Financial Distress and US Airline Fares

Abstract

This paper examines the impact of firm financial distress and bankruptcy on an airline's pricing behaviour. Three theoretical rationales are set forth: the supply-side rationale suggests that the bankrupt firm's lower operating costs may result in lower prices; from a demand perspective, distressed firms' prices may be lowered in response to reduced consumer demand; and the strategic rationale then suggests that distressed firms may reduce prices and sell off inventory to generate cash for long-term survival. The hypotheses are tested by estimating price and output equations with data from the US airline industry. The results provide support for the supply-side and demand-side rationales and confirm the general contention that distressed carriers' fares are lower, all other things being equal.

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