Financial Health and Product Safety

Abstract

We examine the relationship between financial health and product safety in the airline industry. Theoretical models predict that agency problems are exacerbated when a firm is in or near financial distress and lead to increased risk-taking behavior by such firms. We document support for this prediction. Our empirical model, which uses mishaps to proxy for airline safety, and lagged bond ratings to proxy for financial well-being, shows a significant correlation between the two measures: airlines with highly-rated bonds are less likely to be involved in accidents. We find that, on average, a whole higher letter grade for the bond rating is associated with a ten percent lower probability of accident. Our results remain robust in the presence of other variables that could affect the number of airline mishaps.

Note: This is a description of the article and not the actual abstract.

Keywords: financial health, airlines, accidents, reputation, distress, bond ratings, mishaps, incidents

JEL Classification: G32, L93