Contract Form and Technology Adoption in a Network Industry (joint with Silke J. Forbes), Journal of Law, Economics and Organization, forthcoming (Click for PDF)
This paper investigates the relationship between transaction characteristics and contractual form as well as the role of technology adoption as a driver of variation in transaction characteristics. Our setting is the U.S. airline industry, where many large airlines have outsourcing relationships with smaller regional carriers. In the late 1990s, fixed price contracts began to replace revenue sharing agreements as the dominant contractual form in these relationships. Moreover, this change coincided with the diffusion and adoption of a new aircraft technology, the regional jet. We present evidence that the new aircraft technology changed the set of flights that airlines subcontracted to their regional partners and did so in a way that favored the use of fixed price rather than revenue sharing contracts. In particular, our results are consistent with the hypothesis that the new flights being subcontracted had characteristics that would have lead to significant haggling costs under route-level revenue sharing.
Product Recalls, Imperfect Information, and Spillover Effects: Lessons from the Consumer Response to the 2007 Toy Recalls (joint with Seth Freedman and Melissa Kearney), Review of Economics and Statistics, forthcoming (Click for PDF)
In 2007, the Consumer Product Safety Commission (CPSC) issued 212 recalls of toys and other children’s products, a sizeable increase from previous years. Many of these recalls involved the industry’s largest firms and most popular brands. We use this period of recall activity to investigate how consumers respond to information about product safety. Because recalled toys must be removed from the market, this setting offers an opportunity to examine whether – and to what extent – recall announcements have spillover effects to non-recalled items. Using the most comprehensive data available for this industry, we document changes in toy sales in the months following the recall announcements. The data reveal three key findings. First, for manufacturers who had recalls in 2007, unit sales of the types of toys involved in the recall fell, relative to their sales of toys in other categories. Second, these manufacturers’ sales of dissimliar toys did not decline more than sales of toys produced by manufacturers that experienced no recalls at all. Thus, we do not find evidence of within-manufacturer spillovers. Third, units sales of toys produced by manufacturers who did not experience any recalls were, on average, about 30 percent lower in 2007, suggesting that there were industry-wide spillovers of these recalls. Our examination of several high profile recalls finds that recalls of toys that are part of a brand may have positive or negative effects on the sales of other toys bearing that brand. We discuss what these patterns might imply about how consumers draw inferences from recall announcements and we point to possible implications for both firm strategy and public policy.
Does Vertical Integration Affect Firm Performance? Evidence from the Airline Industry, Rand Journal of Economics, Winter 2010, Vol. 41(4), 765-790 (joint with Silke J. Forbes) (Click for PDF)
This paper investigates the effects of vertical integration on operational performance in the U.S. airline industry. All of the large U.S. network carriers use regional partners to operate some of their short- and medium-haul routes. However, some regional partners are owned while others are independent and managed through contracts. Using detailed flight-level data and accounting for the potential endogeneity of integration decisions, we estimate whether an airline’s use of an owned – rather than independent – regional partner at an airport affects its delays and cancellations on the flights that it itself operates out of that airport. Our results indicate that integrated airlines perform systematically better than non-integrated airlines at the same airport on the same day. Furthermore, we find that the performance advantage of integrated airlines increases on days with adverse weather conditions and when airports are more congested. These findings suggest that, in this setting, vertical integration may facilitate real-time adaptation decisions. We believe that this work is one of the first to both document the performance implications of vertical integration decisions as well as shed light on the underlying mechanism.
Adaptation and Vertical Integration in the Airline Industry, American Economic Review, 99(5): 1831–49 (joint with Silke J. Forbes) (Click for PDF)
We explore patterns of vertical integration in the U.S. airline industry. Major airlines subcontract portions of their network to regional partners which may or may not be owned. We investigate if ownership may economize on ex post renegotiation costs. We estimate whether airlines are more likely to use owned regionals on city pairs with adverse weather (which makes adaptation decisions more frequent) and on city pairs that are more integrated into the major’s network (which raises the costs of having adaptation decisions resolved sub-optimally). Our results suggest a robust empirical relationship between adaptation and vertical integration in this setting.
Software Exclusivity and Indirect Network Effects in the US Home Video Game Industry, International Journal of Industrial Organization, March 2009, Vol. 27(2), 121-36 (joint with Kenneth S. Corts) (Click for PDF)
We argue that a recent rise in the prevalence of nonexclusive video games has diminished indirect network effects and reduced the tendency of the US home video game market to be dominated by single firm. We support this argument by estimating hardware demand and software supply equations, using data from the US video game market from 1995-2005. Consistent with the theoretical literature, our results indicate that software exclusivity increases (or conversely, software compatibility decreases) the strength of indirect network effects. We find that (1) the demand for a particular hardware platform is more responsive to exclusive software than non-exclusive software; and (2) the supply of games for a particular platform responds to both the installed base of that platform and the installed base of other platforms in the market, with the latter effect increasing over time as software has become more compatible.
Are Frequent Flyer Programs a Cause of the “Hub Premium”? Journal of Economics and Management Strategy, Spring 2008, Vol. 17(1), 35-66. (Click for PDF)
This paper investigates the extent to which the so-called “hub premium” – the ability of a hub airline to charge higher fares on routes that depart from its hubs – results specifically from the fact that dominant airlines’ have an advantage in the use of frequent-flyer programs (FFPs). While there is considerable evidence documenting the existence of the “hub premium”, there is considerably less evidence establishing its causes. While difficult due to data limitations, this task is important because any potential policy response to high hub fares requires an understanding of what it is that allows airport-level dominance to translate into route-level market power. I develop a novel empirical approach to estimating the relationship between FFPs and fares at dominated airports. The approach exploits variation that results from three reciprocal FFP partnerships formed between the six largest domestic airlines in late 1998. These partnerships allowed members of one airline’s FFP to earn and redeem that airline’s points on flights operated by its partner. By doing so, the partnerships effectively extended an airline’s FFP – and any pricing advantage that result from it – to include a set of flights which was not previously included in the program. If FFPs allow a dominant airline to charge higher fares on routes that depart from airports at which it is dominant, then FFP partnerships should allow a dominant airline’s partner to charge higher fares on routes that depart from these same airports. Using reduced-form price regressions, I find that association with the FFP of the dominant airline at an airport does indeed confer a pricing advantage. Relative to two different sets of control routes, airlines received higher fares on routes that departed from specifically those airports at which their partner was dominant. Consistent with a “FFP story”, the impact of the partnerships was more pronounced at the top of the fare distribution. The estimates imply that offering the dominant airline’s FFP points increased the mean fare that an airline received by between 3.5% and 5% and the 80th percentile fare that an airline received by between 7% and 9%. Combining these estimates with estimates of the “hub premium” suggests that FFPs may account for between 18% and 25% of the “hub premium”.
Do Enhancements to Loyalty Programs Affect Demand? The Impact of International Frequent Flyer Partnerships on Domestic Airline Demand, RAND Journal of Economics, Winter 2007, Vol. 38(4), 1134-1158. (Click for PDF)
Airlines’ reorganization of their networks from point-to-point to hub-and-spoke after deregulation resulted in a significant number of airports being dominated by a single domestic carrier. While there is evidence that hubs allow for lower costs and higher frequency, there is also evidence that airlines are able to exercise market power on routes departing from their hubs. Both academics and policy analysts have argued that frequent flyer programs (FFPs) may be at least part of the reason why. Prior research, however, has not disentangled the impact of FFPs from the other advantages possessed by dominant airlines. This paper uses a novel empirical approach to estimating the relationship between FFPs and demand at dominated airports. In the mid 1990s, domestic airlines increasingly entered into FFP partnerships with international airlines. While these agreements had no direct impact on the quality of individual domestic flights, they did significantly change consumers’ earning and redemption opportunities in domestic airlines’ FFPs. I exploit time-series variation in the extent and scope of airlines’ international FFP partnerships to evaluate the economic impact of enhancements to FFPs. The paper’s main set of results establishes that, controlling for the other advantages of airport dominance, enhancements to an airline’s FFP are associated with increases in an airline’s demand on routes that depart from airports at which it is dominant. The impact of enhancements to FFPs increases with an airline’s level of dominance at an airport, with the effect on routes departing from the airline’s most dominated airports (more than 60% of departing flights) more than double the effect on routes out of airports at which at has between 40% and 60% of flights. To the extent that the airports at which enhancements to FFPs affect demand are the same airports at which FFPs themselves affect demand, then the estimated pattern of coefficients clearly suggests that FFPs confer an advantage to specifically those airlines that have a very dominant position at an airport.
The Role of Regional Airlines in the U.S. Airline Industry, in Darin Lee (ed.), Advances in Airline Economics II, 2007 (joint with Silke J. Forbes)
In 2005, U.S. regional airlines carried almost 135 million passengers or approximately one in five domestic travelers. They completed over 14,000 daily departures and had a combined fleet of over 2,700 aircraft. Regional airline service has increased steadily over the past decade and there are no indications that this trend is likely to slow. Yet, despite the increasingly important role played by regional airlines, this segment of the industry has received surprisingly little attention from airline economists. Indeed, the academic literature has traditionally focused on the roles of large network carriers and, more recently, the so-called “low-cost carriers”, leaving regional airlines virtually untouched. This chapter begins to fill this void by, (1) documenting the role and extent of regional air service in the U.S. commercial aviation industry; and (2) introducing some of the key economic issues that affect regional airlines.
Do Firms Game Quality Ratings? Evidence from Mandatory Disclosure of Airline On-Time Performance (Click for PDF)
Many quality disclosure programs provide consumers with information that is based on whether a product meets a particular threshold. This creates the potential for “gaming” as firms have incentives to improve the quality of specifically those products that can easily be brought above the threshold. We investigate this type of behavior in the context of government-mandated disclosure of airline on-time performance. While this program collects data on the actual minutes of delay incurred, it ranks airlines based only on the fraction of their flights that arrive 15 or more minutes late. This creates the incentive for airlines to selectively reduce delays on flights they expect to arrive with about 15 minutes of delay. We estimate the extent to which airlines engage in this type of gaming and, in particular, whether the occurrence of such gaming depends on whether employees are explicitly incentivized based on the airline’s performance in the program. We find little evidence of gaming by airlines that have no incentive programs in place or by airlines that have implemented incentive programs with targets that are unrealistically hard to achieve. On the other hand, we find strong evidence of “gaming” by airlines that have incentive programs with a target level of performance that can realistically be achieved. Specifically, for these airlines, we find that their flights that are predicted to arrive with between 15 and 16 minutes delay have significantly shorter taxi-in times than other flights and are significantly more likely to arrive exactly one minute sooner than predicted. Counterfactual exercises that simulate an airline’s distribution of delays in the absence of taxi-time distortions indicate that even small improvements in taxi times can – if applied to the “right” set of flights – result in changes in an airline’s ranking.