Deregulation's impact on Continental Airlines' 1990 bankruptcy

Continental Bankruptcy

How can one tell if a company is about to go under? There are at least two ways to answer that. One answer (which is usually not terribly precise) is the long-range one. The other is the (usually far more precise) short-term one. This paper provides at least both long-term and short-terms analysis of the Continental Airlines bankruptcy in 1990, relying for the former on an analysis of the state of the American airlines industry in 1990 and for the short-term specific economic information relevant to Continental at the time.

The major overall economic element affected the entire American transportation industry in 1990 (this included not simply the airlines industry) was the issue of deregulation. For many years, the transportation system of the United States existed within an economic system of a high degree of regulation. That this should have been so should not surprise us if we look only at the legal and not the economic context of the transportation system.

The transportation network of the United States has been, since 1789, subject to a high degree of management by the federal government for the simple reason that this is one of the primary functions of the federal government - to oversee those activities that cross state borders.

Transportation cannot be easily overseen by any one state, nor do states necessarily trust their fellow states to be fair in their practices. Thus for decades, the federal government oversaw the transportation industry. However, over the past several decades, many of those traditional regulations were lifted, which brings us to the historical rumblings leading up to the 1980s Reagan Revolution and the effects that massive government deregulation had on Continental and other airline companies. In a word, that effect was in general disastrous; the recent bail-out of airlines by the federal government has reinforced the idea that airline may not be able to support themselves without governmental oversight and support.

The Long View: Deregulation and Continental

Substantial government regulation of the American transportation sector extends back to at least 1887 when all U.S. railroads came under federal control - in order to prevent the railroad owners from using their monopolistic control of the tracks to punish the American economy (Bethune 31). Because transportation companies tend to require high levels of capital, they tend to be run by a few (or even one) large company and so tend easily toward the monopolistic.

The Interstate Commerce Commission stepped in to control rates and routes of the railroads, a step that was echoed in 1906 when the country's oil pipelines came under governmental control to prevent John D. Rockefeller's using them to monopolize. The trucking industry was added to the list of government regulated industries in 1935 - although this time the government sought to limit rather than increase competition to ensure that only those companies that operated safely would be allowed to perform shipping duties (Peterson 37).

So it was only to be predicted that domestic airlines were also to come under federal regulation, which occurred in 1935 when they were placed under the governance of the newly established Civil Aeronautics Board. (Planes were not in fact the last form of transportation to be regulated - a number of forms of shipping were added to the rolls of regulated industries in the 1940s, as Freiberg etal note.

However, in the decades after World War II, many lawmakers and businesspeople began to believe that regulation was causing more harm than good. One of the signs of how badly regulation was working was the fact that most of the railroads in the northeastern United States had gone bankrupt. Among these railroads was the Penn Central; it was at the time the country's worst commercial bankruptcy (Morrison and Winston 28).

In general, many people felt that regulation slowed or limited competition, which produced far less efficient economic activity than a free market would, as Morrison and Winston note. Thus, beginning in the early 1970s, the U.S. began to reduce or even to remove entirely the regulations that had governed (and in the eyes of many) shackled industries, including those in the transportation sector. Included in this round of deregulation were the airlines.

However, despite the fact that deregulation had been seen by people throughout industry and government as a wonderful boon to commerce, it brought with it its own set of problems, many of which were not resolved by the passage of time but in fact grew worse and worse over the years.

The primary reason for this - and this was certainly true in the case of Continental - was that the industries were not overall as stable under deregulation as they had been when they were regulated, and this condition of industry-wide instability tended to have detrimental economic effects on each of the firms within that industry. We can certainly see this in the airlines industry, which has seen a number of bankruptcies and problems with service.

When assessing the bankruptcy of Continental, it is imperative that we keep in mind the effects that deregulation had both on this airline in particular and on the industry in general. But it is also important that we are not overly eager to blame too much on deregulation: The company in 1990 had problems of its own making, as Altmanm's Z-score indicates.

Those same problems plague the company today, as is suggested by this story from last year when the airline companies once again expressed their uneasy relationship with the federal government - from whom they often want protection but not regulation:

Airlines, their business ravaged by last week's terror and an already sick economy, are taking desperate steps to avert what they say is a fast-approaching financial disaster.

Even as the airlines restore flights shut down for almost 3 days last week, executives say their bookings are evaporating, and costs are escalating because of new security measures. They're begging the federal government to fund a $15 billion rescue plan that seemed to gain momentum over the weekend.

RE= RETAINED EARNINGS

Assessing Continental Airlines in 1990 demonstrated that the company was indeed headed toward bankruptcy, with the predictable consequences of lay-offs, renegotiations with its unions, reduced service (for a period of time), loss of customer loyalty, lower financial ratings and cancelled contracts to suppliers like Boeing, which caused additional financial problems in other sectors of the industry.

However, it must be noted that many of these problems and responses to them were already in evidence before the bankruptcy filing: Employees had already been laid off and morale amongst those who remained, according to Bethune (1999) was very low.

One of the strengths of Altman's model is that it incorporates such intangibles as low employee morale - or rather, it transforms them into tangible, measurable attributes of the company. Altman's model allows us to attend to both the big picture and the small details that collectively go into making up a company's financial health.

We can see this if we perform a Z-score analysis on the company using its current financial indicators to determine if it is poised, once again, to have to file for bankruptcy, which would be the company's third foray into such a dire economic path.

Z-Score for Continental

RATIO

FORMULA

WEIGHT FACTOR

WEIGHTED RATIO

Return on Total Assets

Sales to Total Assets

Equity to Debt

Working Capital to Total Assets

Retained Earnings to Total Assets

It may be useful to consider this score in connection with another airline to provide a basis for comparison:

Z-Score for United

RATIO

FORMULA

WEIGHT FACTOR

WEIGHTED RATIO

Return on Total Assets

Sales to Total Assets

Equity to Debt

Working Capital to Total Assets

Retained Earnings to Total Assets

Conclusion

The signs of Continental's rocky future were plain to read in its financial cards in the months leading up to 1990. Some of its financial woes were clearly the result of the financial instability that had plagued the entire industry in the years after deregulation. And some of its woes were also certainly attributable to the then-current economic problems that resulted when the previous President Bush failed to halt the country's economic decline: Continental was brought low by the same 1991-2 recession that would help defeat Bush himself.

It is also true that some of the problems that brought about Continental's second bankruptcy were peculiar to the company and in many ways of its own making. Especially problematic was the high level of employee discontent.

While the company has had a number of good financial years since its recovery from bankruptcy a dozen years ago, it is once again on the verge of bankruptcy as the airline industry still struggles to recover from the events of 9/11 as well as from the current economic downturn that has reduced travel for both pleasure and business. Numbers do not lie - but Continental executives might be wishing that they did right about now.