On the design of leniency programs

III Encuentro de la ACE en España Madrid, October 23, 2008

Patrick ReyToulouse School of Economics and IDEI

2

Introduction

Collusion: tacit versus explicit

Legal cartels (crisis cartels, Switzerland)Explicit coordination and enforcement

Purely tacit collusion (merger control, regulation)Tacit coordination and self-enforcement

Here: “explicit collusion”Explicit coordination: communication, meetings, …, “legal” (OPEC) or not (Vitamines, …)But tacit (illegal, self-) enforcement

→ make (self-)enforcement more difficult

3

Introduction

Practice: leniency and whistle-blowing programs

Leniency: US 93, EU 96/02, F,UK … 00, Australia 03/05US: more fines in 1999 than all antitrust fines since the Sherman Act (1890)EU: € 855 millions for the vitamins cartel; more than € 3 billion in 2 years

WhistleblowingFraud: procurement (US), tax (France)Cartels (South Korea)

Theory: revelation mechanism

Soft information: difficult revelation mechanisms have no bite on past information

Hard evidence: more hope

4

Introduction

Program design

Corporate / individual (US: jail)

First informant only (US), followers as well (EU)

Before / after investigation

Full leniency (US, EU 02) / partial leniency only (EU 96)

Ringleader exception (US, EU 96)

Repeated offenders, monitoring of exposed cartels

Interaction with the “stick” US : jail for individuals, treble civil damages for firms

5

Introduction

Literature

Motta and Polo (2003): leniency programs help prosecution

Spagnolo (2003): first only, adverse effect limits maximal reward

Aubert, Rey and Kovacic (2005): leniency / bounty, corporate / individuals

Harrington (2005): distinguish investigation / prosecution

leniency creates a “run to the courthouse” in case of investigation

Harrington (2006): birth/death of cartels, desistance/deterrence

Chen and Rey (2007): optimal amnesty rates

6

Framework

Collusion: basic ingredients

Firms face same competitive conditions repeatedly overt time

In each period, must decide whether to collude or competeFirms gain from collusion, but each firm benefits at the expense

of the others from deviating (competing when the other colludes): “prisoner’s dilemma”πM if collusion > πC if competitionπD > πC for a firm that deviates and competes when the others collude

Evidence of collusionCommunication is a prerequisite for collusion (McCutcheon 1997)Communication generates some hard evidence

7

Framework

Antitrust oversight

Random audits: probability of (successful) audit ρ, fine F

Corporate leniency: reduced fine f (< ρF) when reporting collusion

Timing

In each “period”, firms choose whether to collude

If they do not, then “competition”

Otherwise,communication takes place and generates evidenceeach firm then chooses whether to enforce the collusiona (deviating) firm can moreover report the evidenceif no firm reports, evidence is only found in case of a successful audit

8

Leniency

Collusion strategies

Collusion in each period, punish deviations by competition

Without leniency, collusion is sustainable if long-term gains from future collusion offset short-term gains from a deviation

Short-term gain: (πD - ρ F ) - (πM - ρ F )

Long-term loss: (πM - ρ F ) - πC

With leniency, a deviating firm can report and protect itself

→ short-term gain increases: (πM - ρ F ) - (πM - ρ F )

Remark: stick and carrot

9

Leniency

Deterrence

Increasing amnesty (reducing the fine) destabilize collusion

If full leniency is insufficient, offer a positive reward

With a large enough reward, collusion is not sustainable

Concerns

Reduces expected fine

Program may be abused (e.g., “collude and report” …)

10

Leniency

Stick and carrot

Optimal leniency trades off these pros and cons (Chen – Rey 2007)

Full amnesty better than limited leniency

… whenever random audits are not too likely to be successful

Optimal leniency increases with the size of the “stick”“bigger stick” → leniency programs less likely to be abusede.g., “collude and report strategies appear less attractive

→ increase amnesty/reward so as to foster deterrence

11

Leniency

First informant rule

Offering leniency to additional informants does add deterrence

but facilitates abusing the system (“collude and report” …)→ makes leniency program less effective→ reduces optimal amnesty rate (if all informants treated alike,

then no leniency)

Repeated offenders

Ruling out amnesty for repeated offenders

… triggers additional forms of collusion (e.g., “report once”)

→ makes leniency program less effective and reduces optimal rate

12

Leniency

Increased scrutiny for exposed cartelsMakes collusion more fragile

Hurts more “collude and report” strategies than “never report” ones

Increases optimal amnesty rate

Contributes to desistance as well as to deterrence

Ringleader exceptionConcern: give an incentive to form cartels … and denounce them

Actually good: induces distrust … (free-riding)

Amnesty post investigationSimilar pros and cons once an investigation is already underway

Can be optimal to keep offering (less) amnesty post investigation

13

Whistleblowing

Rewarding individuals

Firms rely on individualsPotential agency problemsAntitrust policy can exacerbate these agency problems

If employees get a reward (bounty) B for reporting evidence

Colluding firms must pay bonuses to “informed” employees to secure their fidelityCollusion becomes both less attractive and more fragile

Complementarity between rewarding individuals and corporate leniency

14

Whistleblowing

Concerns

Deterring desirable cooperationAA may mistake “good cooperation” for “bad collusion”→ may provide an incentive for false claims and deter cooperationCounter-measure: a fine when collusion not confirmed by prosecution

Impact on turn-over and inside communicationColluding firms have an incentive to adopt a rigid employment structure and/or restrict the circulation of information even if this reduces productivityBut this reduces gain from collusion…

15

Whistleblowing

Benefits

Multiplier effect: each informed employee must be compensated for the equivalent of the bounty→ collusion increasingly more fragile as number of informed

employees increases→ still the case if reward is paid only to the first informant

Rewarding individuals reduces the profitability of future collusion→ has more effect when firms place a larger weight on future

profits … which is the case in which collusion is most likely

16

On the effectiveness of antitrust policy

The role of evidence

Antitrust agencies need evidence to prosecute cartels

Why do firms (individuals) keep evidence?Agency problems among firms

– Need to keep records– Keeping evidence to report and obtain leniency

Agency problems within the firm– Keeping evidence to increase bargaining power– Evidence for rewarding the agent + lack of commitment

(employer, employee)

How to measure effectiveness of the antitrust policies?

Harrington (2007): duration of exposed cartels

17

Recap

Leniency (amnesty) is good, rewarding informants is even betterAgency problems (among firms / inside firms) → exacerbate these pbs

Rewarding individuals works better than corporate programs

Stick and carrot complementarities

Maintain (some) leniency post investigation

First informant only

No exception for repeated offenders or ringleaders

Scrutiny of exposed cartels

Incentive to keep evidence