Greater Disclosure Harms Cartels

The U.S. Department of Justice estimates that breaking up illegal cartels leads to consumer savings of at least 10% of annual sales in the relevant market. However, from the regulator’s perspective it is notoriously difficult to identify cartels. Even more difficult is to prove that some illegal conspiracy actually occurred: Do companies coordinate their actions by means of informal meetings in a hotel room in some remote location? Or do companies act after observing each other’s actions without exchanging a word or a text message? Both ways to coordinate actions may reduce consumer welfare, while only the former is punishable by law in most countries. In 2011 the FTC has opened an official investigation into whether there are anti-competitive practices going on in the oil and gas markets. The German Federal Cartel Office recently showed how gas retailers coordinate their actions leading to a pattern of price changes that repeated day after day after day… But no illegal behaviour could be proven. Australian cartel authorities faced a similar dilemma. The British consumers suspected illegal gas price manipulations but there is “no way of proving it”.

Is there a remedy? What course of actions can cartel authorities take in such cases? Is it always necessary to prove illegal behavior in order to break up a cartel? Our research shows that there is one patent remedy that can help in most cases – greater disclosure of financial information. Firms – and especially publicly quoted firms – have already to disclose a large deal of financial information about their business. We show that making firms disclose information on their businesses in more transparent way leads to an earlier breakdown of cartels. Disclosure makes it more difficult for cartel members to coordinate their joint actions, and forces cartel members to terminate the cartel. By making cartelists disclose more, law makers reinforce a strong cartel destabilization mechanism – cheating at the cost of other cartel members.

In our research paper “Does Reporting Transparency Affect Industry Coordination? Evidence from the Duration of International Cartels” we looked at a comprehensive sample of international cartels, many of those cartels also faced prosecution in the U.S. Our sample includes such prominent cases as the “Chloroprene Rubber” cartel. The European Commission fined the most prominent members Dow, DuPont, and Eni SpA (ENI) by a total amount of € 247.6 million ($ 334.4 million). Thereof, Dow the largest U.S. chemical maker and DuPont a manufacturer and distributor of synthetic fibres were fined € 59.3 million. Even a more drastic example is Archer Daniels Midland (ADM). ADM and its industry peers engaged in secret meetings and conservations to monitor the quotas in the lysine market resulting in a price increase of 70%. The cartel broke down after an informant passed evidence of price fixing to the FBI.

We discuss that when coordinating joint actions each cartel member faces a trade-off: Should a firm cooperate in a cartel to achieve long-term benefits (at the cost of consumers) or should a firm cheat, winning a greater market share at the cost of its rivals? Coordination among firms is sustained as long as the gains from long-term mutual cooperation outweigh the immediate short-term gain from defection. We find that when cartel firms must disclose more information through their financial statements the likelihood of exiting the cartel in the next year increases by up to 84%. This finding can be explained by the enhanced ability of cartel members to detect cheating by their fellow members when their reports are more transparent. Detection of cheating destabilizes cartels and leads to their earlier break down. Consistent with this argument, we further show that transparency lowers cartel duration when the opportunity costs of cooperation and the likelihood of cheating are high.

The preceding post comes to us from Igor Goncharov, Professor at Lancaster University Management School, and Caspar David Peter, PhD student at Otto Beisheim School of Management.  It is based on their paper entitled “Does Reporting Transparency Affect Industry Coordination? Evidence from the Duration of International Cartels“, which is available here.