Why do contracts between airlines and airports fail?

Abstract

We investigate the sustainability of vertical contracts between airports and airlines. We focus on the case of Quantity Forcing contracts, with a theoretical model that accommodates changes to the contracts' clauses or environments in a two period game, since contracts often include clauses that determine obligations for airlines and airports to be accomplished in more than a single period. We find that contracts – by which airlines commit to carry to the airport the quantity that maximizes joint profits and airports commit to advertise the airlines and to rebate charges – are not sustainable. The relationship holds for both the finite periods and a two period game, a situation similar to a Prisoner's Dilemma. Nevertheless, when there is uncertainty from demand fluctuations the Nash equilibrium of the game depends on the magnitude of the expected fall on demand and on the probability of the state of nature.