Relation to the Literature

There have been many studies on the effect of leniency program. The first paper addressing this issue is Motta and Polo (2003). They mainly focus on the value of Section B5_{: whether firms}

that report information while already under investigation by antitrust authority should also be eligible to leniency. Their central result is that leniency program may increase deterrence by making prosecution more effective although it has a negative effect by reducing overall sanctions. My model deals with Section A and the prosecution technology is simplified by assuming that only one leniency application is sufficient to convict cartel for sure.

Spagnolo (2004) examined the ability of Section A to deter cartels. After he divides “coura- geous” leniency programs, which reward the first reporting party with the fines paid by all other members, and “moderate” leniency programs that only reduce or cancel sanctions, he shows that the former achieves the first best of complete and costless deterrence while the latter may deter cartels under restrictive conditions. Other researches also confirm that posi- tive rewards provide stronger tools for the prevention of cartels. [Brisset and Thomas (2004), Aubert, Rey, and Kovacic (2006), etc.] In particular, Brisset and Thomas (2004) illustrate

5

Section A of leniency policy is to grant leniency to a corporation reporting illegal activity before an in- vestigation has begun, while section B is to give it to a firm reporting after antitrust authority’s investigation began.

that the moderate leniency does not prevent cartel formation under the first price sealed bid auction setting with the asymmetric information on costs. In contrast, Chen and Harrington (2007) and Harrington (2008) show that the maximum moderate leniency makes collusion more difficult whereas softer leniency programs may have pro-collusive effects. While I focus on the pattern of leniency notice under “moderate” leniency program, I show that optimal leniency program among moderate leniency program may have an effect to deter cartels and it may includes a partial reduction for the first reporting firm.

Motchenkova (2004) is closely related to this research in that both papers deal with the “rush to report” phenomenon and cartel duration explicitly. But the timing of firm’s leniency application is quite different in two papers. Cartel members either self-report simultaneously and immediately after cartel is formed or never apply leniency in Motchenkova (2004), whereas this paper predicts that they apply leniency simultaneously right after cartel collapses. The timing of leniency application in Motchenkova (2004) is related to the feature of his model that firms stop colluding because of the potential sanctions from law enforcement. My paper adds unexpected shocks to the sources of cartel instability, examines the incentive compatibility constraint of each firm under this environment, and hence provides more realistic leniency decision outcome.

In contrast, Harrington and Chang (2009a) develops a rich model that endogenizes the birth and death process for cartels given a population of heterogeneous industries. While they focus on how one can infer the impact of competition policy on the population of cartels by measuring its impact on the population of discovered cartels, they show that the average duration of discovered cartels rises in the short run in response to a more effective competition policy because the marginally stable cartels tend to be of relatively short duration and they exit from the cartel population due to the new policy. This paper confirms that they pointed out one important effect of an effective leniency program on the average duration of discovered cartels in a different way, but I also add three additional immediate or short-run effects caused by the introduction of leniency program. First, if leniency program is introduced, all dead cartels satisfying Assumption 3 would be discovered by self-report. Their average duration

1

p

is longer than that of the cartels discovered by antitrust authority’s investigation

1

α+p−αp

because law enforcement did not affect their collapse. Second, leniency program may lower detection rate for non-leniency cases at least in the short run as discussed above. Harrington and Chang (2009b) also points out this possibility based on antitrust authority’s incentive structure.6 In that case, the average duration gets longer in the short run. Finally, cartels that exit from the cartel population due to the installation of an effective leniency program would also be discovered by self report. These cartels have shorter average duration because they did not collapse due to an innate shock or antitrust authority’s conviction. The overall effect of leniency program on discovered cartels’ average duration should be evaluated considering all these effects besides the inference of Harrington and Chang (2009a).

In an empirical side, Miller (2009) develops a dynamic model which predicts that leniency program increases the detection rate and decreases the cartel formation rate if the number of detected cartels temporarily increases and then decreases in the long term. Using Poisson estimation method, he assessed that the 1993 version of leniency program in the U.S. is effective to both detect and deter cartels. I show that leniency program increases the detection rate if it reduces the sanctions of the first reporting firm sufficiently. In contrast, using the E.U. cartel data and hazard model, Brenner (2009) found that the 1996 version of leniency program in the E.U. did not change the average duration of discovered cartels, and interpreted that leniency program did not affect cartel’s instability based on the inference of Harrington and Chang (2009a). Because of the same reason mentioned above, careful interpretation is required about this result.