Does Sunk Cost Affect Prices? Evidence from the U.S. Airline Industry

Abstract

In contrast to the extensive literature on behavior bias by individuals, studies on behavior bias by firms have been relatively scarce. We explore the possibility of the latter in the context of U.S. airlines, where fuel hedging leads to lump sum gain or loss which is sunk to airlines' pricing decisions. Our results show that the (sunk) hedging gain or loss affects airlines' ticket prices. In particular, a 10% reduction in the reported fuel cost (due to hedging gain) leads to a 2.2% reduction in ticket prices. Moving onto non-price decisions, we find that hedging gain leads airlines to use larger aircrafts and reduce airtime of their flights, but has no impacts on the number of routes and flights which airlines operate. Our results provide empirical evidence that fixed/sunk costs can affect firms' price and non-price decisions, establish a link between financial market and product market competition, and have important welfare/policy and managerial implications.

Keywords: Airlines; Fuel hedging; Ticket pricing; Sunk cost fallacy; Full-cost pricing

JEL Classification: D43, G32, L13, L93