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Open Access Publications from the University of California

Essays on Competition and Firm Behavior

  • Author(s): LEE, HWA RYUNG
  • Advisor(s): Gilbert, Richard
  • et al.

Chapter 1 studies how financial distress affects competition and how incumbent bankruptcy affects the growth of rivals, specifically in the context of airline bankruptcies. I begin by studying whether bankrupt airlines put competitive pressures on rivals by cutting fares and maintaining or expanding capacity on the 1000 most popular domestic routes from 1998-2008. The results suggest that, although bankrupt legacy airlines reduce fares, they also reduce capacities significantly. Low-cost carrier (LCC) rivals do not match the fare cuts and expand capacities by 13-18% above trend growth. The significant capacity reductions associated with legacy airline bankruptcies create growth opportunities for LCC rivals. This indicates the existence of barriers that have limited LCCs from expanding faster and more extensively. The LCC expansion during rivals' bankruptcies is even greater when I consider the 200 most popular airports instead of the 1000 most popular routes. During legacy airlines' bankruptcy, non-LCC rivals reduce capacities on the routes affected by the bankruptcy but expand at the affected airports. A likely explanation for this result is that non-LCCs avoid "bankruptcy" routes as more competitive pressure is expected with increasing presence of LCCs, but they pick up the gates or time slots given up by the bankrupt airlines to expand on other routes. On balance the total route capacity on the 1000 popular routes shows only a modest decrease during bankruptcy and eventually recovers, but the capacity mix changes in favor of LCCs. Overall, I find little evidence that distressed airlines toughen competition and lower industry profitability. LCC's capacity growth during legacy rivals' bankruptcy suggests the existence of market frictions in competition. Chapter 2 examines the relationship between multimarket contact (MMC) and competition. When demand is fluctuating, so is the sustainability of collusive profit. This paper investigates how MMC affects collusive profit under demand fluctuations. In particular, I focus on the correlation structure between demand shocks over multiple markets and show how it can lead to a positive link between collusive profit and MMC. Simple theoretical models show that, regardless of whether demand shocks are observable or not, MMC may improve collusive profits through diversification of demand shocks over overlapping markets. If firms meet in multiple markets and link those markets in the sense that deviation in any market will trigger simultaneous retaliations in every market, then a cheating firm will optimally deviate in every market. Demand fluctuations that a firm is facing in its markets in total will be reduced as the number of markets increases, unless demand shocks are perfectly and positively correlated between the markets. The reduction of demand fluctuations can boost collusion (1) by reducing the temptation to deviate in a period of high demand when demand shocks are observable and (2) by reducing the frequency of costly punishments on the equilibrium path when demand shocks are unobservable. The conclusion in the case of observable demand shocks provide us with a new testable implication that price competition will be muted by MMC in periods of high demand.

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