Constrained Contracting and Quasi-Mergers: Price Effects of Code Sharing and Antitrust Immunity in International Airline Alliances

Abstract

This paper presents a simple theoretical model of the effects of airline code sharing and antitrust immunity between noncompeting carriers. When carriers without a code sharing agreement or immunized alliance price a route, a double marginalization problem arises. Immunized alliances internalize this externality and lower fares because they can jointly price and share profits and thus, are likely to internalize only part of the externality. In effect, they trade lower upstream profits for higher downstream profits, but without profit sharing, asymmetries in demand, cost or bargaining power will prevent them from reaching the efficient outcome. I use an eleven year panel of data on international flights between the U.S. and Europe to estimate the price effects of these agreements. The results are consistent with the theory. Immunized alliance fares are 19% lower than non-alliance fares and statistically no different from fares for single carrier service in most specifications. In addition, code sharing alliances are associated with only 11% lower average fares.