تاثیر بحران مالی خطوط هوایی بر کرایه های هوایی ایالات متحده : یک رویکرد اقتضائی

This article investigates to what extent an airline’s financial distress impacts its pricing behavior. While prior research suggests that, on average, distressed airlines sell at lower fares, it is hypothesized that the magnitude of this effect may depend on certain firm and market specific contingencies. A large-scale empirical analysis using panel data from the US airline industry is conducted. The results indicate that firm financial distress and air fares are generally negatively related. It is further shown that the magnitude of the effect of distress on fares decreases with the magnitude of operating costs and firm’s market shares and increases with firm size and the level of market concentration. Implications for policy makers and managers are discussed.

Firm financial distress is often argued to lead to and result from price competition: Low market prices may drive firms into financial distress and bankruptcy, and the latter may, in turn, affect a firm’s competitive pricing behavior. The so-called sick industry problem, thus, is intimately associated with the issues of financial distress and price competition as repeatedly evidenced in the US airline industry. In recent years, many US airlines have sought bankruptcy protection under Chapter 11,1 the ultimate manifestation of financial distress. Between 2001 and 2005 alone, seven large US carriers took advantage of the provisions of this code to facilitate their restructuring processes. Airlines can achieve significant reductions in labor, leasing, and debt costs as they leverage their financial distress to renegotiate contracts or enter Chapter 11 protection (McCafferty, 1995), thus giving distressed firms a competitive edge over their healthier counterparts. Following Delta’s and Northwest’s bankruptcy filings, analysts therefore warned of potentially adverse consequences for other carriers such as American Airlines and Continental Airlines (Trottman, 2005). Consequently, researchers (see e.g. Kennedy, 2000) and managers of non-distressed firms have repeatedly criticized the destructive implications of Chapter 11 protection. Gary Kelly, then Chief Financial Officer with Southwest Airlines, for example, notes that “the length of time an airline can go through bankruptcy protection and offer distressed prices is very unsettling” (McCafferty, 1995). Similarly, Robert Crandall, the former Chief Executive Officer of American Airlines, argues that “Chapter 11 also undermines responsible managements. In an intensely competitive industry providing a commodity product, the ‘dumbest competitor’—unrestrained by fear of failure—sets the standard” and hence calls for “bankruptcy laws designed to incentivize success and penalize failure” (Crandall, 2005). Most of the previous statements make the explicit or implicit assumption that financially distressed and bankrupt firms sell at lower prices than their healthier competitors. This contention, however, has not found consistent theoretical and empirical support. Researchers from the economics, corporate finance, and strategy fields have published a substantial amount of literature on this and related issues (e.g. Borenstein and Rose, 1995, Ferrier et al., 2002 and Opler and Titman, 1994). While many studies conclude that, on average, distressed firms sell at lower prices (e.g. Hofer et al., 2005), it is also evident that the effect of financial distress on prices is not uniform across firms and markets. Borenstein and Rose (1995), for example, find that both Eastern Airlines and TWA lowered their air fares prior to or after declaring bankruptcy in 1989 and 1992, respectively. There is, however, no evidence of systematic price decreases before or after the Chapter 11 filings of Continental Airlines and America West Airlines in the early 1990s. By the same token, distressed firms’ price cuts may be economically viable in some markets but not in others. This study addresses the following research question: In what instances will financial distress impact the firm’s pricing behavior? It is suggested that firm and market-specific contingencies may partly explain the variability of a troubled firm’s pricing behavior. This contention is in line with the work of Singh (1986) who finds that the link between financial distress and firms’ (pricing) strategies is complex and cannot be captured by looking at direct effects only. In a similar vein, Ferrier et al. (2002) stress the importance of context-specific contingencies in defining the relationship between performance distress and competitive behavior. This research builds on the work of Ferrier et al. (2002) and proposes a contingency framework that aims at characterizing the relationship between financial distress and prices, and identifying factors that may affect the magnitude of this relationship. This contingency framework is tested empirically in the context of the US airline industry. The empirical results suggest that financially distressed firms offer lower prices than their healthier competitors, ceteris paribus. The magnitude of the effect of firm financial distress on prices, however, is shown to decrease with unit operating costs, increase with firm size, and decrease with firm market shares. The price effects of financial distress are also stronger in more concentrated markets. The insights provided by this research may be useful to both managers and policy makers. Distressed firms and their competitors gain a better understanding of how financial conditions typically impact pricing decisions. Managers of financially distressed firms may benefit from this knowledge when developing turnaround strategies. Competing (healthy) firms, on the other hand, can more accurately anticipate distressed firms’ pricing actions and act accordingly. For policy makers, the findings of this study will help clarify if, when, and to what extent financial distress and Chapter 11 protection impact sales prices and the competitive behavior of firms. The remainder of this article is structured as follows: A brief review of the extant literature on the distress–price relationship is provided in Section 2 and a baseline hypothesis is formulated. The contingency framework is outlined in Section 3 and the hypothesized moderating effects of firm and market characteristics are discussed. Variable measurement, data, and methodology issues are addressed in Section 4, and the empirical results are presented in Section 5. The study’s findings and their implications are summarized in Section 6, and some limitations and directions for future research are noted.

In summary, ample support for the theoretical arguments set forth in this paper is found. The implications of these findings are discussed in this section, and some limitations and directions for future research are noted. Based on a review of varied theoretical perspectives and several empirical studies, it is suggested that financial distress is negatively related to prices. It is noted, however, that this may not be true in all cases. More specifically, it is hypothesized that operating costs, firm size and market shares, as well as market concentration may impact the magnitude of a troubled firm’s pricing actions. A contingency framework which incorporates these moderating effects is developed and tested using a comprehensive panel dataset from the US airline industry. The empirical results provide clear statistical support for all hypotheses: Firm financial distress negatively impacts prices. Moreover, the results suggest that this is particularly true for larger firms, firms with lower operating costs and smaller market shares, and for firms operating in highly concentrated markets. All hypothesized direct and moderating effects are thus found to be statistically significant. This study contributes to the literature in several ways. First, a theoretical review on the link between financial distress and (ticket) prices is provided and the resulting insights are synthesized into a contingency framework that furthers our understanding of the nature of this relationship. This study, thus, helps reconcile contradictory theoretical contentions and the occasionally inconsistent empirical findings found in the extant literature. Second, both policy makers and managers gain a better understanding of how financial distress typically impacts prices and in what instances this effect is expected to be strongest. This knowledge may be helpful when managers develop competitive strategies or when policy makers evaluate how firms’ financial conditions may impact the competitiveness and allocative efficiency of markets. At the same time, the results presented here raise an important question: Is lowering prices a sensible turnaround strategy for financially distressed firms? It is suggested that future research explore under what circumstances a distressed firm’s price reductions are economically viable. As most research using data from the US airline industry, the dataset used here does not contain any information about booking and service classes. As noted by Lee and Luengo-Prado (2005), the failure to recognize these distinctive attributes of the tickets purchased is a potentially critical shortfall of any empirical analysis of air fares. It should also be noted that this study’s results may depend upon the measurement of financial distress. This study employed distress measures based on Z scores given that they have been widely applied in the extant literature. The finance literature offers numerous variations of these measures as well as entirely different ones (see e.g. Gritta, 2004 for a comprehensive review of some of these measures). Future research may explore the sensitivity of the results with respect the measurement of financial distress.