What is Collusion?

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Definition:

Collusion is a secret agreement between competitors that results in higher prices for products or otherwise provides an unfair advantage over the competition.

🤔 Understanding collusion

In business, collusion occurs when competitors form an agreement to reduce the effects of competition. Under a competitive framework, businesses typically try to capture more market share by lowering prices or providing higher value than the other companies in that space. By coming together, the competitors can demand a higher price without losing market share. Sometimes collusion can result in lower costs for the companies. For example, they may agree not to advertise against one another, thus reducing their marketing budget without losing customers. An example of unlawful collusion is price-fixing, in which competitors agree not to undercut each other. Both companies charge an agreed price, and the consumers end up paying more than they would in a competitive environment.

Example

Imagine there are two gas stations serving a small town. Under natural competition, they would both charge lower prices than they do currently. But to keep profits high, they agree to collude and both charge the same amount per gallon. This would be collusion, and it would cause a clear harm to consumers by keeping the price of gasoline artificially high.

Takeaway

Collusion is like players making their own rules…

When you go to a basketball game, you expect some excellent entertainment. Hopefully, there will be good shooting, rebounding, and defense. While you want your team to win, you also want to see a good game. There is something special about a nail-biter that ends with your team scoring the winning shot as the buzzer sounds. But what if you showed up and the players agreed not to defend each other? That would change the whole game, and it probably wouldn’t be very much fun to watch. As you leave, you may feel that you overpaid for what you got.

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What are the types of collusion?

There are many different ways that collusion can occur. It almost always stems from some level of cooperation among entities that you would not expect to be working together. The difference between collusion and cooperation is usually in the secrecy that is involved.

Conspirators almost always plot to accomplish something that they know they shouldn’t be doing. They then collude to execute their secret agenda.

In the United States, the passage of the Sherman Act in 1890 outlawed corporate trusts. These antitrust laws prohibit companies from colluding to get a better price for their products. By encouraging competition, an economy generally grows more rapidly, and customers get better deals.

If corporations are allowed to work together, it undermines that competition. There tends to be less innovation, lower production levels, and higher prices. Such a business environment is beneficial for companies already doing business — As they get to make more profits with little threat to their sales.

One of the types of collusion that may occur in an attempt to get around the antitrust laws is called price-fixing — Which happens when competitors agree not to reduce their prices below a certain level. Price-fixing is illegal in the United States and several other countries.

Another type of collusion might happen in an oligopoly (an industry with few players) by creating barriers to entry for new entrants. These large industry leaders might formally agree not to contract with the challengers. Or they may decide to work together to put new companies out of business — and then return to a higher price.

In contract bidding, companies may collude by sharing information about what the other will charge and agree not to bid lower than a certain amount. Even more severe cases of collusion might include one bidder providing a kickback (a type of bribe) for letting them win the contract.

Tacit collusion is a more difficult concept to pin down. It is collusion without directly colluding. Companies may tacitly collude to avoid detection by regulators or to avoid directly breaking the law. This type of collusion happens by signaling competitors without directly talking to them and by creating an informal understanding rather than a formal agreement. A common form of tacit collusion is “price leadership,” where one dominant firm in a sector sets prices and then other firms follow the dominant firm’s lead — without any explicit agreement to collude.

Is collusion illegal?

A lawyer would probably point out that there is no criminal charge called “collusion.” But that doesn’t mean collusion itself is legal. It’s just that federal crimes are things that stem from collusion rather than collusion itself.

Of course, not every instance of collusion constitutes an illegal act. You might collude with your spouse’s friends to throw a surprise party. Although there is deceit, the FBI probably won’t claim lying to your spouse is against a federal law. Nor will you go to jail for colluding with your golf partner not to count your first tee shots.

But more severe instances of collusion might land you in jail, you just won’t be charged with “collusion” when you get arrested. Here are a few examples of dishonest behavior that can lead to prosecution:

Conspiracy When people get together and make a plan about doing something illegal, that is a conspiracy. Criminal conspiracy is the charge closest to what people typically mean when they talk about collusion being illegal. Technically, it might not be the agreement (collusion) that is illegal; it is the planning (conspiracy) that violates the law. It is worth remembering that conspiracy is unlawful even if the planned criminal event never happens.

Market Manipulation Price-fixing is illegal under antitrust laws. Getting together and agreeing to a minimum price undermines competition at the expense of consumers. Other forms of cooperation that put consumers or other competitors at a disadvantage could bring charges of market manipulation. More than 100 countries have some type of antitrust laws that make market manipulation illegal.

Fraud Although fraud can be perpetrated by a single person, people can also agree to fabricate a situation to receive some benefit. Taking advantage of a person or entity by deceit for personal gain is illegal. Colluding to defraud someone or some entity could land all parties in jail. For example, two people might agree to a fake marriage so they can get citizenship or qualify for some government program. That plot could constitute fraud.

Obstruction Colluding to thwart an investigation could also result in criminal charges. By agreeing not to cooperate with investigators, it can be hard to build a case. But the act of obstructing an investigation is itself a crime. While you won’t get charged for colluding, the agreement can lead to something illegal.

Election Interference The news made a big deal about potential collusion between the 2016 Trump campaign and the Russian government regarding damaging information about Hillary Clinton. Special Counsel Robert Mueller eventually issued a report that was inconclusive about the allegations. A few indictments did come out of the Mueller report, but the attorney general, William Barr, did not recommend any action against President Donald Trump. Regardless, the charge of “collusion” did not meet the legal definition of an illegal act. If charges were brought, they would have likely been on other grounds.

What does collusion mean in game theory?

A familiar scenario in game theory is called the prisoner’s dilemma. In the story, two people are arrested and placed in separate interrogation rooms. Both prisoners know that without the confession of the other, they will both get light sentences for minor crimes.

But if either agrees to testify against the other, the police can convict the other for a long time. The trick the police officers use is to grant immunity to the confessor to build the case against the other criminal.

Suddenly, there is an incentive to be the first to confess and walk free. With each knowing the offer is being made to the other, it becomes tough to maintain the agreement to keep quiet.

Many situations lead to this same type of outcome, in which cooperation would generate a better result for everyone. But the individual incentives (or the disincentives) provided by the law make it challenging to achieve the optimal outcome.

The most straightforward approach to breaking free from the prisoner’s dilemma is by making a pact — aka colluding.

What factors deter collusion?

The most reliable deterrent for collusion is to take away the incentives to cooperate. In a free-market economy, that deterrent is almost always naturally present. If two companies agree not to compete with each other, there is an incentive to cheat on that agreement. That incentive is especially strong if the cheating is not apparent.

For example, if they agreed only to make 1 million units apiece, the market would fetch a higher price than if they produced at full capacity. But by creating an extra 10,000 units the company could get a little extra profit. That incentive to cheat, especially without detection, makes it hard for collusion to work in the real world.

Another deterrent is to impose a penalty for colluding. The government does that by creating laws that make market manipulation illegal. If the negative consequences for colluding are more significant than the benefits of working together, the desire to collude goes away.

Of course, detecting market manipulation can be difficult. That is especially true when you consider that a perfectly competitive market would look the same as one with price-fixing. It can be hard to know if everyone is charging the same price because that is the market equilibrium or because of collusion.

One way to encourage people to stop colluding is to use the prisoner’s dilemma. By protecting whistleblowers from prosecution for the crime they are part of, the participants lose trust in each other. While mutual punishment would typically prevent someone from exposing collusion, the protection can encourage one party to defect before the other gets the chance.

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The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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