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This paper was published as a Faculty Working Paper (no. 225) for the Lubin School of Business, Center for Applied Research, November 2006.

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Article

Abstract

This paper examines the valuation effects of earnings and book values on security prices of the airline companies under two different market structures: the regulated and the deregulated periods. In regulated markets, and under the cost recovery plus adequate rate of return on assets, security prices are highly aligned with book values of the respective companies. In the airline industry, regulation took the form of guaranteed routes and of subsidies to service rural areas. In addition, many airlines provide international service which was not subject to US regulations. These features give rise to the differential effect of both book values and earnings. In deregulated times, airline firms operate in highly competitive markets with large airline firms enjoying the benefits of economy of scale and service diversification. Thus, both the asset capitalization (book value) and operational efficiencies (earnings) would be major indicators in the market assessment of the firm's future profitability and security price. The literature lacks empirical evidence in examining the relative importance of earnings and book values in regulated and deregulated markets, especially in an airline industry. This paper aims at extending the literature examining the valuation relevance of earnings and book value in the assessment of security prices in the airline industry. The empirical results of this paper support the predictions of differential impact of earnings and book value in explaining security prices of the airline firms in both economic structures.

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