other, but if they are symmetric, bidder C has no reason to avoid bidder A more than bidder B. Porter and Zona (1999) (denoted PZ) propose a test based on the correlation of the residuals of single equation participation choice models. Negative correlation between two bidders’ residuals implies territorial allocation and positive correlation phony bidding. PZ use it to detect phony bidding. I propose a test that is robust to unobserved heterogeneity, unlike the PZ test. This is based on solving the simultaneous equations model of participation. I use estimation techniques proposed by Tamer (2003).
The central difficulty in detecting collusion is that similar market outcomes can be a result of either collusive or competitive behavior. Territorial allocation can be a result of either an explicit agreement or due to cost advantages that firms have in different areas. Due to transaction costs for example, firms could decide to bid only on those markets that are near the location of their operations. With different locations, territorial allocation emerges as a competitive result. We get suspicious if the territories overlap, but firms still systematically avoid bidding for the same contracts. Unfortunately, this can be again a result of competitive behavior if the contracts are heterogenous. Some firms may have costs advantages in some types of contracts. Therefore with heterogenous contracts and asymmetric bidders, participation patterns of any kind may emerge in the competitive setting. However, if we control for bidder and contract heterogeneity, then the identity of other participants should not affect the participation decision of any bidder in the competitive setting. This makes testing for collusion possible. I apply the methods to school yard snow removal auctions in the City of Helsinki held in the autumns of the years 2003-2005. In Figure 1. I present the spatial participation pattern in these auctions in the year 2003. It marks on the city map the schools that each bidder has participated in and the location of bidders’ and city’s garages. The map shows that two bidders (A and K) seem to avoid each other. Moreover they systematically avoid each other in an overlapping geographic area, the city center. This suggests collusive behavior in this market. This I put to test.
I make two contributions to the literature on collusion in auctions. First, I propose a new test to detect collusion. I will show with Monte Carlo analysis that it is robust to missing variables unlike the existing method. I will also show that the old and the new test complement each other. Second, the empirical application is important in itself because it is the first empirical study of a territorial allocation scheme. The minor contribution of this paper is the policy implications of the empirical application.
This study is related to two different fields of empirical industrial organization. The first is the literature on the detection of collusion. The second is the entry literature,
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as it is possible to think of this problem as an entry game with a single auction as an analog of a single market. Harrington (2005) provides a recent survey on detecting cartels. Also Levenstein and Suslov (2006) have a recent survey on cartel studies but they do not address auctions nor the detection of cartels. Berry and Tamer (2007) provide a survey on empirical analysis of entry models. The existing studies on the detection of collusion in auctions (Bajari and Ye (2003), Baldwin, Marshall and Richard (1997), Banerji and Meenakshi (2004), Porter (1983), Porter and Zona (1993,1999)) have only applications to phony bidding scenarios.
In Section 2, I present the market of the application and analyze its characteristics with respect to collusion. In Section 3, I present both the PZ test and my own test. I conduct Monte Carlo analysis to examine the finite sample properties of these tests in Section 4. Then I present the data and descriptive statistics in Section 5 and the results in Section 6. Finally, Section 7 concludes.