The effect of air crashes on plane manufacturers value. Abstract. The effect of air crashes on the airline industry is widely discussed in previous literature. The effect on the manufacturer of the plane is a less commonly discussed topic and this paper will examine this. There is literature available that discusses the effect of air crashes on the manufacturer of the plane; however, this literature is outdated and was based on small samples. This paper uses two models to test the hypothesis that plane manufacturers are negatively affected in their value because of air crashes. Those models are the capital asset pricing model and the market model. Also there will be tested if there is a difference in effect for crashes before the year 2000 and after the year 2000. This study finds that air crashes have no significant effect on the returns of aircraft manufacturers when using the entire sample. The average abnormal returns are not significant for both models. Moreover, when comparing the subsamples with the two different models the test results do not show any difference. The value of plane manufacturers is not negatively affected by plane crashes, regardless of when they happened. Bachelor thesis for E&BE, BE Jochem Loonstra, S2543427 Rijksuniversiteit Groningen 1 1. Introduction Ever since the beginning of aviation in human history there have been accidents. Accidents involving aircrafts often create horrible scenes because they frequently lead to loss of human life. A loss of human life is not something that cannot be accounted for or compensated. Airline companies suffer, as described by Davidson, Chandy, and Cross(1987), in at least three ways. Firstly, the damage to the aircraft itself, mostly beyond repair. Secondly, the compensation for physical injury or death to the passenger. Lastly (and perhaps the most important one) is the loss of goodwill, often resulting in lower demands for the industry or switching to different airlines. That the airline suffers major losses due to an aviation disaster is a commonly known fact. Whether the manufacturers of the involved planes also suffer from a decrease in value will be tested in this paper. Aviation is an industry that is sensitive to political and economic changes. Therefore, a change in the value of companies involved in air crashes is something that can be expected. The hypothesis that the value of the involved airlines decrease after air crashes has also been shown by research. Chance and Ferris(1987) proved that there is a decrease in stock value of the carrier right after a crash. On average, the manufacturer of the airplane has less harm of a crash, this is because there are less substitutes for them. A consumer can easily switch between airlines, but plane manufacturers are less sensitive to switching as there are less options, and often there are contracts involved. Commercial aviation has only been around since 1914 and people were more sceptical towards flying in the early days. The aviation industry has developed a lot in the past decades and has become more widely available. Scepticism has decreased and rules for safety have increased. Therefore, we will also test if investors reacted stronger to aviation disaster before the year 2000 than after the year 2000. In this paper the effect of air crashes on the returns of plane manufacturers will be tested, by the use of event study methodology. The hypothesis which will be tested, is that the value of plane manufacturers is negatively affected because of plane crashes. The second 2 hypothesis that will be tested is the one that crashes that occurred before the year 2000 have more negative effect than crashes after the year 2000. 2.1 Literature review Literature on the effect of air crashes on the value of companies involved is easily available. Three papers are very relevant to my paper because of their similarity in topic and use of event study methodology. These papers are are Chance and Ferris(1987), Davidson, Chandy, and Cross(1987) and Walker, Thiengtham, and Yi Lin(2005). Chance and Ferris(1987) examined the effect of air crashes on the value of the two companies that are most involved in an air crash; the manufacturer of the plane and the carrier. Their samples consist of crashes that occurred in the period 1962-1987, a period in which aviation was still developing on a large scale. Their main findings is that the stock market immediately reacts to an air crash by a significant negative abnormal returns of 1.2% on average. This effect does not continue after the day of the crash suggesting that the stock market only reacts on the economic impact on one trading day. They do not find significant effects on the value of the plane manufacturer after a crash. As an explanation for this they argue that investors apparently see aviation disaster as a carrier specific event, that has no financial relevance for the manufacturer. Davidson, Chandy, and Cross(1987) also examined how the value of airlines is affected by air crashes. They also use event study methodology and have a sample of 57 crashes. They also examine whether the most severe crashes in their sample have a more significant effect than the less severe ones. They find that, when using all crashes in their sample, the value of the airliners decreases by 0.785% on average. They explicitly mention that the negative effect is reversed within 5 trading days after the crash. Walker et al.(2005) also examine the impact of plane crashes on the value airline and manufacturer. They also test the effect of different causes and severity of the crash. They find that investors react to a crash by a decrease in value of 2.8% and 0.8% respectively for the carrier and the manufacturer. Moreover, they find that crashes which are caused by acts of terrorism have a more significant effect and this is the same for crashes with a higher 3 number of fatalities. This counts both for manufacturers and carriers, so they do find a negative effect for manufacturers, in contradiction to the findings of Chance and Ferris (1987). The effect of plane crashes on the carrier has been tested many times, and all literature agrees on the fact that it has a negative effect. When it comes to manufacturers of the planes, the literature is contradictory. Chance and Ferris(1987) use old data and have a small sample, they find no effect. Walker et al.(2009) on the other hand use a large sample that is up to date; however, they have included 9/11, which is more than a firm-specific event and they do find an effect. By using a large sample and leaving out 9/11 this paper hopes to give a decisive answer to the question whether plane manufacturers are also significantly affected by plane crashes. Thereby, the test to see if there is a more negative effect for crashes before than after the year 2000 will be conducted. 2.2 Hypothesis. This paper will test two hypotheses. Hypothesis 1: the value of plane manufacturers is negatively affected by air crashes. Hypothesis 2: crashes that occurred before the year 2000 have more negative impact on the manufacturers value than crashes that occurred after the year 2000. 3. Data and methodology 3.1 Sample The sample used for this study consists of 120 events, that occurred between 1963 and 2015. For this study it was necessary to have crashes from a wide range of time to make sure the effects for the entire sample are not time related. The first event used in this study was in 1963, one year after the Boeing went public for the first time. The sample was collected by working down a list of most severe crashes, provided by the aviation network(https://aviation-safety.net/), an online database, that is updated every week and contains descriptions from over 15,800 aviation accidents and incidents since 1921. The sample contains three different plane manufacturers, Boeing, Airbus and Lockheed. Appendix 1 shows the event number, date, airline, manufacturer and number of fatalities of the selected crashes. The subsample of crashes that happened before 2000 contains 82 4 events and the one subsample of crashes after 2000 has 38 events in total. The average number of fatalities was 131 and the average date of occurrence was 28-4-1992. The data on historical stock prices of the plane manufacturers was obtained from Yahoo Finance. 3.2 Methodology This study uses event study methodology using two different models. These models are the constant mean return model and the market model. According to MacKinlay (1997) the constant mean return model is the simplest model and uses an estimation window with the stocks on returns to obtain an expected return for the event window. Although it is a very simple model Brown and Warner(1980,1985) find that it often creates results similar to more complex models. The market model works in a manner that it relates the return of any given security to the performance of the market portfolio. The models linear specification comes forth out of the assumed joint normality of the returns of the security and the market. In case the day of the crash was not a trading day, the first following trading day was used as the event day. Every event study, no matter what model, uses abnormal returns to measure the economic impact of an event on the company’s value. The return function used in this study is: Ri,t= LN(Pi,t) – LN(Pi,t-1) (1) In this formula R is the return on day t, given as a function of the adjusted closing price of stock i, on time t and t-1.