Continental 1990 Bankruptcy Term Paper

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Continental Bankruptcy

How can one tell if a company is about to go under? There are at least two ways to answer that. One answer (which is usually not terribly precise) is the long-range one. The other is the (usually far more precise) short-term one. This paper provides at least both long-term and short-terms analysis of the Continental Airlines bankruptcy in 1990, relying for the former on an analysis of the state of the American airlines industry in 1990 and for the short-term specific economic information relevant to Continental at the time.

The major overall economic element affected the entire American transportation industry in 1990 (this included not simply the airlines industry) was the issue of deregulation. For many years, the transportation system of the United States existed within an economic system of a high degree of regulation. That this should have been so should not surprise us if we look only at the legal and not the economic context of the transportation system.

The transportation network of the United States has been, since 1789, subject to a high degree of management by the federal government for the simple reason that this is one of the primary functions of the federal government - to oversee those activities that cross state borders.

Transportation cannot be easily overseen by any one state, nor do states necessarily trust their fellow states to be fair in their practices. Thus for decades, the federal government oversaw the transportation industry. However, over the past several decades, many of those traditional regulations were lifted, which brings us to the historical rumblings leading up to the 1980s Reagan Revolution and the effects that massive government deregulation had on Continental and other airline companies. In a word, that effect was in general disastrous; the recent bail-out of airlines by the federal government has reinforced the idea that airline may not be able to support themselves without governmental oversight and support.

The Long View: Deregulation and Continental

Substantial government regulation of the American transportation sector extends back to at least 1887 when all U.S. railroads came under federal control - in order to prevent the railroad owners from using their monopolistic control of the tracks to punish the American economy (Bethune 31). Because transportation companies tend to require high levels of capital, they tend to be run by a few (or even one) large company and so tend easily toward the monopolistic.

The Interstate Commerce Commission stepped in to control rates and routes of the railroads, a step that was echoed in 1906 when the country's oil pipelines came under governmental control to prevent John D. Rockefeller's using them to monopolize. The trucking industry was added to the list of government regulated industries in 1935 - although this time the government sought to limit rather than increase competition to ensure that only those companies that operated safely would be allowed to perform shipping duties (Peterson 37).

So it was only to be predicted that domestic airlines were also to come under federal regulation, which occurred in 1935 when they were placed under the governance of the newly established Civil Aeronautics Board. (Planes were not in fact the last form of transportation to be regulated - a number of forms of shipping were added to the rolls of regulated industries in the 1940s, as Freiberg etal note.

However, in the decades after World War II, many lawmakers and businesspeople began to believe that regulation was causing more harm than good. One of the signs of how badly regulation was working was the fact that most of the railroads in the northeastern United States had gone bankrupt. Among these railroads was the Penn Central; it was at the time the country's worst commercial bankruptcy (Morrison and Winston 28).

In general, many people felt that regulation slowed or limited competition, which produced far less efficient economic activity than a free market would, as Morrison and Winston note. Thus, beginning in the early 1970s, the U.S. began to reduce or even to remove entirely the regulations that had governed (and in the eyes of many) shackled industries, including those in the transportation sector. Included in this round of deregulation were the airlines.

However, despite the fact that deregulation had been seen by people throughout industry and government as a wonderful boon to commerce, it brought with it its own set of problems, many of which were not resolved by the passage of time but in fact grew worse and worse over the years.

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The primary reason for this - and this was certainly true in the case of Continental - was that the industries were not overall as stable under deregulation as they had been when they were regulated, and this condition of industry-wide instability tended to have detrimental economic effects on each of the firms within that industry. We can certainly see this in the airlines industry, which has seen a number of bankruptcies and problems with service.

When assessing the bankruptcy of Continental, it is imperative that we keep in mind the effects that deregulation had both on this airline in particular and on the industry in general. But it is also important that we are not overly eager to blame too much on deregulation: The company in 1990 had problems of its own making, as Altmanm's Z-score indicates.

Those same problems plague the company today, as is suggested by this story from last year when the airline companies once again expressed their uneasy relationship with the federal government - from whom they often want protection but not regulation:

Airlines, their business ravaged by last week's terror and an already sick economy, are taking desperate steps to avert what they say is a fast-approaching financial disaster.

Even as the airlines restore flights shut down for almost 3 days last week, executives say their bookings are evaporating, and costs are escalating because of new security measures. They're begging the federal government to fund a $15 billion rescue plan that seemed to gain momentum over the weekend.

Continental Airlines

Continental Airlines was suffering not just from deregulation woes in 1990, but from other economic ills that were affecting not only it but other airlines - as well as the U.S. economy in general.

The nation's airlines posted an all-time loss of about $2 billion in 1990, thus making 1990 the worst year's performance since the deregulation act of 1978. Higher fuel costs, linked to Iraq's invasion of Kuwait in August 1990 and the general economic slowdown contributed to the losses that year. Fuel prices double between 1989 and 1990 according to Association President Robert Aaronson. The $2 billion loss sustained that year doubled the record lost of 1982 almost threefold. To make matters worse the government taxed the industry in 1990 with a $18.6 billion airline-ticket tax and other special levies during the nest five years as part of the deficit-reduction deal.

Jobs were vanishing and many more were at stake throughout the industry. Strong carriers had frozen management hiring and halted all non-essential capital spending. USAir had dropped all expansion plans and delayed deliveries of its aircrafts. Many small carriers were crush by debt, Continental had to declare Chapter 11 bankruptcy, Eastern had shut down, Pan Am also filed Chapter 11 bankruptcy and cut it work for by 15%, eliminating 4000 workers.

Continental Airlines was in a poor state of financial health in 1990, when it's Z-score - as calculated by Altman's model - fell into the "danger" zone. Altman's model is a powerful tool for determining the overall financial state of a company has proven to offer a prescient view into the workings of a company:

Any single one of the 20 or so acknowledged financial ratios cannot adequately evaluate the overall strength of a company, although each of them can be extremely useful in identifying specific strengths and weaknesses that contribute to the general financial health of the firm.

The Z-Score Bankruptcy-Predictor combines several of the most significant variables in a statistically derived combination that was first published by Dr. Edward I. Altman in 1968 (See The Journal of Finance, September, 1968.) It was originally developed on a sampling of manufacturing firms. However, the algorithm has been consistently reported to have a 95% accuracy of prediction of bankruptcy up to two years prior to failure on non-manufacturing firms as well. There have been many other bankruptcy predictors developed and published. However,.none has been so thoroughly tested and broadly accepted as the Altman Z-Score. The Altman Z-Score variables influencing the financial strength of a firm are:

CA = CURRENT ASSETS

TA = TOTAL ASSETS

SL = NET SALES

IN = INTEREST

TL = TOTAL LIABILITY

CL = CURRENT LIABILITIES

VE = MARKET VALUE OF EQUITY

ET = EARNINGS BEFORE TAXES

RE= RETAINED EARNINGS

Assessing Continental Airlines in 1990 demonstrated that the company was indeed headed toward bankruptcy, with the predictable consequences.....

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