How Do Firm Financial Conditions Affect Product Quality and Pricing?
Gordon M. Phillips
University of Southern California; National Bureau of Economic Research (NBER)
Universidad de los Andes, Chile
March 16, 2010
AFA 2011 Denver Meetings Paper
Robert H. Smith School Research Paper No. RHS RHS-06-141
We analyze the interaction of firm product quality and pricing decisions with financial distress and bankruptcy in the airline industry. We consider an airline's choices of quality and price as dynamic decisions that trade off current cash flows for future revenue. We examine how airline mishandled baggage, on-time performance and pricing are related to financial distress and bankruptcy, controlling for the endogeneity of financial distress and bankruptcy. We find that an airline's quality and pricing decisions are differentially affected by financial distress and bankruptcy. Product quality decreases when airlines are in financial distress, consistent with financial distress reducing a firm's incentive to invest in quality. In addition, firms price more aggressively when in financial distress consistent with them trying to increase short-term market share and revenues. In contrast, in bankruptcy product quality increases relative to financial distress.
Number of Pages in PDF File: 50
Keywords: Financial Distress, Bankruptcy, Product Quality, Pricing, Airlines
JEL Classification: G33, D21
Date posted: March 16, 2010 ; Last revised: February 18, 2011
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