How Do Firm Financial Conditions Affect Product Quality and Pricing?
50 Pages Posted: 16 Mar 2010 Last revised: 18 Feb 2011
Date Written: March 16, 2010
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.
Keywords: Financial Distress, Bankruptcy, Product Quality, Pricing, Airlines
JEL Classification: G33, D21
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