Cash, Financial Flexibility, and Product Prices: Evidence from a Natural Experiment in the Airline Industry

Abstract

Corporate cash holdings impact firms’ product pricing strategies. Exploiting the Aviation Investment and Reform Act of the 21st Century as a quasi-natural experiment to identify exogenous shocks to competition in the airline industry, I find that firms with more cash than their rivals respond to intensified competition by pricing more aggressively, especially when there is less concern of rival retaliation. Financially flexible firms based on alternative measures respond similarly. Moreover, cash-rich firms experience greater market share gains and long-term profitability growth. The results highlight the importance of strategic interdependencies across firms in the effective use of flexibility provided by cash.

Keywords: Cash, Cash Holdings, Financial Flexibility, Pricing, Product Market, Competition, Multimarket Contact

JEL Classification: G30, G32, G35, L10