The paper studies the role of communication in facilitating collusion. It is well known that the main obstacle for the stability of a cartel is the threat of defection of a cartel agreement by either undercutting the commonly agreed - upon collusive price (in case of price competition) or producing more than the agreed - upon collusive output (in case of quantity competition). When such deviations are perfectly observable cartel members can overcome this problem by inflicting a punishment for the cheating: they can threaten to set prices below unit costs or to flood the market with the goods thereafter.
When deviations are imperfectly observable the firms might wrongly impose the punishment when cheating did not actually occur. This can happen when the firms observe only their own production levels and a common market price. When the demand fluctuates, say because of changes in consumer preferences, then the market price does not allow to make exact inference about the true behavior of the cartel participants: unexpectedly low price may signal either deviations from collusive output levels or a ‘downward’ demand shock.
This implies that in the absence of proper information about firms’ individual actions collusion is fragile. Communication allows the firms to share private information about past outputs and thus helps resolve the problem of detection of deviations in the presence of uncertainty. However, communication is not completely innocuous for the collusive firms because it leaves incriminating evidence of a cartel behavior which can be uncovered by competition authorities, in which case the firms are sued and pay a fine. The paper examines two collusive schemes - with and without communication and identifies the reasons for communication. In choosing between the two schemes the firms face the following tradeoff. Without communication collusion always involves informational costs due to the lack of complete information about firms’ individual actions while with communication collusive profits are reduced because of the expected fine imposed in the event the meeting is detected.
The main finding of the analysis is that as long as the punishment for cartel behavior is not too large, the most profitable collusive strategy involves communication.
WP No. 672 ”Private Observation, Tacit Collusion and Collusion with Communication” is authored by Igor Mouraviev, University of Toulouse I.