On the design of leniency programs

1. III Encuentro de la ACE en España Madrid, October 23, 2008 On the design of leniency programs Patrick Rey Toulouse 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 03/05 US: 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 Whistleblowing Fraud: 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 2

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 3

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 4

6. Framework Collusion: basic ingredients Firms face same competitive conditions repeatedly overt time In each period, must decide whether to collude or compete Firms gain from collusion, but each firm benefits at the expense of the others from deviating (competing when the other colludes): “prisoner’s dilemma” πMif collusion > πC if competition πD> πCfor a firm that deviates and competes when the others collude Evidence of collusion Communication is a prerequisite for collusion (McCutcheon 1997) Communication generates some hard evidence 5

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 evidence each firm then chooses whether to enforce the collusion a (deviating) firm can moreover report the evidence if no firm reports, evidence is only found in case of a successful audit 6

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- ρF ) - (πM - ρF ) Long-term loss: (πM - ρF ) - πC With leniency, a deviating firm can report and protect itself → short-term gain increases: (πM- ρF ) - (πM - ρF ) Remark: stick and carrot 7

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” …) 8

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 abused e.g., “collude and report strategies appear less attractive → increase amnesty/reward so as to foster deterrence 9

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 10

12. Leniency Increased scrutiny for exposed cartels Makes 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 exception Concern: give an incentive to form cartels … and denounce them Actually good: induces distrust … (free-riding) Amnesty post investigation Similar pros and cons once an investigation is already underway Can be optimal to keep offering (less) amnesty post investigation 11

13. Whistleblowing Rewarding individuals Firms rely on individuals Potential agency problems Antitrust 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 fidelity Collusion becomes both less attractive and more fragile Complementarity between rewarding individuals and corporate leniency 12

14. Whistleblowing Concerns Deterring desirable cooperation AA may mistake “good cooperation” for “bad collusion” → may provide an incentive for false claims and deter cooperation Counter-measure: a fine when collusion not confirmed by prosecution Impact on turn-over and inside communication Colluding firms have an incentive to adopt a rigid employment structure and/or restrict the circulation of information even if this reduces productivity But this reduces gain from collusion… 13

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 14

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 15

17. Recap Leniency (amnesty) is good, rewarding informants is even better Agency 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 16