Firm Decision Making Under Financial Distress: A Study of U.S. Air Fares and an Analysis of Inventories in U.S. Manufacturing Industries

Abstract

This dissertation investigates the effects of firm financial distress on two key firm decision variables: sales prices and inventories. These analyses contribute to the Structure-Conduct-Performance paradigm literature. Specifically, the feedback loop between financial distress, a result of poor past performance, and two firm conduct parameters, prices and inventories, is explored in great detail.

The first essay is motivated by the ambiguity of prior research on the relationship between firm financial distress and prices. The extant economics, corporate finance and strategic management literatures differentially approach this relationship, and empirical research has found only limited, at times ambiguous support for any single theoretical contention. These theoretical perspectives are reviewed and an attempt is made to reconcile the apparent conflict by adopting a strategic contingency perspective that identifies in which way and in what instances firm financial distress may impact prices. The model is empirically tested using data from the U.S. airline industry. The results indicate that firm financial distress and prices are generally negatively related. Moreover, this effect is substantially stronger for firms operating under Chapter 11 protection than for firms approaching bankruptcy. It is further shown that the magnitude of the effect of financial distress on prices depends on firm factors such as operating costs, market power, and firm size, as well as on competitive characteristics such as market concentration and the financial condition of competitors.

The second essay analyzes the impact of firm distress on firm inventories and investigates if this relationship is impacted by a firm's power relative to its upstream and downstream supply chain partners. Building on prior work in the economics field, this research is not only based on microeconomics theory, but also draws on inventory theory as well as on prior work on supply chain relationships. A comprehensive inventory estimation model is specified, and novel measures of inventory determinants and power are developed. The hypotheses are tested using panel data from the U.S. manufacturing industry. It is shown that distressed firms hold less inventory and that a firm's power within the supply chain will determine to what extent inventory ownership is reduced during times of financial distress. Implications for supplier selection and supply chain cooperation are discussed.

In summary, this research significantly enhances researchers' understanding of why, how, and when firm financial distress affects prices and inventories.