LIQUIDITY, SOLVENCY, AND FINANCIAL HEALTH: DO THEY HAVE AN IMPACT ON U.S. AIRLINE COMPANIES' PROFIT VOLATILITY?

AuthorZarb, Bert J.
PositionReport

INTRODUCTION

Since deregulation in the late 1970s, profits in the airline industry have been affected by several economic and non-economic factors (Baltagi, Griffin, & Rich, 1995). Some of these factors include oil prices, labor disputes, passenger demand, ticket prices, ancillary charges, and revenue management. The roller-coaster ride of airline profits could also be attributed to calamitous events such as September 11th, the bird flu, and the 2008-2009 recession. Recently, however, despite years of record losses, airlines have returned to unprecedented profitability. Over the years, the airline industry has proved, time and time again, that it rebounds well after severe shocks (Airlines for America, 2017).

The airline industry is a vibrant industry, conjuring images of glamor, jet-setting, and most of all the reality of connectivity. Perhaps this last attribute is what keeps the airline industry alive...connecting millions of people on a daily basis (Airlines for America, 2017). Nevertheless, it must be admitted that the airline industry is a tough industry. In fact, airlines have to weather industry-specific pressures coming from daunting passenger demands such as, passenger satisfaction, comfort, on-time performance, lost luggage, and on-time performance.

Taken together, all these pressures have an effect on airline companies profit volatility. This study sets out to examine whether liquidity, solvency, and financial health have an impact on airline companies' profit volatility.

This study is organized as follows: a discussion of the airline industry is followed by a literature review. The research design and instrumentation is discussed in the methodology section, and the findings and limitations of this study are presented in the results section. Conclusion and recommendations and suggestions for further research are presented in their respective section of this study.

BACKGROUND OF THIS STUDY

The Airline Industry

With its spectacular past and despite its turbulent cyclical nature, the airline industry still tunes the mind and excites the imagination. From its humble beginnings just over a hundred years ago, the industry is an economic juggernaut that pumps more than $1.5 trillion into the U.S. economy and provides more than 10 million U.S. jobs (representing approximately 7.3 per cent of U.S. jobs) (Airlines for America, 2017). Over its relatively brief existence, the airline industry has developed into a truly global business by boasting the safest mode of transportation, emerging as a critical economic engine, embracing green operations, and above all, connecting countries and people (Airlines for America, 2017).

U.S. airlines alone carry over two million passengers and over 50,000 tons of freight on a daily basis. Working closely with aircraft manufacturers, the Department of Transportation, the Federal Aviation Administration, the National Transport Safety Board, the Department of Homeland Security, and several other government agencies, U.S. airline companies provide the safest mode of transportation. Commercial aviation fuels the U.S. economy at the local, state, and national levels. Apart from its huge impact on employment, the industry accounts for 5 cents of every dollar of U.S. gross domestic product (GDP) (Airlines for America, 2017).

Between 1978 and 2015, U.S. airlines improved fuel efficiency by over 120 per cent resulting in over four billion metric tons of carbon dioxide savings. In addition, the industry has become very environmentally responsible. Manufacturers have created quieter and more fuel-efficient aircraft and continue to invest in new technologies such as more fuel-efficient engines, composites, alternative fuels, and operational procedures. The airline industry can be described as the "physical internet" (Airlines for America, 2017) connecting 110 countries serving over 800 destinations, bringing people together and supporting the global good (Airlines for America, 2017). This study, sets out to examine whether liquidity, solvency, and financial health in the airline industry has an impact on airline companies' profit volatility.

Profit Volatility

Profit volatility, in this paper, is the degree of variation in an airline company's operating profit. According to Gritta and Seal (2009), there is a long history of using the operating ratio in the transportation sector. The operating ratio, or operating expenses divided by operating revenues, has been used in the past to set rates for motor carriers and as a measure of railroad performance. It was used by the Civil Aeronautics Board "...as a measure of airline efficiency and as a complement to the so called "fair rate of return" or cost of capital, (Gritta & Seal, 2009).

According to Gritta & Seal (2009), the operating ratio could be input into an equation that will gauge the operating profit volatility of a carrier or the industry itself. Gritta (1975) found that high operating ratios indicated greater instability in operating profits, while low ratios indicated the opposite. Gritta (1975) considered ratios greater that 90% to be high. As a matter of fact, Gritta and Seal; (2009), found that the mean airline operating ratios for the airline industry between 2004 and 2007 was 93% compared to a mean of 81.7% against a random sample of industries. Since the airline industry is highly cyclical and vulnerable to changes in economic conditions, together with a high price elasticity of...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT