HOCHSCHULE RHEIN-WAAL

RHEIN-WAAL UNIVERSITY OF APPLIED SCIENCES

FACULTY OF SOCIETY AND ECONOMICS

TERM PAPER WS 2014/2015

Module “Applied Topics in Competition Policy”

Prof. Dr. Jörn Sickmann

The influence of the Leniency Policy in Cartel formation

Group Members: Gala Palermo #15160 Thi Trang Nhung Nguyen #15714 Thien Ai Nguyen #15838

M. Sc. Economics and Finance WS 2014/2015

Due Date: 28. February.2015

TABLE OF CONTENT

I. Introduction............................................................................................................1

II. Literature Review...................................................................................................2

III. Experimental Design..............................................................................................4

IV. Experimental Result...............................................................................................5

1. Pricing...............................................................................................................5

2. Leniency activities............................................................................................7

V. Conclusion..............................................................................................................8

VI. References..............................................................................................................9

Appendix................................................................................................................10

Work Process..........................................................................................................14

1

I. Introduction

In an oligopolistic market, it is very common to observe the rise of Cartels. A Cartel is the

agreement between firms to achieve a join price, production and share of the market, creating

new entry barriers for other companies which try to enter this market. It is only possible when

few companies have presence in a certain market and when this market is large enough to allow

all companies to be profitable. The Cartel members can agree in different areas such as price

fixation, amount of total industry output, market shares fixation, allocation of customers or a

combination of these. The main purpose of this collusion (cartel agreement) is simple, as

mentioned before increase each member´s profit and reduce competition. All companies in a

Cartel work together as a monopoly.

A cartel formation, nowadays, is illegal. There are many laws regulating the free market and

competition, which forbids the formation of any kind of collusion that could manipulate the

market´s behavior. Even though each country has their own regulations in competition law, the

largest and most influential systems of competition regulation are the USA antitrust law and the

European Union competition law.

There is always a great risk of betray between members of a Cartel, a member of the Cartel find

himself with the prisoner’s dilemma; he could make more profit by breaking the agreement in

prices or quantity of production, however if all members break the agreement the result will be

much worse. He could inform the competition regulators about the Cartel. Because of all these

reasons, a Cartel is very fragile entity and can be easily broken. It is very difficult to maintain a

Cartel functioning through longs periods of time.

The penalties for companies that break the competition laws can be very severe. However,

companies that have participated in a Cartel have a limited opportunity to avoid or reduce a fine

(or penalty). The European Commission created a leniency policy in which companies that give

information about a Cartel in which they were members receive full or partial immunity to fines

and penalties given to this Cartel. In order to obtain full immunity, the company must be the first

one to report the Cartel.

2

Due to the information explained above, a question arose; how are the Cartels formed and how

can the leniency policy influence the dissolution of Cartels? The experiment we conducted is a

fictional market in which manufacturers of the same industry are motivated to collude but, they

have also the risk of being detected by the competition regulator. A leniency policy can be

applied to the reporter of a Cartel. The goal of this experiment is to analyze the behavior of all

participants to find a trend, in which will be showed how the competition regulator can motivate

a member to report with different punishments and rewards.

II. Literature Review

The design of this experiment was based on the following literature:

Hesch, Michael:

This article is about an experiment conducted about Leniency programs and how these programs

generate distrust among members of illegal Cartels. In the US law, the Leniency policy excludes

the ringleader of the Cartel; the ringleader cannot report the Cartel and receive the benefits of the

Leniency policy however, in the EU law, the ringleader is included. The ringleaders are treated

differently by the national competition authorities; they are not eligible for full immunity only for

fine reduction. This experiment tries to determine the influence of the ringleader in the Cartel´s

stability and deterrence on reporting according the Leniency policy.

The experiment was designed in a one-shot Bertrand Game and in several rounds adding new

aspects of the Leniency policy on each round to take into account. On the first round, the antitrust

authorities do not take part of the investigation. The Cartel can only be detected by the

application of one player for Leniency, and then the punishment will be deviated to the other

players. On the second round, the antitrust authorities are included; groups that discuss prices are

investigated with a 15% probability of detection. On the third round, a “race to report” policy is

introduced; it means that only the first player to report will be granted with full immunity from

fines. On the next rounds, the probabilities of being detected and the amount of reduction or

immunity can vary.

3

The results of the experiment were divided in three sections: pricing, cartel activities and cartel

stability. The hypotheses were analyzed under a symmetric and asymmetric setting; which means

a different setting regarding the Ringleader, if he receives a discriminatory treatment or not.

The prices are significantly higher in markets with an asymmetric treatment, players distrust less

in a cartel where one player is unable to report the conspiracy. The average of players that

collude in an asymmetric treatment is much higher than that from a symmetric one. As for the

stability of a Cartel, there is no difference between a symmetric and an asymmetric setting. Once

the trust between players is broken, it will be very difficult to collude again.

Bruttel, Lisa:

This paper analyses the level of stability of tacit collusion in price setting duopolies and the

pricing behavior as an infinitely repeated Bertrand oligopoly. Explicit agreements between firms

are prohibited by law nevertheless, firms often agree on their prices with less obvious methods.

There is a discount factor which makes appealing to agree in a price with the other firms of the

industry, moreover it makes the collusion more stable. The discount factor can be the punishment

of the authorities discovering the collusion or some other exogenous variables.

The larger this discount factor is, the less stable the Cartel will be. The reason for this outcome is

the actual price; each firm analyzes the benefits of colluding subtracting the discount factor to the

agreed price.

European Commission:

The European Commission in its website explains the Leniency policy. This policy was

established in the late 1990s to motivate companies which belong to an illegal Cartel to report

and hand in evidence of the Cartel activities and to list who the other Cartel members are, in

exchange of reducing a percentage or even the whole amount of the fines the government

otherwise would assign them.

4

In order for a company to obtain full immunity, it must apply for the Leniency policy first than

the other companies’ members of the Cartel. The Ringleader of the Cartel does not apply for a

full immunity. The other Cartel members that do not qualify for full immunity can receive a

reduction between 30% and 50% of the total amount of the fine.

The Leniency policy has proved successful in fighting cartel formation. The largest fine imposed

to a Cartel by the European Commission is 1,3 billion euros.

The website, beside of explaining the definition and characteristics of this policy, explains the

procedure of reporting and fine reduction, and also hands in information of the commission;

contact information to report Cartel activities.

III. Experimental Design

There are nine participants divided into three separate groups, with three different turns for each

group in the experiment.

The experiment is processed in three main stages:

Stage one - Coordination: three players, with the same cost function of 100 and capacity of

manufacturing of thirteen units, are welcomed with information about the market, in which three

manufacturers have to consider to form the Cartel or not. The players are informed about the

illegality of Cartel and the probability of being detected. Each player decides to join the Cartel

with the two others or not. Only when the three players agree, will the cartel be formed.

- In case of failure to establish Cartel, manufacturers will do business independently,

according to the Bertrand effect; whoever offers the lowest price (in range of 101 – 113,

knowing that cost is 100) will serve all the markets. Consequently, the others’ profit in this

case will be 0.

The profit of the one who has the lowest price would be calculated by:

Profit of non-Cartel = Lowest offered price * Q / Number of players having lowest price

5

- In case of Cartel, three players have possibility of discussion about price (using Chat box

function of Ztree). This colluding discussion takes place in 30 seconds. The Cartel’s price is

the average of three offered prices from the three manufacturers.

Profit of Cartel = Price of agreement * Q/3

Stage two - Reporting to Leniency Policy: This stage is accessible only when the Cartel was

established. After receiving profit, members of Cartel are implied that there is 25% probability of

being detected by the Antitrust Authority. Whenever detected, all members would have a

deduction of 35% from their profit as a fine. In order to maintain the profit, all members are

motivated to report the Cartel. The Leniency Policy is developed to give the Cartel members

incentives to report. This experiment only accepts one Reporter and it would be the first one to

click Report. As a consequence, the profits of the other two players would be immediately

deducted by 35%. They will not know who the Reporter is.

Stage three - Detection by Antitrust Authority: In case no one reports, the experiment would

continue with a probability of 25% of Cartel detection by Antitrust Authority. The computer

would randomly decide in which round the Cartel will be investigated. When detected, all of

three members will receive 35% of deduction from their profit.

IV. Experimental Result

1. Pricing

This Experiment wishes to investigate the impact of Leniency Policy on pricing strategies of

firms. Our three groups of participants have apparently offered two trends of behavior in pricing.

Our group temporarily divides the result into two divisions: the first group’s behavior and the

second and third group´s behavior.

6

1 2 3 4 5 6 7 8 9 10949698

100102104106108110112114

Price group 1

Price group 1

Round

Price

With Group one, and some early rounds, players representing the firms are profit-maximizing.

They tried to find the optimal profit by different prices with wide range from 101 up to 113.

Obviously, from round 3-4 onwards, they considered 108 is the most optimal price. Nevertheless,

analyzing the Cartel activity, Group one has continuously a reporter. Due to this result, from

round 7 until the end of experiment, there was no establishment of Cartel any more, which led to

a rational behavior: manufacturers do business independently and strive to offer the lowest price,

so that he could cover all the market´s demand.

Groups two and three represent a totally different output. Observations from the Cartel activity

analysis have shown that they had high belief and commitment. The explanation is the wide

range of pricing. Group two’s average price fluctuated from 108 decreasing to 104 and then back

to 106, which is the optimal price for the Cartel. Unlike the beginning of Group two, Group three

started with the lowest price 101, modifying their prices afterwards up to the high price of 111,

then 104, and finally 106.

There is an average of 23% of the rounds in which the members of the Cartel got optimal or

almost optimal profits, whereas in only 13% of the rounds the market could take advantage of

Leniency policy to have the low price from manufacturers due to non-established Cartel cases.

7

1 2 3 4 5 6 7 8 9 1096

98

100

102

104

106

108

110

112

Price group 2 & 3

Group 2Group 3

Round

Price

2. Leniency activities

We considered the impact of the leniency policy on the formation of cartel. The result was

summarized as in the table below:

Ro JOIN price report detect Ro JOIN price report detect Ro JOIN price report detect

1 1 113 1 n/a 1 0 101 1 n/a 1 0 101 n/a n/a2 0 101 n/a n/a 2 0 101 n/a n/a 2 0 101 n/a n/a3 1 109 1 n/a 3 1 108 0 1 3 0 101 n/a n/a4 1 109 1 n/a 4 1 107 0 1 4 1 109 1 n/a5 0 101 n/a n/a 5 1 106 0 0 5 0 101 n/a n/a6 1 109 1 n/a 6 1 105 0 0 6 1 111 0 07 0 101 n/a n/a 7 1 106 0 0 7 1 108 0 08 0 101 n/a n/a 8 1 106 0 1 8 1 104 0 19 0 101 n/a n/a 9 1 106 1 n/a 9 1 106 0 0

10 0 101 n/a n/a 10 1 106 0 0 10 1 106 1 n/a

Group 1 Group 2 Group 3

Table 1: Summary of Cartel activities

While dissecting the group behaviors, we saw two converse trends, one tried to build a mutual

trust between members and the other one easily got upset on the joint venture once there was a

8

betrayer. These both could be the scenes in reality. All the manufacturers have to consider the

profit and the risk, in which the detection of collusion with many effects resulted from this

decision.

The first group decided to join the cartel for the reason of maximizing profit. As known, the

profit of colluding is always higher than in normal competition (to see the profits´ result per

manufacturer, see table 2 to 4 in the appendix). But once there was a disloyalty, the collusion

was easily broken in the next round. The attractiveness of high profit could once again reconnect

them, but the mutual belief was not well reinforced, leading to the result of continuing deceiving.

Finally, no cartel was built more.

On the contrary, the other two groups showed a bigger effort in fortifying cooperative belief and

more faithful manner. After the first rounds seeing the result of normal competition, they all came

to the price discussion. We witnessed quite a strong formation. Though facing the risk of being

detected, and they were in fact detected, rarely did they break the agreement. However, a

question related to level of fine reduction arose. The amount of the fine was up to 35% of the

profit but, even by being detected or reported, they could earn better than in a normal race. This

leave the unanswered question in this experiment of how much the amount of the penalty should

be once this illegal act of collusion was discovered, so that the leniency policy start to have

strong effect.

V. Conclusion

The result observed from the experiment showed that the leniency policy would probably be

effective with either a group with mutually distrusted members or with a substantial fine.

However, due to the limitations of scope and sample size of this experiment, this conclusion

would only be persuasive if we can continue enlarging and go into more detailed designed

experiment.

A deeper analysis of the Leniency Policy can derive into the effectiveness of this policy in

reality; according to the European commission, the leniency policy has proved to be a success

breaking cartels. Each member search obviously for their own benefit, if the punishment is high

9

enough to decrease significantly their profit or perhaps incur in losses, many or even all members

of the Cartel will decide to report. Another important fact of reporting is that even when a

company gives information about a Cartel, if this company is the first to report will receive total

immunity to the Cartel´s fines but, if not, the commission will evaluate the information given by

the company and will grant them a partial reduction of the fine.

In the experiment, members of group two and three were willing to collude whereas group one

was more preoccupied in their personal gain as in the benefits of the Cartel. In the first round,

group one formed a Cartel but one of the members reported to the competition regulator. This

behavior reinforces the bases of leniency policy and how does it work. The trust between

members was broken and, in the next rounds, there was practically no collusion and if they were

to collude, the motivation of report was higher, all members reported. In the first rounds, both

groups two and three did not collude but, after they realized that colluding was more profitable

for everyone thy colluded; there was no report from any member allowing the Cartel to function.

When the probability of being detected is high, all members of the Cartel try to cover their steps

by reporting, the amount of fine reduction is also a motivation to report but, when both of them

are not significant enough and the profits within the Cartel are much higher, the Cartel members

will not report. We can conclude that the most important fact in the Leniency Policy is the reward

of reporting; the fines should be high enough that reporting seems as the best way and the

probability of being detected should be also high.

VI. References

Bruttel, Lisa (2009) The critical discount factor as a measure for Cartel stability. J Econ, vol. 96, pages 113–136

European Commission, Leniency policy, Available at: <http://ec.europa.eu/competition/cartels/leniency/leniency.html > [Accessed 23 January 2015]

Hesch, Michael (2012) The effects of Ringleader discrimination on Cartel deterrence and stability. Journal of Advanced Research in Law and Economics, vol. III, issue 1, pages 26-39.

.

10

APPENDIX

Table 2: Summary of result of group 1

ROUN

D

Joi

n

Pric

e

Earn

carte

l

Earn

non

carte

l

Repor

t

Earn

repor

t

Detec

t

Earn

detec

t

1 or

0

1 or 0

or -2

X or

V

1

1 113 0 1 0

1 113 0 -2 0

1 113 0 -2 0

2

1 101 4

0 101 4

1 101 4

3

1 113 12 -2 8

1 101 12 1 12

1 113 12 -2 8

4

1 113 12 0 8

1 101 12 1 12

1 113 12 -2 8

5

1 101 4

0 101 4

1 101 4

6

1 113 12 -2 8

1 101 12 -2 8

1 113 12 1 12

7

1 101 6

0 102 0

1 101 6

8 1 101 4

11

0 101 4

1 101 4

9

1 101 4

0 101 4

0 101 4

10

1 101 4

0 101 4

1 101 4

Table 3: Summary of result of group 2

ROUN

D

Joi

n

Pric

e

Earn

carte

l

Earn

non

carte

l

Repor

t

Earn

repor

t

Detec

t

Earn

detec

t

1 or

0

1 or 0

or -2

X or

V

1

0 101 12

0 105 0

1 104 0

2

0 101 6

1 101 6

1 103 0

3

1 108 13 0 13

V

9

1 108 13 0 13 9

1 108 13 0 13 9

4

1 107 14 0 14

V

9

1 107 14 0 14 9

1 107 14 0 14 9

51 106 14 0 14

X14

1 106 14 0 14 14

12

1 106 14 0 14 14

6

1 105 13 0 13

X

13

1 105 13 0 13 13

1 105 13 0 13 13

7

1 106 14 -2 14

X

14

1 106 14 1 14 14

1 106 14 -2 14 14

8

1 106 14 0 14

V

9

1 106 14 0 14 9

1 106 14 0 14 9

9

1 106 14 -2 9

1 106 14 -2 9

1 106 14 1 14

10

1 106 14 0 14

X

14

1 106 14 0 14 14

1 106 14 0 14 14

Table 4: Summary of result of group 3

ROUN

D

Joi

n

Pric

e

Earn

carte

l

Earn

non

carte

l

Repor

t

Earn

repor

t

Detec

t

Earn

detec

t

1 or

0

1 or 0

or -2

X or

V

1

0 101 0

V1 101 6

0 108 6

2 1 101 6 X

0 102 0

13

1 101 6

3

1 101 4

X1 101 4

0 101 4

4

1 108 13 -2 8

X1 110 13 1 12

1 108 13 -2 8

5

0 101 4

X1 101 4

1 101 4

6

1 110 8 0 8

X

8

1 112 8 0 8 8

1 110 8 0 8 8

7

1 110 13 0 13

X

13

1 110 13 0 13 13

1 104 13 0 13 13

8

1 104 12 0 4

V

8

1 104 12 0 4 8

1 104 12 0 4 8

9

1 106 14 0 14

X

14

1 107 14 0 14 14

1 106 14 0 14 14

10

1 106 14 0 9

X1 107 14 1 14

1 106 14 0 9

14

WORK PROCESS

Task Gala Palermo

#15160

Thi Trang Nhung

Nguyen

#15714

Thien Ai Nguyen

#15838

Z-tree programming √ √

Introduction √

Literature Review √

Experimental Design √ √

Experimental Result -

Pricing

√

Experimental Result -

Leniency activities

√

Conclusion √