DOES COLLUSION WITHOUT COMMUNICATION EXIST?
Some Experimental Evidence
1
Astri Muren2
Department of Economics
Stockholm University
and
Roger Pyddoke
Swedish Institute for Transportation
and Communications Analysis
Revised Draft, 990714
ABSTRACT
Tacit cartels did not arise in experimental triopoly markets even
with the help of detailed instructions to prospective cartel members on how to coordinate actions. In duopoly markets tacit cartels were successful, with winning bids and supporting “pass”
bids increasing gradually. A simulated third bidder, entering
with known probability, prevented the buildup of cartel prices
in duopoly markets. We suggest that tacit cartels can operate
when members are able to build trust in and support for each
other. In markets with more than two sellers the inability to
communicate appears to prevent the creation of mutual trust.
(Keywords: tacit collusion, laboratory experiment. JEL codes:
C91, L41)
1
We thank Peter Bohm and Martin Dufwenberg for helpful discussions on the design of
the experiment, Björn Carlén and Jan Edman for assistance with sessions and colleagues
and seminar participants for comments. Financial support from the Jan Wallander and
Tom Hedelius Foundation (Muren) and from the Bank of Sweden Tercentenary Foundation
is gratefully acknowledged.
2
Corresponding author. Address: Stockholm University, Department of Economics, S106 91 Stockholm, phone: +46-8-163306, fax: +46-8-159482, e-mail: [email protected].
1
1
Introduction
Tacit collusion means that firms in a market collude without the aid of an
explicit agreement to do so. The concept of tacit collusion is present in the
U.S. Antitrust Law, as is demonstrated by the following statements from the
Theatre Enterprises (346 U.S. 537) case: “the crucial question is whether
[the film distributors’] conduct . . . stemmed from independent decision
or from an agreement, tacit or express.” A distinction is made between
parallel but independently determined behaviour and conduct based on an
agreement, which need not be explicit. European Competition Law uses
the term “concerted practices”, which is defined by the 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.”3
From the perspective of the policy-maker the problem with tacit collusion
is that it is difficult to prove. (See e.g. Allen, 1981). Normally in cases where
restraint of trade is at issue, there is some evidence of an agreement, either
an a priori illegal one or a more innocuous one that may have potential as a
collusive device in a particular case. From the point of view of the potential
colluders, a lack of proof is an advantage. If a collusive outcome can be
achieved without an explicit agreement, clearly this would be preferable to
the parties involved, since the risk of prosecution must be lower.
The fact that tacit collusion is difficult to prove casts some doubt on
whether it actually exists, other than as a theoretical possibility. At least,
it may be doubted whether it exists other than under very favourable circumstances. A couple of recent papers report on experiments where tacit
3
Both quotes are found in Martin, (1993, 141-142).
2
collusion has been one of the outcomes investigated. Kruse et al (1994) find
”little evidence that sellers set stable high prices” in a Bertrand-Edgeworth
competition experiment. Cason & Mason (1998) conclude that observed behaviour in a Cournot competition experiment is better explained by risk
attitudes than by tacit collusion. Holt (1995) summarizes the experimental
evidence on tacit collusion in terms of pure-numbers effects, i.e. whether
and how the number of firms affects the occurrence of tacit collusion. He
concludes that a numbers effect exists only when the number of sellers is
increased from two to three, i.e. tacit collusion seems to occur when there
are two firms in the market, but not when there are three or more sellers.
Holt suggests an explanation in terms of the other firm being easy to monitor
in the duopoly, together with the fact that in a duopoly punishments can be
aimed directly at the one firm that defects from the agreement.
There is a good deal of evidence that collusion on the basis of an explicit agreement does occur. The obvious example is the OPEC cartel, and
American and European anti-trust cases present other examples. In experiments, the possibility of explicit collusion has been introduced by allowing
pre-sales discussion among subjects. In this context, Isaac & Walker (1985)
found collusion in some but not all of their four-seller markets, and Davis
& Holt (1998), investigating the effects of secret discounts in a three-seller
and three-buyer design, found successful price-fixing in their baseline treatment without discounts. A numbers effect limiting the size of a successful
cartel to two sellers does not seem to be operative for explicit cartels, real or
experimental.
A successful cartel must solve two basic problems: (i) The members must
agree on a cartel price and on an allocation mechanism which determines
how much each member produces. (ii) The members must have a method
of discovering if someone is cheating by selling more than their share. The
faster and the more precisely this can happen, the better the cartel will
3
work.4 By assumption, members of tacit cartels do not communicate directly,
although they might engage in less direct communication, like signaling. The
ability to communicate directly and explicitly would obviously be useful when
attempting to agree on price and output. Discovering cheating and punishing
rivals, on the other hand, would be more difficult for a tacit cartel only if these
functions required an agreement, or communication, which seems unlikely.
The experiment described in this paper tests the hypothesis that the real
difficulty for the tacit cartel lies in how to reach an agreement on price and
output. In order to remove the need for communication we suggested to the
prospective cartel members how to coordinate their actions. In addition, the
formation of a cartel was encouraged by the experimental design in that all
sellers had identical costs, which was common knowledge, and in that they
interacted for at least nine periods with the same subjects. The subjects
were not able to communicate or to identify one another at any point in the
experiment.
We found that with three firms/subjects per market, no cartels formed.
With two firms, there were cartels where sellers took turns at a price well
above cost. Cartel prices built up gradually but none of the cartels achieved
the reservation price. These results are in accordance with the numbers
effect identified by Holt. In an attempt to understand the underlying factors
explaining these results we ran “disturbed” two-seller markets, where a third,
simulated player came in with a known probability. In this market cartel
prices were below the clean two-seller treatment. Comparing the two, we
found that cartel prices did not build up gradually in the disturbed treatment.
On the basis of the experimental results we would like to suggest a description of tacit cartel operation as follows: a tacit cartel is dependent on its
members being able to trust one another, in the sense that the seller whose
4
Sherer & Ross (1990, 205-206) list the following complications for the forming of
a tacit cartel: a large number of sellers, cost and market share differences, substantial
time lags before price cuts are matched, uncertainty about “the reactions, intelligence, or
farsightedness of their rivals”.
4
turn it is to win can trust that the other seller(s) will offer support and
charge high prices. In the absence of communication, cartel members will
offer support reciprocally to one another, if they know that they alone are responsible for the gains or losses of their co-“conspirators”. In the two-seller
treatment one seller is always completely responsible for the other seller’s
gain, which facilitates the working of the cartel. In the disturbed two-seller
markets and, even more, in the three-seller market, the presence of another
potential defector reduces or removes personal responsibility and induces lack
of support.
2
Experimental design
The experimental formulation was a Bertrand price competition game with
a homogenous good, which was framed as a procurement auction. The game
was repeated and subjects always interacted within the same group of sellersubjects. In each period there was demand for one unit of a “service”, with a
specified reservation price. The production cost was identical for all sellers in
all markets and was set at 60 SEK. Sellers submitted their bids and the lowest
of these was advertised as the winning bid, provided that it was not higher
than the reservation price. The assigned “seller identity” of the winning
bidder was also advertised. No other information about bids or bidders was
made public.
The instructions described this process and stated the number of sellers in
each market and the reservation price, which was 120 SEK in the three-seller
market and 100 SEK in the two-seller market.5
The following advice on tacit collusion was given:6
5
The difference between the reservation prices was calibrated in such a way that the
expected profit for the participants in a successful cartel would be about the same, 60
SEK one third of the time in the three-seller markets and 40 SEK half of the time in the
two-seller markets.
6
This quote is from the instructions for the treatment with three sellers in each market.
Complete instructions are available from the author.
5
In procurement auctions there may sometimes arise “tacit cartels” that imply that the agents avoid competing with one another. Such cartels may arise without any need for the involved
agents to agree explicitly. They may for example take turns winning. What they then do is that the seller whose turn it is to
win submits a reasonably high bid (e.g. 95 SEK), and the others
“pass” by bidding well above (e.g. 110 SEK). (Remember that
bids above 120 SEK are not taken as valid.) In this experiment
you can profit from taking turns winning. This can for example
be done by checking who wins the first time in your market. If it
is seller II who wins the first time, you let seller III win the second
time etc. If everyone in a market does the same you have started
a working cartel. Each seller is of course at liberty to breach the
cartel.
You are however not allowed to talk, send notes, or show one
another your offers or your identity. If we see anyone doing that
we will not pay any profit to those involved. On the other hand,
we have no objection to any offers you may submit.
Subjects were introductory level economics students at Stockholm University. Sessions were carried out over a period of two days and ran simultaneously with 4-6 markets in the same room, so that subjects/sellers knew
that their competitors were real, but without them being able to identify their
competitors by face or by anything but their assigned “seller identities”.
The three-seller markets were run for at least nine rounds. After the
ninth round the auction continued with a probability of one half to the tenth
round (this was determined by casting a die), and then again, similarly, to
a possible eleventh and twelfth round. In the two-seller markets there were
ten certain rounds and two conditional ones. The subjects were paid their
actual earnings in cash immediately after the sessions. Care was taken not
6
to disclose the identity of any seller/subject to the others.
3
Experimental outcome
Clearly, competition in each period with each seller setting a price just above
the cost of production is an equilibrium of this game. The instructions on
cartel formation did not change the rules of the Bertrand competition game—
they merely informed subjects that there were no rules within the framework
of the experiment that prohibited tacit collusion, although there were rules
aiming to prevent explicit collusion. Without these instructions, the subjects
might have believed that they were not supposed to collude even tacitly.
Such a belief would probably have prevented at least some from attempting
to collude.
The instructions also provided advice on how to coordinate a cartel in
the situation at hand, starting from the outcome of the first period (or of
any period). This would do away with the need for communication serving
the purpose of coordinating the cartel’s decisions on who does what when.
The Bertrand competition/auction design implies that it is not necessary for
the cartel to coordinate on one common price—neither for the winning bid
nor for the “pass” bids.
The actual bids in all two- and three-seller markets, with winning bids
underlined, are presented in table 1 (three-seller markets) and table 2 (twoseller markets). It is clear from these tables that in the three-seller sessions,
all markets are close to the competitive equilibrium in all periods except
possibly the first one. In the two-seller sessions the outcome is markedly
different and the dominant pattern is that the sellers take turns winning.
Competition occurs at the end, in periods ten through twelve, and appears
to be an end-game effect.
These results suggest that even with detailed instructions to prospective
cartel-members, tacit cartels will not form in markets with more than two
7
sellers. If we maintain the hypotheses that (i) explicit cartels, where agreements are allowed, are possible and (ii) the difference between an explicit
cartel and tacit collusion is that in tacit collusion there is no direct communication between sellers, then a logical conclusion of the experimental result
is that communication in a cartel, at least if there are more than three members, must serve some other, or additional, purpose than the coordination of
price and output decisions. Since there is such a marked difference between
the three-seller markets and the two-seller markets, and this difference shows
up in other experiments which do not actively attempt to achieve coordination, a proposed explanation of the role of communication in cartels should
also explain this difference.
4
Building trust in a tacit cartel
There is a growing literature, both experimental and theoretical, on explanations for the observation that cooperative outcomes occur in experimental
settings in spite of the fact that they are not equilibria. Hoffman, McCabe &
Smith (1998) give a broad survey of the contributions of several disciplines
to this field, including their own and others’ experimental results. On this
basis they formulate the hypothesis that people tend to be “trusting”, and
“...programmed to try cooperation in dealing with other people who are not
detected as foes”. They refer to the results of Isaac & Walker (1988) as illustrative of the important role of (non-binding) communication in creating
a cooperative environment.
In working tacit cartels such as those described in Table 2, each cartel
member whose turn it is to win must trust that the other cartel member will
be supportive and quote a high, “passing” price. The level of the “win” bid
could be taken as an indicator of the amount of trust the intended winner has
in its co-player. The level of the “pass” bid indicates the amount of support
given to the intended winner by the other player. To sustain the cartel over
8
time, the level of support must be high enough to correspond to the trust in
it and the higher the trust and support, the more efficient the cartel.
Table 3 shows measures of trust and support. “Trust” is measured by the
median of the bids made in each market by the seller whose turn it was to
win, defined, as suggested in the cartel instruction, as the seller next in order
after the seller who won in the previous round.7 “Support” is measured as
the median of the bids of the sellers who were not due to win i.e. those not
included in the trust measure. The first two columns show the 7 three-seller
markets and are derived from Table 1, while the next two columns show the 5
two-seller markets and are derived from Table 2. As it happens, the median
initial bid is 75 in both treatments, although the maximum bid is higher in
the three-seller treatment. The subsequent development in the three-seller
markets is one of dwindling support and, in consequence, reduced trust. In
the two-seller markets support increases from period two onwards, bringing
with it increased trust. In periods 10 through 12 of the two-seller treatment,
support goes down and so does trust, which looks like an end-of-game effect.
The time-paths of the measures of trust and support in the three-seller,
unsuccessful cartels and the two-seller, successful cartels suggest the following
interpretation: A tacit cartel becomes established when support and trust
build gradually. This happens more easily in a two-seller market.
5
A disturbed two-seller cartel
To investigate how the number of sellers and the market mechanism combine
in determining the build-up of trust and support in the tacit cartel we look
at the results of a third treatment which is a variant of the two-seller market.
This variant consisted of adding a third, simulated player (bidder number
III) whose bids were determined for each of the markets and in each period
7
In a two-seller market sellers take turns, in a three-seller market seller I comes after
III, II after I etc.
9
by the throw of a die as follows:
If the throw results in 1, 2 or 3 bidder
number III does not enter. If the die shows 4 bidder III bids 62, if the die
shows 5 bidder III bids 84 and if the die shows 6 bidder III bids 110. Thus
the third bidder was only a potentially effective competitor with probability
1/3, and then with equal probability at bids 62 and 84.
The disturbed treatment can be seen as introducing a stochastic reduction
in the reservation price somewhat in the spirit of Green and Porter (1984),
although our sellers are fully informed about the source of the demand fluctuations so there is no reason why a particular bid from the simulated third
bidder should trigger a change in behaviour. However, the existence of this
bidder may affect the level of trust i.e. the win bids—specifically, the preferred win bid might change to 83 which reduces the probability that a round
is lost to the third bidder. There is no a priori reason why the support bids
should be affected.
The bids in the disturbed two-seller treatment are shown in Table 4.
Table 5 shows the measures of trust and support in this treatment.8
By
comparing Table 4 with Table 2 we see that although there is some cartel
cooperation also in the disturbed treatment, the cartel is very much less
effective in the disturbed treatment than in the undisturbed treatment. The
measures of support and trust in Table 5 show a different pattern compared
with the clean two-seller case (in Table 3), in that the levels of support in the
disturbed treatment do not build up gradually over the periods as they did
in the clean two-seller treatment.9 In consequence, the levels of trust do not
build up either, but stay low compared with the clean two-seller treatment,
below 84, but above competitive levels.
8
The simulated player III is of course not included in the measures of trust and support.
In the rare cases where player III won we assume that the (real) player whose turn it was
to win, keeps his/her turn for the next round.
9
The difference in the disturbed treatment becomes pronounced after a few rounds.
A Wilcoxon-Mann-Whitney test rejects the null hypothesis in favour of the alternative
hypothesis that support in the disturbed market is lower at the 0.10 significance level for
rounds four through ten (and at the 0.05 level for rounds five through nine).
10
We conclude that the addition of the simulated bidder III did change
cartel behaviour in that the bids by players not due to win were lower.
Could Holt’s explanation for the numbers effect, i.e. easier monitoring and
the ability to punish the one firm that defects from the agreement, account
for this change? With only two real players involved in the disturbed twoseller market, any punishment would affect only that firm, so there is no
difficulty about aiming punishment. The third bidder does however affect
the probability of detecting a defector. Any defection from the implicit cartel
agreement to a bid above 84 would go undetected with probability 1/3, and
a defection to a price at or below 84 and above 62 would go undetected with
probability 1/6.
We think that the approach introduced by Rabin (1993), provides a useful
way of interpreting the disturbed cartel results. Rabin argues that the parties
of a transaction care about fairness in the sense that they “like to help those
who are helping them, and hurt those who are hurting them” (p. 1281). The
gradual build-up of trust and support in the clean two-seller markets could
be thought to coincide with the wish of each seller to be kind (place a high
support bid) to the other seller who was kind (placed a high support bid) in
the previous round. In the disturbed cartel it is not as easy to be kind since
even if you place a high support bid the third seller could come in with a low
bid, in which case the kindness would not be noticed. If it is important that
the other player notices kindness, or would notice an absence of kindness,
the imperfect monitoring in the disturbed cartel could explain the resulting
lack of cartel cooperation.
Another way of putting the fairness argument is that in the clean twoseller treatment, the gradual buildup of support and trust takes place because
each player is prevented from defecting by guilt feelings.10 The disturbance
caused by the simulated third bidder reduces support and thereby prevents
10
Rabin mentions that a player who is mean to someone who is nice to him, would be
likely to feel guilty.
11
the buildup of trust because it reduces the guilt feelings caused by defecting.
The “internal argument” of a seller not due to win would be this: Even if
I don’t defect, the simulated bidder could come in with a low bid and my
co-player loses through no fault of mine. Thus if I defect, I’m not solely to
blame for my co-player’s loss.” In the clean three-seller treatment this lack of
responsibility is just more pronounced and tacit cartels are even less efficient.
6
Conclusion
We attempted to create a tacit cartel, in order to test the hypothesis that
the lack of communication inherent in a tacit cartel causes problems for
cartel members in coordinating decisions. We aimed to supplant the need
for communication by suggesting to the prospective cartel members how to
coordinate their actions. Direct communication between subjects was not
allowed, and the formation of a tacit cartel was encouraged by identical
costs and repeated interaction.
We found that tacit cartels were most effective in markets with two sellers.
In these markets, cartel prices built gradually through increasing “win” and
“pass” bids. In markets with three sellers there were no tacit cartels and in
markets with a disturbance term in the form of a simulated third seller, cartels
formed but at significantly lower prices than in the clean two-seller markets.
In the disturbed two-seller markets cartel prices did not build gradually.
This implies that communication in a cartel serves some further purpose
in addition to coordination of price and output decisions. We suggest that
an important function for communication in a cartel may be to build and
maintain mutual trust among cartel members. This suggestion is based on
our finding that in successful tacit cartels support and trust build gradually,
but when the successful tacit cartel setting is disturbed by a simulated third
seller support does not increase, which prevents the establishment of trust.
Our conclusion is that tacit cartels will not occur in laboratory settings
12
even under very favourable conditions if there are more than two sellers,
and found a convincing argument why this is so. An obvious question is if
this result carries over to real markets. One aspect that we have ignored
is anonymity versus non-anonymity. In our experiment the subjects were
anonymous in that they did not know which of the people in the room were
their co-player(s). In real markets firms are not anonymous, which could
make the establishment of mutual trust easier. Thus it may be the case that
real tacit cartels with more than two members may exist.
13
7
References
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Rabin, M., 1993, “Incorporating Fairness into Game Theory and Economics”,
American Economic Review, 83(5), 1281-1302.
14
Scherer, F.M. and D. Ross, 1990, Industrial Market Structure and Economic
Performance, Houghton Mifflin.
15
8
Tables
16