The effects of global leniency programs on margins and mergers

• DOI: http://doi.org/10.1111/1756-2171.12299
• Author: Ailin Dong,Massimo Massa,Alminas Žaldokas
• Date: 01 December 2019
• Published date: 01 December 2019

RAND Journal of Economics

Vol.50, No. 4, Winter 2019

pp. 883–915

The effects of global leniency programs

on margins and mergers

Ailin Dong∗

Massimo Massa∗∗

and

Alminas ˇ

Zaldokas∗∗∗

In a cross-country study, we investigate how staggered passage of national leniency programs

from 1990–2012 has affected firms’ margins and merger activity. We find that these programs,

which give amnesty to cartel conspirators that cooperate with antitrust authorities, reduced the

gross margins of the affected firms. However, firms reacted to new regulations by engaging in

more mergersthat had negative effects on downstream firms. Our resultsimply that although these

programs were generally effective, their full potential was mitigated by mergers that substitute

for cartels, and that a strong merger review process might be a prerequisite for strengthening

anti-collusion enforcement.

1. Introduction

Researchers, policy makers, and media have recently raised concerns about potentially

decreasing product market competition in the United States (US) and the rest of the world.1

∗Shanghai Jiao Tong University; a.dong@sjtu.edu.cn.

∗∗INSEAD; massimo.massa@insead.edu.

∗∗∗Hong Kong University of Science and Technology; alminas@ust.hk.

For helpful comments, we thank our editor, Katja Seim, and two anonymous referees. We havealso benefited from the

detailed comments from our conference discussants Renee Adams, Ashwini Agrawal, Aaron Edlin, Mark R. Huson,

Evgeny Lyandres, Thomas Moeller, Per Str¨

omberg, Stefan Zeume, as well as the conversations with Gennaro Bernile,

Sudipto Dasgupta, Claire Hong, Ron Masulis, Abhiroop Mukherjee, Tom Ross, D.Daniel Sokol, and the participants at

Finance Down Under Conference 2016, WFA Meetings 2015, EFA Meetings 2015, AFFI Eurofidai International Paris

Finance Meeting 2015, FMA Asia Meetings 2015, ABFER Conference 2014, EARIE Meetings 2014, Conference on

Empirical Legal Studies 2014, CEIBS Conference on Law and Finance 2014, HKUST Corporate Finance Symposium

2013,the seminars at the Bank of Lithuania (2013) and the University of Illinois at Chicago (2017). ˇ

Zaldokasacknowledges

the hospitality of the Bank of Lithuania, where part of this research has been conducted. The web Appendix for this

article is available on www.alminas.com/.

1Grullon, Larkin, and Michaely (2019) find that 75% of US industries have become more concentrated over the

last two decades. De Loecker and Eeckhout (2017) document the rise in averagemarkups across US industries, primarily

coming from the increased number of high-markup firms. The Economist (2016) notes that corporate profits have been

rising over time, as does the Council of Economic Advisers (2016). Shapiro (2018) provides a critical review of the

recent policy debates, media discussion, and academic evidence on the topic, and calls for additional resources for cartel

enforcement and tighter merger control (among other suggestions).

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884 / THE RAND JOURNAL OF ECONOMICS

Reduced competition may come from increasing industry consolidation as well as collusion

among market participants to retain their individual market shares. Recently, many countries,

including the United States, have sprung into action to combat anticompetitive misconduct by

making the formation of cartels more difficult. However, whereas stronger enforcement has been

shown to deter cartels and enhance detection (Miller, 2009), observations that product market

competition has not intensified and in fact may even have weakened, raise questions about the

effectiveness and unintended consequences of antitrust enforcement.

One possible reason for such ineffectiveness could lie in the substitutability betweencar tels

and mergers in achieving market power. Westudy this issue by focusing on the staggered passage

of leniency programs around the world as a proxy for strengthening antitrust enforcement against

cartel activities. We focus on firms from 63 countries and territories over 1990–2012, using data

from the Compustat Global and North America databases. We first show that the global leniency

programs were effective in general. They led to more cartel detections and lower margins of

affected firms, and thereby likely improved consumer welfare. However, we also find that when

firms face new regulatory barriers to cartel formation, they acquire other firms—and these

mergers have a negative effect on customer firms’ stock prices. Given that breaking up cartels is

justified as it encourages competition and protects consumer welfare, our findings suggest that

although leniency programs are effective in general, their positive effects might be mitigated if

firms redraw their boundaries in response to regulatory actions. Thus, anti-collusion enforcement

may be effective only when coupled with a strong merger review process.

Leniency programs have been among the most important developments in cartel detection

and deterrence (Chen and Rey, 2013). By reducing fines or even providing immunity for cartel

members that collaborate in conviction cases, leniency programs are expected to increase the

costs of forming cartels and the benefits of breaking them up. We exploit the fact that countries

passed leniency laws at different points in time between 1993 and 2011 to establish their causal

effect on firms’ gross profit margins and merger activity. In particular, we compare the change in

the margins and acquisition strategies of firms that are affected by the lawto the contemporaneous

change in the margins and acquisition strategiesof control fir ms that are headquartered in countries

that have not yet passed such a law.

We focus on a sample of 54,189 firms over the period of 1990–2012. We follow three

difference-in-difference identification strategies: (a) an estimation based on a staggered passage

of the laws, (b) a one-to-one firm matching, and (c) an identification based on a firm’s exposure

to the passage of laws in foreign countries (exposure is defined in terms of the industry’s export

share to a country or the firm’s own operations there).

Using all three identification strategies, we show that leniencylaws have indeed affected the

margins of firms. This suggests that, by and large, leniency programs have been effective tools

in dissolving existing collusive arrangements and/or preventing the formation of new ones. The

effect is significant in economic terms. Our estimation based on a staggered passage of the laws

suggests that leniency laws lead to a 14.8% drop in gross margins from the average sample gross

margin before the leniency law passage. We further find that such restrictions on the ability to

create a cartel increase incentives to engage in mergers. The passage of a leniency law raises the

annual total dollar value of mergers from 0.6% to 1.3% of the lagged total assets. In other words,

firms replace the market power provided by a cartel with the market power provided by a larger

scale.

Weobtain consistent results if we use a matched sample methodology.We match each country

with a control country with the closest Gross Domestic Product (GDP) per capita selected from

the countries that had not passed the law by the time the treated country did. We then match

firms in the treated country to the corresponding firms in the control country that are operating

in the same industry and are closest in size. These firms are in the same industry, are similar in

size, and are located in countries with similar states of economic development; therefore, in the

absence of leniency laws, we expect them to have experienced similar changes in profitability

and to have followed similar corporate policies. When we control for matched-pair*year and firm

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DONG, MASSA AND ˇ

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fixed effects, the results indicate that passage of the law has a greater effect on the margins and

the merger activity of firms headquartered in the countries that passed the law than it does on the

margins and the merger activity of their counterparts in countries that did not pass the law.

Our results are also robust to the third specification in which, instead of focusing on leniency

laws passed in the country where the firm is headquartered (i.e., the country that the firm is

presumably most exposed to), we exploit the passage of leniency laws in countries to which the

firm’s industry is exporting. Because these foreign countries represent the most likely markets

of the firm’s international operations, the firm is also likely affected by their leniency laws. At

the same time, however, there is less concern about the spurious link between the unobservable

trends in a firm’sindustr y in its home market and the passage of the laws. This specification also

addresses the concern that our firm-level observations may not be spread equally across countries.

The analysis based on these alternative and more exogenous measures of a firm’s exposure to

leniency laws delivers consistent results.

We also investigate the economic effects of the mergers that follow leniency law passages.

We start by demonstrating that firms that pursue mergers after the passage of leniency laws

experience a smaller drop in profitability than (a) similar firms in their industry and country, and

(b) similar firms in their industry and country that attempt but fail to complete mergers.

Finally, we distinguish between merging to improve efficiency and merging to increase

market power by studying how downstream firms react to the cartel-busting-related mergers of

suppliers. Weexamine the merger deal announcements and, using the Organisation for Economic

Co-operation and Development (OECD) Input-Output tables, we compare the stock price reac-

tions following these deals for firms that are more and less likely to be the downstream firms of

the merging suppliers. This analysis allows us to control for deal fixedeffects and any differences

in unobservable and observable deal characteristics before and after leniency laws. We find a

strong negative stock market reaction for downstreamfir ms around the post-leniency-law merger

announcements of supplier firms. This suggests that potential customer firms are expected to

lose from the mergers initiated in the wake of new leniency laws. At least to a certain extent,

then, these mergers act as a substitute for now harder-to-form explicit cartels, mitigating the

effectiveness of the leniency laws. The remainder of the paper is organized as follows. Section 2

describes our theoretical background and our contribution to the literature. Section 3 describes

describes leniency laws and our data. Section 4 providesthe results on the leniency law effects on

cartel detection and profitability margins. Section 5 relates leniency laws to the merger activity.

Section 6 discusses the economic effects of these leniency-law-induced mergers while Section 7

their drivers. Section 8 discusses the robustness of our results. A brief conclusion follows.

2. Theoretical background and contribution to literature

Leniency programs allow the courts and/or regulators to grant full or partial immunity

to companies that participated in illegal cartels but cooperated in providing information about

the cartel. US was the first country to adopt such a program in 1973. However, this program

remained largely ineffective until 1993, when it was strengthened by making the guarantee of

amnesty clearer and broader. The revised lawstipulates that if a cartel is not being investigated by

the Department of Justice (DOJ) and the Federal Trade Commission (FTC) or if these antitrust

authorities do not have sufficient evidence, the first self-reporting cartel member, including its

managers, employees, and directors, will be granted amnesty. The revised law proved successful

in destabilizing existing cartels and in deterring new cartel formation (Miller, 2009) and inspired

several other countries to pass similar laws (Hammond, 2005).

Our article contributes to the literature on the effects of leniency programs (see Spagnolo

and Marv˜

ao, 2018, for an extensive recent summary of the literature). The theoretical literature,

which started with studies on how leniency can prevent collusion in hierarchical relationships

(e.g., Kofman and Lawarr`

ee, 1996), has distinguished two main countervailing forces. On the

one hand, leniency laws destabilize cartels, as they reduce leniencyapplicant’s costs of defection

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