Title: Are the Bankrupt Skies the Friendliest? (Fee or subscription required)
Authors: Federico Ciliberto and Carola Schenone (both University of Virginia)
Publisher: Journal of Corporate Finance; vol. 18, no. 5
Date Published: December 2012
It sounds like a weary business traveler’s sarcastic lament: Airlines run better when they’re bankrupt. But it turns out to be true, according to this study of the U.S. airline industry, which found that carriers reduced the age of their aircraft and trimmed flight delays and cancellations while operating under Chapter 11 bankruptcy protection. However, once the companies emerged from Chapter 11, which allows insolvent businesses to operate while they restructure, the delays and cancellations returned to pre-bankruptcy levels—or got worse.
In a broader sense, the authors write, the study is the first to empirically show that firms improve the quality of their products and services after they file for Chapter 11. But operational improvements, presumably the result of a heightened effort to overcome the stigma of bankruptcy, disappear when the stigma is lifted. Only changes in quality that stem from fixed investments, such as the purchase of new planes, persist, say the authors.
The study’s conclusion that Chapter 11 spawns two tiers of improvement also has implications for healthier companies in the airline industry and for other highly competitive businesses. The fact that one type of change lasts longer than the other offers guidance in shaping responses to the shifts implemented by bankrupt rivals, who have much more leeway during Chapter 11 to renegotiate leases and labor contracts. Competitors may decide to commit more resources to match gains made by their bankrupt rivals on the fixed-asset side than on the operational side, since the operational improvements may prove transitory. In recent years, the actions of companies in Chapter 11 have grown in importance because the number of bankruptcies has soared in the wake of the Great Recession. The study notes that nearly 13,000 companies filed for Chapter 11 protection in the fiscal year ending in June 2009, an increase of almost 94 percent from the year before.
Most media and research attention has focused on the costs that companies incur during bankruptcy—including lost sales, legal fees, and administrative expenses—and the effects on laid-off employees and distressed suppliers. Bankruptcy’s impact on the quality of products and services that companies offer, however, has proven difficult to measure in most sectors.
But the airline industry is particularly ripe for study, the authors write, because product quality can be measured clearly and objectively—for example, by tracking cancellations, delays, and the age of the aircraft.
Combining several databases, the authors analyzed all national and low-cost carriers operating in the United States between 1997 and 2007, focusing on the performance of those that went bankrupt (six national airlines filed for Chapter 11 protection during that time). The federal Bureau of Transportation Statistics provided data on flight delays, cancellations, and fleet age. The authors controlled for several factors, including the effects of downsizing on the number of departed flights within markets and time periods (to make sure there weren’t fewer cancellations simply because bankrupt airlines were running fewer flights).
The analysis showed that compared with pre-bankruptcy levels, the number of canceled flights for carriers under Chapter 11 decreased by 8 percent. After the carriers emerged from Chapter 11, however, cancellations not only returned to the old level, but actually topped that level by an average of 3 percent. In terms of on-time performance, the number of flights with a delay of 15 minutes or more fell by 9 percent while companies were operating under Chapter 11, only to return to pre-bankruptcy levels afterward. Airlines also used bankruptcy as an opportunity to phase out older planes and introduce newer ones; the age of the aircraft dropped by 9 percent while firms were insolvent, and the improvement in average age remained for some time.
“Overall, these results show that a firm operating in bankruptcy might be able to improve the quality of its services only temporarily,” the authors write. “The only significant improvement we document is the one stemming from changes that relate to investments in durable fixed assets.”How does this research apply to other industries? Consider retail. Capital investments made during Chapter 11 to improve locations, for instance, might be the main legacy of a company’s stay in bankruptcy and the chronic challenge facing competitors. Kmart, for example, emerged from Chapter 11 in 2003 with five prototype stores—featuring wider aisles, better product selection, and brighter lighting—that paved the way for a rebound based on fewer but better-quality locations.
While under bankruptcy protection, airlines upgraded their fleet and experienced fewer cancellations and delays. After they emerged from insolvency, however, their performance returned to pre-bankruptcy levels. This analysis indicates that firms use Chapter 11 to temporarily change the quality of their products and services, but that only investments in fixed assets have staying power.