Sab 101 Compliance: Revenue Accrual Management and the Cost of Capital: The Airline Industry

53 Pages Posted: 8 Dec 2004

See all articles by Carolyn M. Callahan

Carolyn M. Callahan

University of Louisville - College of Business

Marion McHugh

University of Arkansas - Sam M. Walton College of Business

Rod Smith

Cal State University Long Beach

Date Written: November 24, 2004

Abstract

Incorporating the pricing dynamics of external jet fuel markets, this paper investigates the regulatory impact of Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) 101 on discretionary revenue accrual behavior, profitability and the firm's cost of capital in the airline industry. Prior to SAB 101, we posit that airlines could use GAAP flexibility to manage revenues to compensate for fuel price shocks on profitability and the firm's cost of capital. While the regulatory motivation for SAB 101 was to restrain misleading revenue management, we argue that after SAB 101, the potential for additional SEC scrutiny caused airlines to be more conservative in their air traffic liability-revenue accruals leading to increase in airline firms' costs of capital for the airlines making more conservative accruals. First, we find that prior to SAB 101, the air traffic liability account is significantly inversely related to both airline profitability and fuel prices. We then find that an unexpected change in the air traffic revenue liability account affects unexpected profitability. After SAB 101, the relation between profitability and changes in the air traffic revenue liability changed dramatically even after controlling for work disruptions and other economic factors related to the profitability. At the same time, average airlines' cost of capital as measured by bid-ask spreads increased markedly. This increase in the airlines' cost of capital suggests that the SEC intended revenue regulation guidance that did not change GAAP, did impose capital markets consequences on the airline industry.

Keywords: SAB 101, revenue accruals, cost of capital, airline industry

JEL Classification: L94, M41, M43, M44, G38

Suggested Citation

Callahan, Carolyn M. and McHugh, Marion and Smith, Rodney E., Sab 101 Compliance: Revenue Accrual Management and the Cost of Capital: The Airline Industry (November 24, 2004). Available at SSRN: https://ssrn.com/abstract=627821 or http://dx.doi.org/10.2139/ssrn.627821

Carolyn M. Callahan (Contact Author)

University of Louisville - College of Business ( email )

Dean's Office
Louisville, KY 40292
United States
(502) 852-6443 (Phone)
(502) 852-7557 (Fax)

Marion McHugh

University of Arkansas - Sam M. Walton College of Business ( email )

Fayetteville, AR 72701
United States

Rodney E. Smith

Cal State University Long Beach ( email )

Long Beach, CA 90840
United States
562-985-5421 (Phone)

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