Does sunk-cost affect prices? Evidence from the US airline industry

Abstract

In contrast to the extensive literature on behavior bias by individuals, studies on behavior bias by firms have been relatively scarce. We explore the possibility of the latter in the context of US airlines, where fuel hedging leads to lump sum gains or losses which may impact airlines' pricing decisions. Our results show that the (sunk) hedging gains or losses affect airlines' ticket prices. In particular, a 10% reduction in airlines' reported fuel costs (due to hedging gains) leads to a 2.2% reduction in ticket prices. Moving onto nonprice decisions, we find that hedging gains lead airlines to use larger aircraft and reduce the airtime of their flights, yet have no impact on the number of routes and flights which the airlines operate. Our results provide empirical evidence that fixed/sunk costs can affect firms' prices and nonprice decisions, establish a link between financial market and product market competition, and have important welfare/policy and managerial implications.