • 1950s through 1980s: Don’t ask, don’t tell • “we didn’t have any evidence that international cartels continued to be a problem” (Klein, 1999) • 1990s: Vigorous extraterritorial application of U.S. antitrust law • Mark Whitacre and ADM lead DOJ to revise Corporate Leniency Policy • Amnesty from all U.S. criminal penalties automatically granted to first firm to confess (if no pre-existing investigation). EU changed to automatic amnesty in 2002. • Amnesty Plus Program: Substantial reduction in penalties by admitting to cartel practices in other markets that are not being investigated.

4. Cross-Section Sample Sample Criteria • involve more than one producer • include producers from more than one country • attempt to set prices or divide markets • convicted by US or EU in 1990s or 2000s • Yields a sample of 81 cartels for which we have been able to collect cartel and market characteristics. • Sample selection bias: Are only the fragile or careless cartels caught?

5. Who Colludes? • Answer #1: Everyone, but it varies by time and place • Previous studies: industry composition reflects legal and institutional environment, extent of market integration, and sample selection criteria • This sample: primarily sophisticated manufactured goods and services • Answer #2: Firms in highly concentrated industries • Average C4 in our sample is 80% • Mean # firms = 7.1 and Median = 5 • Maximum # firms = 35, but of the 12 cartels with more than 10 members, 10 of these involved a trade association

6. Cartel Duration • On average, cartels in our sample last 8 years

7. Basic Theory of Cartel Duration • In a market with identical price-setting firms, infinitely repeated interaction among these firms, and perfect information, collusion can be sustained if • collusive (monopoly) price charged by firm i in period t • price charged by firm i if it chooses to defect • price charged by firm i in continuation equilibrium after defection • Permanent collusion can be an equilibrium if firms are sufficiently patient and if the difference between the profits earned while colluding and the profits earned after a firm cheats is sufficiently high

8. Basic Theory of Cartel Duration • So, what can this model tell us about how long an existing cartel will last? • Some theories of cartel behavior have tried to answer this question by considering equilibria in which collusion does last, but in which firm behavior fluctuates. These behavioral fluctuations are often observationally equivalent to cartel breakup. • We also consider the possibility that, while firms expect this inequality to hold when a cartel is formed, the constraint is violated by future unanticipated shocks. • Must distinguish between those that broke up because • They fell apart • They got caught

9. Determinants of Cartel Duration • Hypothesis: Cartel organization matters to cartel duration. • Successful cartels develop mechanisms to prevent and punish defection without expensive price wars. • Rarely included in cross-sections. Several case studies provide rich detail, e.g., Genesove and Mullin (2001), Spar (1994), Baker and Faulkner (1993)

10. Cartel OrganizationEleven characteristics Vitamin A: “If at the end of the year a producer was substantially ahead of its quota, it had to purchase vitamins from the others in order to compensate them for the corresponding shortfall in their allocation.” Vitamin B2: Hoffman-LaRoche monitored Japanese government export data knowing that there was only one cartel member, Takeda, producing in that geographic location. • Monitoring of output and pricing • Market or customer allocation • Agreeing to other terms & conditions of sale • Standardize product characteristics or quality • Control of distribution • Trade association participation • Bid rigging • Compensation scheme for exceeding cartel quotas • Disciplinary actions in response to cartel violations • Exclusionary actions to prevent entry or expansion • Hierarchical internal structure Organic Peroxides: Producers “agreed that each of them would purchase...a (new) competitor. Akzo agreed to acquire the organic peroxide business of Nobel and Enichem. Laporte would purchase Aztec. Atochem would take over [...]. Only the latter did not occur.”

11. Other Determinants of Cartel Duration • Discount rate • External shocks • Demand variability • Exchange rate variability • Industry structure • Number of firms • Industry concentration

12. Variable Definitions & Descriptive StatisticsN = 81 continued...

13. Variable Definitions & Descriptive Statistics

14. Kaplan-Meier CurvesNonparametric: probability of failure after time tShows basic shape of raw survival data

15. Kaplan-Meier Curves Those cartels with few members fail at about the same rate as those with more members (MEM_OVER5 = 1)

16. Those cartels with few organizational mechanisms fail more quickly than those with more sophisticated organization (ORGINDX > 3) Kaplan-Meier Curves

17. Kaplan-Meier Curves

18. Kaplan-Meier Curves

19. Kaplan-Meier Curves

20. Kaplan-Meier Curves

21. Kaplan-Meier Curves

22. Kaplan-Meier Curves Those cartels that break up on their own fail more quickly than either those ended by antitrust investigation or those ended by confession.

23. Competing Hazards ModelDeath by Anti-trust Coefficient > 1 indicates that the variable increased the probability of cartel breakup. Coefficient < 1 indicates that the variable decreased the probability of breakup.

24. Competing Hazards Model“Natural Death” Organizational Effects

25. Competing Hazards Model“Natural Death” Industry Structure Non-effects

26. Competing Hazards Model“Natural Death” Discount rate effects

27. Competing Hazards Model“Natural Death” Macroeconomic shocks

28. Conclusion • Cartels can last • Unexpected shocks disrupt cartels • Increases in firm-specific discount rates disrupt cartels • Price wars disrupt cartels • Organizational innovations can attenuate the incentive to cheat • Trade association, compensation schemes, exclusive tactics all contribute to internal cartel stability • Trade associations make cartels more visible to authorities, but market division agreements and price wars hide them

29. Comparison of Cartel Organization

30. Cartel DurationComparison of Studies

31. Examples of Cases in our Sample INDUSTRY DURATION INDUSTRY DURATION (years) (years) Aluminum Phosphide 1 Paper, Carbonless 3 Bromine 3 Plastic Dinnerware 1 Cable-stayed Bridges 1 Polyester Staple 3 Carbon Cathode Block 2 Rubber Chemicals 7 Cartonboard 5 Shipping, Cent. W. African 21 Cement 11 Sodium Erythorbate 3 Citric Acid 4 Sodium Gluconate 9 Explosives 5 Sorbates 17 Ferrosilicon 2 Stamp Auctions 22 Fine Arts 6 Stainless Steel 1 Graphite Electrodes 5 Steel Beam 6 Graphite, Isostatic 9 Steel Heating Pipe 4 Laminated Plastic Tubes 9 Steel Tube, Seamless 5 Lysine 3 Tampico Fiber 5 Memory Chips 4 Thermal Fax Paper 1 Methionine 11 Vitamins 9 Methylglucamine 10 Zinc Phosphate 4

32. Sectoral Composition