Firm Financial Condition and Airline Price Wars

Abstract:     
If cutting price can trigger a price war, then a firm must weigh present versus future gains and losses when considering such a move. How a firm values such tradeoffs can be affected by its financial situation. Using data on 14 major airlines between 1985 and 1992, this paper tests the hypothesis that firms in worse financial condition are more likely to start price wars. Empirical results suggest that this is true, particularly for highly leveraged firms. The paper also explores which firms join existing price wars, and finds that a firm is more likely to enter a price war when the share of its traffic on routes that are also served by the price war leader is greater.

Keywords: Price wars, airlines, financial constraint, liquidity constraint

JEL Classifications: L11, L13, L93

Working Paper Series