Contract Form and Technology Adoption in a Network Industry

All major U.S. carriers subcontract portions of their networks to regional partners who may either be owned or governed with contracts. Beginning in the late 1990s, there is a change in the nature of contracts in this industry, with fixed price contracts replacing revenue sharing contracts as the predominant contractual form. Moreover, this change is correlated with the diffusion of a new aircraft technology, the regional jet (RJ). To explain this correlation, we investigate whether technological features of the RJ led majors to subcontract new types of flights to their regionals and whether these new flights had characteristics that favored the new contractual form. In particular, we argue that, in addition to the standard insurance/incentives tradeoff, there may be a second advantage to fixed price contracts in this setting as they eliminate the haggling over route selection that can arise under revenue sharing. Combining detailed data on RJ adoption with a novel dataset on contractual form, we show that the emergence of the new technology did result in regionals being used in new ways - for example, serving long, thin spokes and supplementing or replacing the major’s own flights. We then investigate whether these new uses are consistent with a change in the optimal contract and find that they are. Specifically, relative to turboprops, RJs were more likely to serve to serve flights whose characteristics suggested that the standalone revenue of the flight might provide limited incentives for a regional to operate that flight.