Strategic Delegation and Collusion : An Experiment

The assumption that firms maximize profit has been widely used in Economics to explain firms' behaviors and market outcomes. But the profit maximization assumption may lead to incorrect predictions when firms engage in strategic delegation between owners and managers who might have different incentives. To understand the degree to which misspecifying firms' behaviors lead to poor predictions of market outcomes, I employ a lab experiment to examine firms' competitive or collusive behaviors under the assumption that firms engage in strategic delegation and compare the outcome to that under profit maximization. Considering the US antitrust regime, the experiment sets up cartel fines for firms' managers as well as owners. I find that (i) Market outcome under strategic delegation is more competitive than under profit maximization, but it does not guarantee fewer cartels in a market. (ii) Cartel formation occurs in two distinct ways. In one case, firms simultaneously choose low output, and in the other case, firms periodically switch off high and low output in order to evade cartel fines. (iii) Managers are more likely to form cartels when managers' and owners' incentives are different compared to when their incentives are the same