Monday, June 6, 2011

Short-Term Liquidity and Capacity Constraints

Blog readers may be interested in Matthew Gustafson et al.'s working paper, The Effect of Short-Term Liquidity and Capacity Constraints on Industry Cooperation (Mar. 16, 2011) (available from SSRN here). From the abstract:

A recent $1.7 billion anti-trust settlement makes the airline industry a natural setting to analyze how short-term liquidity and capacity considerations affect a firm's decision to cooperate. To this end, we employ a unique dataset of aggregate airfare rate increases and provide novel empirical evidence on how firms in the airline industry appear to cooperate. Specifically, we use the peculiar mechanism by which airlines perform aggregate price increases to argue that these rate hikes represent attempted cooperation. This allows us to investigate how liquidity considerations and capacity constraints affect the cooperation decision. In line with anecdotal evidence, we find that financially constrained airlines are more likely to hike rates. This indicates that as short-term financial health deteriorates firms are more willing to sacrifice long-term reputation and take on increased future litigation risk for cooperation today. In addition, our results support the idea that airlines with low idle capacity levels stand to gain more from cooperation. Finally, we analyze the cooperation decision from the competitor's perspective. We find that competitors with lower idle capacity and worse financial health are more likely to cooperate with the hike leader.

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