Socially optimal capacity and capital structure in oligopoly - The case ofthe airline industry

This paper investigates the relationship between air carrier's debt and cap acity. It is shown that the capacity chosen by a profit-maximising carrier will be larger than the cost-minimising capacity due to the effect of passe ngers' schedule delay. The paper also shows that in oligopolistic markets, the chosen capacity does not minimise the total social costs, which include both the carrier's private costs and passengers' schedule delay costs. Giv en that the airline industry is among the most highly leveraged industries, and that the heavy use of financial leverage would affect airlines' capaci ty decisions, this paper attempts so identify the capital structure that wo uld lead to the socially optimal allocation of capacity. The results of an empirical examination of ten major US carriers suggest that the excessive d ebt load of the carriers appears to have led to excess capacity as compared with the social optimum.