INTRODUCTION
Structural theories of collusion posit that demand and supply characteristics of an industry's structure can be used to determine the likelihood of anticompetitive cooperation by competitors. A variety of structural approaches have been advocated by academics and applied by both enforcement agencies and courts.
Any structural theory, however, must at bottom rest on an understanding of the necessary conditions for collusion. To collude effectively, firms must be able (1) to reach an agreement, (2) to detect breaches of the agreement, and (3) to punish firms that breach. Advocates of the structural approach have suggested a variety of market characteristics that affect these conditions. Some characteristics (such as seller concentration, or the homogeneity of the product) relate to the ease of reaching an agreement; others (such as stable demand, or announcement of the lowest sealed bid) affect the ability to detect price-cutting breaches.
However, none of the structural variables currently considered by academics or enforcement agencies relate to the third condition for successful collusion--the necessity of being able to punish breach; thus the current list of structural variables is systematically incomplete. This omission of variables affecting the ability to punish may explain the empirical failure of the structural approach to identify collusion.
Focusing on the necessity of self-enforcement can also serve to harmonize economic and legal conceptions of collusion. Legal scholars have traditionally distinguished between explicit and tacit collusion. The law punishes the former, so that the act of communication is of central importance. For economists, however, this distinction has no meaning. In game theory models of collusion, the term "agreement" does not imply a formal communication--all that is needed is for the cartel members to have an "understanding" of how others will react to their behavior. Such shared beliefs--whether acquired tacitly or not--can support a self-enforcing, collusive equilibrium. The analysis in this Article will thus have policy implications for both tacit and explicit collusive agreements. Since tacit agreements can also be self-enforcing, the theory provides no clear reason for exempting such collusion from the concern of antitrust.
Note, though, that the meeting of the minds involved in even an explicit cartel agreement is very different from the meeting of the minds in the normal contractual setting. Part of a legal agreement is the intention that it be susceptible to legal enforcement. Not only is such intention absent from cartel agreements, these agreements must in fact include their own enforcement rules. The ability of a cartel to punish is essential because courts will not remedy the breach of an illegal contract. (In fact, by revealing the existence of collusion, the plaintiff could face criminal prosecution.)
This Article extends and refines the structural approach by identifying variables that would let us differentiate industries by the ability of colluding firms to punish breaches of a collusive agreement. The ability to punish crucially depends upon the credibility of punishment. This Article provides a rigorous definition of credibility and analyzes what influences the credibility of various punishments. Threats of punishment that are not credible will not facilitate collusion. Part I presents a general theory of self-enforcing collusion supported by credible punishments. Part II catalogs structural variables that might influence the ability to punish. Colluding firms can punish by either decreasing the demand or increasing the costs of breaching firms. Demand-side punishments are especially important because a firm's demand is usually much more dependent on the actions of competitors than a firm's costs. For example, rivals can drastically affect a firm's demand simply by changing their own prices. This Part begins then by analyzing how price can be used as a demand-side punishment and examines how industry characteristics can limit the availability of such pricing punishments. It also presents an account of nonprice demand-side punishments and suggests an explanation of their causes.
Also analyzing supply-side punishments, Part II extends Salop's work on exclusionary practices that "raise rivals' costs." It shows that exclusive dealing or price squeezes can also be used to support collusion by raising a breaching firm's costs after a breach has occurred. Following Williamson's work on "hostage" exchanges that facilitate vertical agreements, it shows how joint ventures and product exchanges could serve as hostages that commit firms to more effective punishment even before a breach occurs.
Exploring the implications of the preceeding analysis, Part III examines the unique importance of interest rates upon the incentives to collude. Additionally, Part IV reveals how cartel punishments can be disguised within otherwise legal arrangements so as to enlist the state's assistance in enforcing collusive agreements. Part V discusses how identifying and distinguishing the ability to punish allows policy makers to target enforcement efforts, identify actual episodes of punishment, and promote structural characteristics that constrain collusion.