Collusion and Cartel Problems in the Case of Symmetric and Asymmetric Firms - Essay Example

 Examine collusion and cartel problems in the case of symmetric and asymmetric firms. I. Introduction When examining the types and activities of firms in the international area we usually proceed to the identification and interpretation of their particular elements as can be observed through their daily presence in the global market. On the other hand, corporate activities are usually related with 'trust' or 'collusion' practices which have as main target to promote a specific firm in relation to its competitors. The above activities have been characterized by the relevant legal rules as illegal, however, in practice, their appearance remains at significant levels mostly due to the complicated structure of modern commercial markets. In this context, the issue of symmetric and asymmetric firms, as related with collusion and cartel problems has been examined thoroughly in the literature but also in the empirical field. The results of the relevant studies have shown that the phenomena of collusion and cartel are rather common in the corporate area, however this assumption should not lead to their acceptance in every day business activities. II. Collusion in corporate activities - definition, types and characteristics The definition of collusion has been proved a difficult task. According to the views of economists (Harrington, 2005) "collusion" is present when: a) price exceeds some competitive benchmark; b) the optimality of each firm's price depends on the anticipated aggressive response of other firms if they were to act differently; c) this anticipated response is not attributable to a change in the other firms' environment (or beliefs over that environment). The collusion has been furthermore divided (Harrington, 2005) into the following categories: The explicit and the tacit collusion, which are presented below: Tacit collusion: firms can only coordinate on price. Explicit collusion: firms can coordinate on price and firm quantities. The above researcher also presented a definition for "Concerted practices" which were defined (European Court of Justice) as 'a form of coordination between undertakings which, without having reached the stage where an agreement properly so-called has been concluded, knowingly substitutes practical cooperation between them for the risks of competition'. Furthermore, a relevant decision of the U.S. Supreme Court (1993) as presented in Harrigton (2005) states that brands of collusion according to antitrust practice are the following one: a) Explicit collusion: Coordination through direct communication. - Legal status: Always illegal; b) Tacit collusion: 'Tacit collusion ... describes the process, not in itself unlawful, by which firms in a concentrated market might in effect share monopoly power, setting their prices at a profit-maximizing, supracompetitive level by recognizing their shared economic interests and their interdependence with respect to price and output decisions'. Analyzing the issue of collusion brings us closer to a more realistic view of the relationship between separate units of the firm. In this context, Laffont (1998, 282) stated that various cliques form within the firm. The so-called horizontal cliques involve groups of managers or workers sharing a common interest who act as informal associations willing "to increase their status, their rewards or to get more support for their job activities." They may, for instance, be reluctant to enforce changes in production on the work place, or they may be willing to develop some norms of reciprocity that allow exchanges of favors among them. According to the above views, if an organization has been avoiding uncertainty about competitors' behavior by overt collusion and has had some adverse experience with the Justice Department and public opinion, we would expect it to seek some new modes of uncertainty avoidance rather than immediately abandon the general strategy. On the other hand, the negotiation among firms is not obviously collusion for profit maximization. Rather, it is an attempt to avoid uncertainty while obtaining a return that satisfies the profit and other demands of the coalition. The lack of a profit-maximizing rationale is suggested by (1) the stability of the practices over time and (2) the occasional instances of success by firms willing to violate the conventional procedures (e.g., discount houses in retailing). (Cyert, 1963, 103) Collusion is a balancing act. Each colluding firm balances the short-term temptation to cut its price against the expected long-term cost of the price war that such an act might instigate (Bagwell, 1997, 82). In this context, when the level of demand grows and fluctuates through time, as along a business cycle, the relationship between the short-term temptation to cheat on a collusive agreement and the expected long-term cost from doing so need not be constant, and maintaining a balance between the two may require periodic adjustments in the collusive price. In this way, it is possible to forge a link between the state of the business cycle and the price level of colluding firms III. The phenomenon of cartel in the industrial area Before the Single European Market measures came into effect, public procurement was still very fragmented with a different procurement system in place for each member state (Davies et al., 1996, 215). This created high (often prohibitive) barriers for the exports of manufacturers based in other EU member states or outside countries: only 2-3% of all public procurement contracts were awarded to enterprises from other member state. Of course, to the extent that these barriers were only trade-related, 'foreign' manufacturers could resort to establishing local production units in order to become 'indigenous' manufacturers. However, other discriminatory measures, or strategic behaviour by national champion firms in collusion with their national governments, could also sometimes block this kind of market entry. For example, one possible information system for firms in an oligopoly is complete collusion. Normally, it provides the maximum amount of information sharing within the industry. It can also be encompassed rather easily within the theory. Such collusion has, however, two major drawbacks for the typical firm. First, social regulation of market systems ordinarily inhibits the development of collusive information sharing Various prohibitions of conspiracy and collaboration among competitors (in combination with erratic enforcement) make the costs of manifest collusion highly uncertain. Second, the full effectiveness of collusion depends on assured cooperation among the several firms in the industry, and for at least some firms in the industry the uncertainties of polyarchy within a cartel are at least as forbidding as the uncertainties of oligopolistic markets. Because of the costs involved, the difficulties in enforcing cooperation, and the substantial commitment in the culture to the immorality of complete collusion, such a strategy is generally not considered except when the organization -- or some part of it -- feels under considerable pressure from actual or impending failure to achieve critical goals. Attempts at some form of collusion are certainly common (Cyert, 1963, 282). On the other hand, according to Edlin (1997, 529) price-matching policies can be highly anticompetitive. They allow firms to raise their prices above competitive levels by discriminating in price between informed and uninformed customers. The resulting high prices can persist even when new firms enter the industry, a fact that gives price matching the potential to be much more socially costly than an ordinary monopoly or cartel. At the same time, widespread entry implies that the agreement among sellers that is typical of a Sherman Act (U.S.A.) price-fixing case may be absent. Moreover (Edlin, 1997, 529), the fact that price matching may have little to do with collusion not only makes it harder to attack, but also suggests that the policy problem posed by price matching is more substantial than that posed by cartels. High prices are inherently unstable when they are sustained only by a collusive agreement: high prices invite entry, and, as firms become too numerous, agreements become unworkable, whether they are tacit or explicit. Price matching, in contrast, can maintain high prices even when barriers to entry are low. These observations suggest a resistance to downward price movements under threat-based matching, but this still leaves an aspiring cartel with the problem of climbing the price ladder without explicit agreement. However, computerized markets may make it easier to surmount this difficulty as well. If prices can be adjusted and monitored quickly and costlessly, one firm may signal another of its desire to collude. For instance (Edlin, 1997, 568), airlines commonly test new high prices on weekends, when few buyers purchase tickets, and maintain them if others follow their lead IV. Presentation and analysis of symmetric and asymmetric firms Multinationals seem to be ubiquitous, increasing their presence in many markets (Jain et al., 2001, 651). It has long been believed that multinational firms exist in order to exploit economies of scale in production, that is, declining marginal costs. However, if that were the case, these "efficient" firms would take over the entire market. Yet such behavior does not seem to occur. Instead, multinationals seem to be encountering increasing competitive pressures as foreign markets mature. For example (Jain et al., 2001, 648), it is commonly believed that asymmetric information puts the multinational at a disadvantage with respect to the local competitors, lowering its profits compared to markets in which it is fully informed. However, an implication of the results of this paper is that the possibility of learning and the existence of other markets that the multinational serves mean a lower cost of learning for the multinational than another informationally disadvantaged firm that operates in only one market and is unable to learn. Thus, the ability of the multinational to move resources across markets helps it lower the costs of learning. It should also be noticed that the categorization of firms into symmetric and asymmetric is mainly connected with their activities and their information available and less related to specific characteristics of the companies involved. If firms are symmetric then price leadership ought to be sufficient to achieve a symmetric outcome. Explicit collusion may be unnecessary. In fact, firm asymmetries are ubiquitous, vast, and relevant to the stability of collusive arrangements. In this context, it has been accepted by Harrington (2005) that there is a lot more to collusion than coordinating on a single price. The main objective when examining the role of 'symmetric' and 'asymmetric' firms in their market, is to look at the locational inefficiencies induced by pricing policies alone, independently of whatever may be the deadweight loss associated with pricing above marginal cost. In order to separate the distortions (Jain et al., 2001, 651) in pricing above marginal costs from those which are due to purely locational effects, we could specify a model in which mill pricing is the (first best) optimal pricing policy (regardless of the absolute level of the mill price) for any fixed (symmetric) pair of locations. In this model, mill pricing therefore yields highest welfare. Once we account for endogenous locations this finding is overturned. Because mill pricing yields equilibrium locations way outside the social optimum ones it causes welfare to be lower than that arising under pricing policies which are not in themselves optimal. The equilibrium concept that we could use is a standard one, a two-stage game with locations as the first stage and price-setting at the second. The justification for this set-up is that prices tend to be relatively flexible vis-a-vis locations. Hence we could consider a game where locations are chosen first, bearing in mind the anticipated equilibrium in the subsequent pricing game. V. Antitrust laws - general legal environment related with illegal corporate behaviour In order to face collusion, researchers have proceeded to the formulation of a generally accepted scheme of policies, which could be divided in the following categories: Merger policy Identifying mergers that may make collusion more likely. Identifying industry traits conducive to collusion. Concerned with both explicit and tacit collusion. Cartel policy Identifying "prosecutoriable" cases of collusion, which effectively means explicit collusion. Identifying industry traits conducive to explicit collusion. Distinguishing explicit collusion from tacit collusion and competition. According to Harrington (2005) the most commonly applied policy in the corporate area regarding the collusion-related activities is the cartel policy. On the other hand, a net of legal rules has been formulated in order to help to the limitation of the phenomenon to the lowest possible level. The relevant legislation has been however differentiated in USA comparing to the European legal orders. United States Section 1 of the Sherman Act (1890) "Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal." European Union Article 81 of the Treaty of the European Communities (1999) "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 within the common market ..." VI. Conclusion In the context of excess entry and excess investment theorems, which have been stated in the literature, the simplifying assumption of identical firms and symmetric equilibria may seem to be so drastically unrealistic that the theorems whose validity hinges squarely on the simplification rendered thereby may be regarded as suspect. However, the research of Suzumura (1995) showed that all firms are identical, both in technology and in behaviour, which motivated us to focus exclusively on symmetric equilibria. In this context, the corporate behaviour towards the phenomena of collusion and cartel will have similar elements although there will be certain differentiations in accordance with the nature and the objectives of each particular firm. References Anderson, S., De Palma, A., Thisse, J. F. (1992). Social Surplus and Profitability under Different Spatial Pricing Policies. Southern Economic Journal, 58(4): 934-948 Bagwell, K. (1997). Collusion Over the Business Cycle. Rand Journal of Economics, 28(1): 82. Cabral, L. (2005). Collusion Theory: Where to Go Next? Journal of Industry Competition and Trade, 5: 3/4, 199-206 Cyert, R. M., March, J. G. (1963). A Behavioral Theory of the Firm. Englewood Cliffs Davies, S., Lyons, B. (1996). Industrial Organization in the European Union: Structure, Strategy, and the Competitive Mechanism. Oxford University. Oxford Harrington, J. (2005). The Collusion Chasm: Reducing the Gap Between Antitrust Practice and Industrial Organization Theory. Johns Hopkins University, Csef-Igier Symposium on Economics and Institutions - June/July 2005 Jain, N., Mirman, L. J. (2001). Multinational Learning under Asymmetric Information. Southern Economic Journal, 67(3): 637 Laffont, J. J. (1998). Collusion and Delegation. Rand Journal of Economics. Volume: 29(2): 280-306 Suzumura, K. (1995). Competition, Commitment and Welfare. Oxford University. Oxford Woodward, J. (1982). Industrial Organization: Theory and Practice. Oxford University Press. Oxford Read More