Dealing with Cartels

In most developed free-market economies restrictions exist to prevent cartels, groups of otherwise independent businesses that collaborate to lessen or prevent competition. Cartel activity includes bid rigging, price fixing and allocating markets (or customers). Since these illegal activities take place in secret, it is difficult to get information about them. Anti-cartel efforts, however, offer a picture of their impact. From January 1990 to December 2008, over 500 private international cartels were the subject of governmental, regulatory or private legal actions globally. Over this period, the total of known affected sales of cartel activity topped US$16 trillion, according to research by Purdue University emeritus professor John M. Connor.

Governmental bodies have committed substantial amounts of time and resources to battle illegal corporate activity. Sophisticated regulatory schemes exist in most developed nations to catch price fixing and antitrust behaviour in its infancy. Furthermore, the global marketplace has been transformed by industry-wide codes of conduct and corporate ethical guidelines, which can be found in almost every annual report. And yet, one only needs to follow the news to recognize that illegal corporate activity, including cartels, still frequently occurs. For example, the Canadian Competition Bureau’s ongoing investigation of price-fixing of air cargo surcharges for shipments on certain routes in Canada has already resulted in several convictions and fines of over $22.6 million. Some corporations appear to view legal and regulatory rules as nothing more than suggestions. Many even reoffend after being sanctioned for a crime. This suggests sanctions have a limited effect as a deterrent in general or that some factors increase the probability of recidivism. This article examines how organizational governance relates to illegal activity, specifically price fixing cartels, and offers remedies to prevent cartels.

New research we have conducted suggests illegal corporate activity is influenced by external factors as well as internal control mechanisms of organizations. Using data from a proprietary database that contains details of all known international cartels from 1970 to 2008, we examined details on firm activities, including participation, estimated market share, beginning and end dates of the cartels, levied penalties, fines and court settlements. From this database, we created a matched sample of 296 observations of international firms, covering illegal cartel activity that spans 40 years. Along with variability in the size of the cartels and variability in their market share, there was variability in the size of the markets affected. In our sample, the smallest market affected was that for the Three Tenors CD, of which AOL Time Warner was the American cartel participant. The Three Tenors market was estimated at US$500,000. The industrial diamonds market, estimated to be worth US$600 million, and the disposable contact lens market, estimated to be worth more than US$1 billion, were more typical when it comes to the size of markets affected by cartel activity.

Given our interest in finding the causes of illegal cartel activity, we began by exploring the role played by the external environmental conditions, which influence the actions of an organization, particularly ones faced with a scarcity of resources and an inability to control those resources. These environmental conditions include profits, industry, market concentration, the availability of resources and the stability of the environment in which the organization operates (dynamism).

We found weak profitability and environmental dynamism (which is change in the environment that is hard to predict and therefore leads to uncertainty for executives and managers) increase the likelihood of illegal behaviour.  Indeed, as the environment becomes more challenging for management to meet expectations of shareholders, we found the incentive to engage in illegal activities increases. None of the other environmental variables tested predicted illegal corporate activity. However, our findings also suggest that the relationship between the environment and illegal activity is impacted by a firm’s board due to the responsibility of directors to determine if a firm’s strategy and actions are appropriate under current conditions. Simply put, the more effective the environmental scanning ability of a board, the more directors can assist management in dealing with a hostile environment. We defined board scanning as the ability to take notice of events in the external environment. The effectiveness of a board’s scanning ability was found to influence an organization’s propensity to commit illegal activities. This finding was supported by interviews we conducted with international legal practitioners experienced in cartel cases. Understanding how the concept of board scanning interacts with environmental variables to influence the likelihood of illegal behaviour adds to our collective knowledge of what drives cartel activity.

Our study also looked at internal organizational characteristics that could cause illegal corporate activity, namely the control methods (behavioural or output based) that exist within the organizations. While some research has been performed in this field, we presented the unique argument that the use of output-based control mechanisms (such as measuring executives based solely upon accounting or financial metrics like return on equity or earnings per share) increases the incidence of illegal activity as viewed through the criminological lens of strain theory (in which certain stressors create pressure for criminal corrective action). We found a cascading effect from board compensation to CEO compensation, namely that the method of board compensation, such as how strong the link was to accounting measures, is mimicked in CEO compensation. We also found that an increase in the independence of the board results in an increase in output controls for the CEO.  This finding suggests that independent directors with less day-to-day knowledge of internal actions rely more on output controls to monitor CEO performance. However, we were unable to find any support for the idea that the method through which the CEO is controlled by the board impacts the likelihood of illegal corporate activity. While not supported by our statistical analysis, the attorneys we interviewed emphatically stated their belief in a causal link between the variable portion of CEO’s compensation and illegal activity.

Our research helps clarify the influence external and internal characteristics have on illegal cartel activity. We suggest four remedies:  

  1. Remuneration practices need to be designed with a better understanding of the environmental drivers of illegal activity. Too much reliance on outputs only encourages those who have innovative tendencies (a good thing) to innovate outside the boundaries of ethical behaviour. Compensation systems need to be built on “the means” of achieving profits rather than on “the ends” themselves. The compensation of the CEO should focus on solid strategic behaviours rather than rewarding short-term performance.
  2. Our research suggests that the greater the output control mechanisms for the CEO, the greater the incidence of illegal activity. Thus, we are left with the result that independent boards are associated with an increase in illegal activity. This is counter-intuitive and has significant implications for corporate governance efforts to increase board independence. Indeed, by pushing for more accountable management through independent boards, we may in fact be creating the conditions that exacerbate the occurrence of organizational deviance. The call for more independent boards must take into account the negative tendency of independent boards to structure CEO compensation to be more output based. This will require enhanced skill sets and training at the board level to ensure independent directors can more adequately assess CEO performance from a means perspective rather than an ends perspective. 
  3. Regulators should introduce very onerous financial penalties to incent “means-based” organizational behaviour and more strongly punish “end-based” activity, meaning there should be an emphasis on process rather than results.
  4. Ensure organizations have a legal requirement to protect society.  This would include amending corporate laws to broaden a corporation’s purpose to include other constituencies.

Our research highlights the impact of the scanning and control mechanisms at the highest levels of the organization on illegal corporate behaviour. We find that the influence of the board on the organization’s environment is subtle, yet palpable, and produces the internal conditions that implicitly encourage innovation to achieve the perceived wants of shareholders and that can encourage illegal behaviour. We need to begin considering illegal corporate activity in a way that takes into account external influences and internal organizational control mechanisms. If we do, we will have a new tool to help both researchers and practitioners better understand how organizational deviance, as manifested through illegal corporate activity, can be prevented. 

About the Author

David Kunsch is an Assistant Professor of Management at the School of Business at St. John Fisher College in Rochester, NY.

About the Author

W. Glenn Rowe is the Paul MacPherson Chair in Strategic Leadership and an Associate Professor, Strategic Management, at the Ivey Business School at Western University in London, Ontario. He can….
Read W. Glenn Rowe's full bio

About the Author

W. Glenn Rowe is the Paul MacPherson Chair in Strategic Leadership and an Associate Professor, Strategic Management, at the Ivey Business School at Western University in London, Ontario. He can….
Read W. Glenn Rowe's full bio