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Bankruptcy and low cost carrier expansion in the airline industry

  • Hwa Ryung Lee
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    This paper studies how financial distress affects competition and how incumbent bankruptcy affects the growth of rivals, specifically in the context of airline bankruptcies. I begin by studying whether bankrupt airlines put competitive pressures on rivals by cutting fares and maintaining or expanding capacity on the 1000 most popular domestic routes from 1998-2008. The results suggest that, although bankrupt legacy airlines reduce fares, they also reduce capacities significantly. Low-cost carrier (LCC) rivals do not match the fare cuts and expand capacities by 13-18% above trend growth. The significant capacity reductions associated with legacy airline bankruptcies create growth opportunities for LCC rivals. This indicates the existence of barriers that have limited LCCs from expanding faster and more extensively. The LCC expansion during rivals' bankruptcies is even greater when I consider the 200 most popular airports instead of the 1000 most popular routes. During legacy airlines' bankruptcy, non-LCC rivals reduce capacities on the routes affected by the bankruptcy but expand at the affected airports. A likely explanation for this result is that non-LCCs avoid 'bankruptcy' routes as more competitive pressure is expected with increasing presence of LCCs, but they pick up the gates or time slots given up by the bankrupt airlines to expand on other routes. On balance the total route capacity on the 1000 popular routes shows only a modest decrease during bankruptcy and eventually recovers, but the capacity mix changes in favor of LCCs. Overall, I find little evidence that distressed airlines toughen competition and lower industry profitability. LCC's capacity growth during legacy rivals' bankruptcy suggests the existence of market frictions in competition.

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    File URL: http://www.iew.uzh.ch/wp/iewwp502.pdf
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    Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 502.

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    Date of creation: Sep 2010
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    Handle: RePEc:zur:iewwpx:502
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    1. Louis S. Jacobson & Robert J. LaLonde & Daniel G. Sullivan, 1992. "Earnings losses of displaced workers," Working Paper Series, Macroeconomic Issues 92-28, Federal Reserve Bank of Chicago.
    2. Green, Edward J. & Porter, Robert H., 1982. "Noncooperative Collusion Under Imperfect Price Information," Working Papers 367, California Institute of Technology, Division of the Humanities and Social Sciences.
    3. Justin Wolfers, 2006. "Did Unilateral Divorce Laws Raise Divorce Rates? A Reconciliation and New Results," American Economic Review, American Economic Association, vol. 96(5), pages 1802-1820, December.
    4. Ciliberto, Federico & Schenone, Carola, 2010. "Bankruptcy and Product-Market Competition: Evidence from the Airline Industry," MPRA Paper 24914, University Library of Munich, Germany.
    5. Michael Greenstone & Richard Hornbeck & Enrico Moretti, 2008. "Identifying Agglomeration Spillovers: Evidence from Million Dollar Plants," Working Paper Series 36-08, The Rimini Centre for Economic Analysis, revised Jan 2008.
    6. Steven Berry & Panle Jia, 2010. "Tracing the Woes: An Empirical Analysis of the Airline Industry," American Economic Journal: Microeconomics, American Economic Association, vol. 2(3), pages 1-43, August.
    7. Campello, Murillo, 2003. "Capital structure and product markets interactions: evidence from business cycles," Journal of Financial Economics, Elsevier, vol. 68(3), pages 353-378, June.
    8. Kristopher S. Gerardi & Adam Hale Shapiro, 2009. "Does Competition Reduce Price Dispersion? New Evidence from the Airline Industry," Journal of Political Economy, University of Chicago Press, vol. 117(1), pages 1-37, 02.
    9. Harumi Ito & Darin Lee, 2003. "Low Cost Carrier Growth in the U.S. Airline Industry: Past, Present, and Future," Working Papers 2003-12, Brown University, Department of Economics.
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