Government resource constraints, cartel enforcement, and firm performance

Abstract

A collusive product market environment can help firms gain market power and extract economic rents, but such an environment may also lead to inefficiency in resource allocation and investment decision, leaving the net impact on firms’ financial performance unclear. I empirically examine the impact of a more collusive market on firms’ financial performance by relying on a difference-in-differences approach based on an exogenous decrease in cartel enforcement resources due to government budget constraints. I first show that the reduction in enforcement resources diminishes the likelihood of cartel detection in the affected territories. Following weaker cartel enforcement, on average, firms realize lower profits, suggesting that the negative impact of a more collusive market dominates. This negative impact is more pronounced for firms that experience more significant reduction in the level of cartel enforcement, firms relatively downstream in the supply chain, firms in competitive markets, firms in capital-intensive industries, and firms with less flexible operation. I document two mechanisms—rent effect and deterrence effect—through which a more collusive product market affects firms’ performance. Overall, this study examines a theoretically ambiguous and empirically underexplored relation between collusion in product market and firms’ financial performance, and highlights the economic consequences of weak cartel enforcement.