Cartels, agency costs, and finding virtue in faithless agents.

Author:Leslie, Christopher R.
 
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ABSTRACT

Although price-fixing conspiracies are inherently unstable, many cartels manage to endure, often for long periods. Many successful cartels have hierarchical structures made up of high-level executives (principals) and lower-level managers (agents). For these cartels, agency cost theory could provide some insights as to how to destabilize them from within. Agency costs exist when a faithless agent pursues her own interests instead of those of the principal. Although agency costs are generally considered inefficient, when the principal's goals are undesirable, the acts of a faithless agent can be beneficial. Because one traditional approach to reducing agency costs is to align the interests of the principal and agent, this Article argues that antitrust policy should maximize agency costs in cartels by decoupling these interests through several interrelated strategies. First, antitrust law should increase the severity and probability of criminal punishment of individuals who participate in price fixing. Second, antitrust law should reward individuals who expose cartel activity by providing them immunity from all criminal and civil liability and by paying antitrust bounties to such faithless agents. Finally, antitrust law should be structured so that employees of a cartel firm will not trust their employers to protect them should the cartel be exposed. This Article discusses how antitrust law can perform this decoupling function while minimizing any negative consequences of creating distrust within firms.

TABLE OF CONTENTS INTRODUCTION I. CARTEL STABILITY II. CARTELS AND THE SOCIAL BENEFITS OF AGENCY COSTS A. Agency Costs, Faithless Agents, and Unworthy Principals B. Agency Relationships Within Cartels C. Examples of Faithless Agents in Cartels D. The Wisdom of Targeting Agents E. Aligned Interests: Cartel Employees' Incentives To Be Faithful Agents III. DECOUPLING INTERESTS FROM THE AGENT'S PERSPECTIVE A. Punishing the Faithful Agent B. Rewarding the Faithless Agent 1. Individual Leniency Program 2. Private Liability 3. Antitrust Bounties C. Rewarding Disloyal Principals D. Educating the Agents 1. Antitrust Education and Overcoming Social Norms Within Cartels 2. Education as a Decoupling Device a. Penalties b. Firms' Incentives To Sell Out Employees c. Individual Leniency Policy d. Probability of Detection 3. How To Educate Agents a. Antitrust Compliance Programs b. Presentations at Trade Association Meetings IV. DECOUPLING INTERESTS FROM THE PRINCIPAL'S PERSPECTIVE: GETTING EMPLOYERS TO DISTRUST EMPLOYEES A. The Risk of Faithless Agents Increases Cartel Costs B. Preemptive Confession by Cartel Firms V. THE POTENTIAL DOWNSIDES OF CREATING DISTRUST WITHIN FIRMS A. Distrust and Inefficiency B. False Accusations of Price Fixing CONCLUSION INTRODUCTION

Federal antitrust authorities had long suspected that the world's two leading auction houses--Christie's and Sotheby's--were engaging in illegal collusion, but they lacked proof. (1) The auction houses had traditionally made the bulk of their money by charging a buyers' commission, whereby the successful bidder in each auction would pay a premium to the auction house above and beyond the winning bid. (2) Historically, each rival competed to lure sellers who had attractive, high-end items to use its auction services, in the hope that such items would lead to frenzied bidding and, consequently, higher commissions from buyers. But in 1995, both auction houses ceased their fierce competition when each announced a new policy of non-negotiable sellers' commission rates. (3) Federal officials suspected collusion, but their investigation yielded insufficient evidence. All seemed lost until Christie's did the previously unimaginable: It presented the authorities with a cache of approximately 500 pages of documents, mainly handwritten notes, from its former CEO that detailed his illegal meetings with his counterpart at Sotheby's and outlined a criminal conspiracy between the firms even greater in scope than previously suspected. (4) Both firms eventually pled guilty to criminal price fixing, (5) and the chairman of Sotheby's was convicted and imprisoned for his role in the conspiracy. (6)

Federal agents had not suspected that the multi-hundred million dollar international market in lysine--an amino acid added to animal feed--was being controlled by a well-heeled cartel. Archer Daniels Midland (ADM), a major agribusiness concern, started a new bioproducts division to manufacture lysine in the early 1990s and named Mark Whitacre as the division's manager. (7) Initially, the division failed to take seed. (8) Whitacre informed his superiors that he discovered the reason for ADM's inability to grow lysine when a stranger called Whitacre, informed him that an internal saboteur at ADM had contaminated the company's lysine, and offered to remedy the problem for $10 million. (9) Whitacre explained the situation to his bosses and asked ADM for the money. (10) Through a series of events, the FBI was called in to investigate. When approached by FBI agents, Whitacre panicked because there was no saboteur; he had fabricated the story of industrial sabotage in an attempt to embezzle money from ADM. (11) In an effort to divert the government's attention from his own crime, which the FBI had not yet discovered, Whitacre exposed the fact that ADM had been participating in an international lysine cartel. (12) He volunteered to wear a wire and tape his conversations with his bosses about the cartel. (13) Eventually, Whitacre worked with the FBI to videotape actual cartel meetings. (14) Once prosecutors secured enough evidence, all of the lysine firms pleaded guilty and collectively paid over $100 million in criminal fines. (15) But for Whitacre's moment of panic, the lysine cartel would probably be functioning today.

Although the lysine and auction house cartels operated very differently, both conspiracies illustrate the difficulty and serendipity of cartel exposure. Price fixing is fundamentally different from most other crimes, in that the offense is self-concealing; it leaves no obvious trace, when police discover a body riddled with bullets, they commence looking for the murderer. When drums of toxic waste are found leaching into a lake, it is safe to conclude that illegal dumping has occurred. Like most felonies, murder and toxic dumping generally leave telltale signs of criminal activity. In all of these crimes, the issue is who did it. By contrast, in price-fixing cases, the great mystery is whether the crime happened at all. Because economic theory predicts that rivals will charge similar prices in either perfectly competitive or cartelized markets, the presence of common pricing practices does not necessarily indicate an illegal agreement to restrain competition. As a result, instead of investigators first discovering the crime and then looking for the culprit, cartel conspiracies are most often exposed because an actual participant in the crime steps forward and confesses. In many instances, a confession marks the first time that antitrust authorities are aware that the crime had been committed. This represents an unusual model for law enforcement.

Price-fixing cartels illegally divert billions of dollars from consumers' wallets into the coffers of firms that are committing felonies. The total harm inflicted by such price fixing is impossible to estimate accurately because, by definition, successful cartels are never detected. From just those cartels that have been exposed, however, we know that cartel overcharges are measured in the billions of dollars. (16) Although antitrust authorities have enjoyed recent success in defeating major cartels, much work remains to be done. Exposing and punishing additional price-fixing conspiracies requires understanding how cartels operate and where their weaknesses lie in order to design enforcement strategies that exploit those vulnerabilities.

Agency cost theory may help antitrust officials locate and target a cartel's Achilles' heel. (17) Cartels often have many agency relationships within them. Each firm that belongs to the cartel generally has several employees who manage the firm's participation in the cartel, including attending cartel meetings and negotiating terms, such as the price to be fixed and market share allocations. (18) Each employee who plays a part in the price-fixing conspiracy is an agent of a firm participating in a criminal enterprise.

This Article argues that antitrust enforcement efforts should exploit these agency relationships to destabilize cartels. Part I shows that antitrust enforcement against cartels is necessary. Some scholars have argued that cartels are inherently unstable because of the conspirators' incentives to cheat--by charging a lower price than the agreed-upon fixed price, or by producing a greater quantity than their cartel allocation--and thus, cartels will fall apart even without a vigorous antitrust program. (19) But experience demonstrates that many price-fixing conspirators have figured out how to stabilize a cartel and have consequently been able to secure supracompetitive profits for decades. For those cartels that are not destabilized through the risk or actuality of cheating by participants, prosecutors need to develop alternative mechanisms to create instability. An antitrust program that creates agency costs within individual firms can weaken otherwise strong cartels.

Part II begins a discussion on principal-agent relationships. Many price-fixing cartels have a hierarchical structure in which high-level decisions are made by senior executives while the cartel's day-to-day operations are carried out by lower-level managers and salespeople within each member firm. The connection between the high-ranking executives and their lower-level employees is a classic principal-agent relationship. Although most of the literature on agency costs in employer-employee relationships...

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