Sky-High Airline Debt Feeds Air Safety Debate : Transportation: Leveraged buyouts and takeovers have left U.S. air carriers more heavily in debt than ever, raising concerns that cost cutting could lead to inadequate staffing, poor aircraft maintenance and endanger passengers.


What price airline safety?

The question is being heard loudly in the halls of Congress, as well as in the executive offices of U.S. airlines. Takeover activity in the airline industry has triggered worries that the level of safety in air travel will be diminished if a carrier takes on a large load of debt.

Definitive answers are difficult to find.

Although buyout and takeover moves in the airline industry have come to a virtual halt in the wake of the Friday the 13th stock market plunge, most observers agree that deals requiring high levels of indebtedness will eventually return to the airline scene and that the argument over their effect on safety will persist.

One such deal, the purchase of NWA Inc., parent of Northwest Airlines, took place this year. Another, a proposed management-employee purchase of UAL Inc., parent of United Airlines, has broken down, though attempts are being made to revive it. And while financier Donald J. Trump's offer to buy AMR Corp., parent of American Airlines, has been withdrawn, it is highly likely that Trump--or someone else--will go after AMR before long. Other airline companies are also said to be vulnerable.

What does all that have to do with safety?

Many people, among them Transportation Secretary Samuel K. Skinner, believe that safety can be compromised by an airline's financial difficulties. But not much evidence has been forthcoming.

In leveraged buyouts, a company is purchased with borrowed funds that must be repaid with cash from operations or from the sale of some of the company's assets. Takeovers are always based on the belief that the assets of a company are worth much more than the value represented by the total market price of the stock.

According to Paul P. Karos, airline analyst with the First Boston Corp. investment firm, 40% of U.S. air travelers are already being carried by highly leveraged airlines. If the UAL and AMR deals had gone through as originally structured, that figure would have risen to 75%.

Veteran airline observers maintain that if heavy debt is a major factor in safety considerations, Trans World Airlines, Pan American World Airways and Eastern Airlines should have been grounded long ago.

But do debt burdens compromise safety?

Will a heavily leveraged airline--should there be a downturn in the economy--be forced to skimp on the maintenance required for safe operations? Has deregulation resulted in greater competition--forcing down profits, causing airlines to cut corners in ways that put their passengers in danger? Will interest payments take precedence over airplane repairs? Will airlines that are heavily in hock postpone the purchase of new planes? Might they spend less on pilot training and hire less-experienced pilots to keep salaries low?

Opinions are widely divided. And the relatively little research that has been done is not conclusive.

Despite the belief that huge debts do, indeed, present a significant danger to the traveling public, some experts staunchly maintain that the last thing an airline will do is put safety in second place. Indeed, they say that safety standards might even improve at airlines with financial difficulties.

Hunter College Prof. Devra L. Golbe, in a March, 1986, article entitled "Safety and Profits in the Airline Industry," wrote:

"Evidence suggests that it is unlikely that profit-reducing changes in regulation will lead to more accidents. The evidence presented here on airline safety and profits does not support the popular wisdom. There does not seem to be a statistically significant relationship between safety and profits.

"If there is any relationship, it is weak and of the 'wrong' sign: That is, more profitable firms may have more accidents. It does not appear that profit-reducing changes in regulation will necessarily lead to less-safe airlines."

Nancy L. Rose, of the Sloan School of Management and Center for Transportation at the Massachusetts Institute of Technology, wrote in a paper entitled "Financial Influences on Airline Safety":

"My sense is that this whole airline safety debate over the last five years is more heat than light generated by people who have very strongly held opinions. But they are not based on an analysis of the statistics. They are based on gut feelings which have some validity to them but are not always on target."

Rose added: "Evidence suggests that deregulation may have improved the industry's financial condition, which means a financial performance-safety link could lead to increased safety since deregulation."

She noted that some private incentives, including lower insurance premiums, encourage safety.

Also, she said, airlines have an important stake in maintaining a reputation for providing safe service in order to attract and retain business. Airlines with bad safety reputations are likely to lose passengers to their safer competitors

Moreover, she added, large, profitable airlines might be the most vulnerable to accidents simply because they fly more miles.

"There is no relationship between safety and debt," said Phil Bakes, president of Eastern Airlines. "Safety cannot be equated to the balance sheet, (to) debt-to-equity ratios or profits and losses."

Bakes noted that Delta Air Lines, one of the most profitable carriers, has had some serious safety problems in the past year or so. And he added that most recent airline accidents have been caused by human error. "The human factor is the one area which needs improvement," he said, "and it is the one which costs the least."

Transportation Secretary Skinner vows that his department--through its Federal Aviation Administration--will not allow airline debt to compromise safety. Noting that the NWA takeover will increase that company's long-term debt fourfold, he said, "The pressures to pay down the principal and to meet interest payments could threaten the carrier's ability to meet its other obligations, including fleet replacement, aircraft repair and maintenance. . . . Financial distress and excessive debt in a cyclic industry such as the airlines is a cause for concern."

But when pressed to put a price tag on safety, Jeffrey N. Shane, assistant secretary of transportation for policy and international affairs, conceded, "I don't think you ever could quantify it." He, too, promised that the FAA will never allow airline safety to be compromised.

Congress has gotten into the act in an effort to give Skinner's agency more clout to control airlines when takeovers put them too deeply in debt. Legislation pending in both the Senate and House of Representatives that would empower the secretary of transportation to stop leveraged buyouts of airlines. If there was too much debt and the agency believed that safety had been compromised as a result, the transaction could be rejected.

However, because the Bush Administration opposes the legislation--as move back toward airlines regulation--there is the possibility of a presidential veto.

The worries persist. "LBOs can be appropriate financial strategy for certain companies," said Philip Baggaley, vice president of Standard & Poors Corp., a debt-rating agency that judges the credit-worthiness of airlines. "Companies in stable, recession-proof industries can safely support large amounts of debt . . . but airlines are hardly stable or recession-proof. . . . Airlines continue to have greater-than-average risk."

Baggaley backed his contention with figures: "Airlines are growing companies with a voracious appetite for capital. . . . The total cost of aircraft on order or option by U.S. airlines is approaching $100 billion. Total operating cash flow in the industry last year, a very profitable year, was less than $5 billion. . . . Clearly, the industry will have to finance most of its deliveries using debt or leases."

Economic analysts David R. Graham and Marianne Bowes, in a study done for the Public Research Institute of the Center for Naval Analysis, said, "We find it plausible, in theory, that an unprofitable or insolvent airline would cut back on investments in maintenance, safety and services."

But they added, "We find that although there are some circumstances in which it is plausible to expect financially unsuccessful airlines to be less safe . . . to spend less on aircraft maintenance, we have not found this to be true for the major airlines."

Many pilots also fear that financially strapped airlines might be dangerous.

The Air Line Pilots Assn. commissioned a study in 1986 that found that the majority of the union's members were very concerned with what they perceived to be a declining level of commercial aviation safety. Forty-three percent of the pilots questioned said deregulation had had a greatly adverse effect on airline safety. Another 53% said safety had been affected to some extent. Of those who said airline safety had declined, 65% said the decline was a result of "airline financial difficulties brought about by deregulation."

Commenting on the pilots' survey, Ian Savage, an economics professor at Northwestern University, said, "There is a belief that financial pressure has caused some airlines to reduce expenditures on inputs to safety such as training and maintenance." But, he added, "People who study accidents have been unable to find any strong relationship. It is very difficult to pin down any relationship between the amount of money you spend on safety and whether or not you have accidents."

In fact, in a study that he conducted with Leon N. Moses, another Northwestern professor, the safety record of the nation's airlines was determined to actually have improved since deregulation. For large airlines flying jets, he said, accidents from the time of deregulation in 1978 through 1987 declined by 36%, fatal accidents by 40% and fatalities by 32% compared with the 1970-78 period.

According to an Indiana University study, the increased competition since deregulation has actually resulted in improved safety for many travelers because the cheaper air fares lured people away from automobile trips. Driving on rural roads, the report explained, is more than three times as risky as taking a commuter airplane.

Michael E. Levine, dean of Yale University School of Management, maintains that large indebtedness by airlines is nothing new. Levine, also a member of the Aviation Safety Commission and a former staff member of the now-defunct Civil Aeronautics Board, told Congress recently, "Many airlines have operated with highly leveraged financial structures for many years. Although it seems logical that financial stress should put pressure on airlines to cut corners and safety should suffer as a result, no systematic link between finances and safety has ever been demonstrated. . . .

"This comes as a relief to us all, since at any given time since the dawn of aviation, many airlines have been flying without noticeable equity, and many have failed to make a profit. Some airlines have operated in this way for many years at a time."

Thus, he says, the government has no business meddling in such affairs.

"Turning the Department of Transportation into a federal commission," he said, "where they formally or informally try to outguess capital markets on whether a deal has 'too much debt' smacks of the kind of central capital allocation which has failed around the world and from which governments everywhere are beginning to retreat."

But there are no precedents to study as a guide to what may happen.

"We have never seen such high levels of debt compared to net worth in the airline industry," said Edie Kesner, an associate professor at the University of North Carolina. "We have seen such cases (of high debt) but they have all (eventually) declared bankruptcy. We saw it with Continental, we saw it with Braniff and more recently we saw it with Eastern."

Speaking about the huge debt that UAL Inc. would have incurred had the financing of the employee-management takeover not fallen through, she said: "We have never had a situation where a company has experienced such massive levels of debt, yet not been protected by Chapter 11. The protection of the bankruptcy court has allowed them to repay their debts on a more beneficial payment schedule. When it comes to how such debt affects safety, you are asking us to project from the past. We have never seen this kind of incident."

One observer said executives attempting to hold onto their jobs might put a company's earnings ahead of safety. This, he said, is true of any industry. Richard A. D'Aveni, professor of corporate strategy at Dartmouth College, said corporate executives try to keep shareholders content by showing decent profits.

"If profits drop too far," he said, "CEOs tend to get fired. When companies get in trouble, they are more likely to do illegal things. Social responsibilities go down the drain when you get into trouble."

It is not possible to measure airline safety by the number of accidents that occur. It is not like automobile safety, for which a large number of mishaps can be analyzed to calculate, for example, what the effect would be on the accident rate of decreasing the speed limit to 55 m.p.h. from 65 m.p.h.

In the end, though, researchers Savage and Moses pointed out, "Airlines have a strong incentive to avoid accidents: Accidents cost money." And, they added, "Passengers shy away from a company after an accident involving one of its aircraft."

This effect lasts for about three months and costs a typical large airline roughly $30 million, according to an earlier study quoted by Savage and Moses. That report, which did not differentiate between minor and major accidents, also found that after a mishap, a carrier loses an average of $4.5 million in its equity value on the stock market.

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