AIRLINE INDUSTRY RISK

Airline Industry Risk



Abstract

Understanding the high operating risk nature of the airline industry is important in effectively managing the business. This study aims to investigate firm-specific variables as they relate to systematic risk (beta). Findings from 16 airline companies for the period of 1997-2002 indicate that profitability, growth, and safety are negatively associated with the systematic risk, while the debt leverage and firm size are positively related to the risk. The significant relationship of debt leverage, profitability, growth, and safety to the systematic risk is consistent with previous empirical studies, but the positive association of the firm size with the risk is a paradoxical finding as opposed to the relevant finance theory and previous research. This unique finding proposes significant implications for airline executives as well as investors.

Airline Industry Risk

Introduction

Different airline companies, many of which have shown unsatisfactory financial performance, have suffered from severe business environments. The economic downturn and 9/11 terrorist attacks have aggravated the situation over the past few years, putting United Airlines, US Airways, Hawaiian Airlines, and National Airlines under bankruptcy protection. The US airline industry recorded a net loss of $7.7 billion in 2001 (Campbell, 2002). Eleven major US airline companies showed the average debt-to-capitalization ratio of more than 90% (Velocci, 2003). Declining commercial passenger traffic and high labor and financing costs stranded the US airline industry (United States House of Representatives (2002) United States House of Representatives (2002). Subcommittee on aviation hearing on financial condition of the airline industry.(Campbell,2002)

Discussion

The airline industry is highly susceptible to high external operating risk environment, or systematic risk that is triggered by many uncontrollable external factors (war, threat of terrorists, and outbreak of disease, market recession, and high fuel price). Substantial attention in finance and accounting literature has been devoted to identifying the determinants of systematic risk as measured by beta in that the beta reflects the collective judgment of investors on the extent to which macroeconomic conditions influence firms and depends on marketing policy, production policy, and firm policies and decisions, all of which are affected by corporate financial policy.

To identify the effects of financial characteristics on systematic risk (beta), several financial variables have been commonly utilized in similar previous studies liquidity, debt leverage, operating efficiency, profitability, firm size, and growth. The same variables are employed to develop hypotheses in this study for airline companies. Also, this study adopts a unique variable (airline safety) since the ...