AIRLINES Research Brief

Sustainable Industry Classification System™ (SICS™) # TR0201

Research Briefing Prepared by the

Sustainability Accounting Standards Board®

www.sasb.org Copyright 2014 SEPTEMBER 2014

AIRLINES Research Brief SASB’s Industry Brief provides evidence for the material sustainability issues in the Road Transportation Industry. The

brief opens with a summary of the industry, including relevant legislative and regulatory trends and sustainability risks

and opportunities. Following this, evidence for each material sustainability issue (in the categories of Environment,

Social Capital, Human Capital, Business Model and Innovation, and Leadership and Governance) is presented. SASB’s

Industry Brief can be used to understand the data underlying SASB Sustainability Accounting Standards. For

accounting metrics and disclosure guidance, please see SASB’s Sustainability Accounting Standards. For information

about the legal basis for SASB and SASB’s standards development process, please see the Conceptual Framework.

SASB identifies the minimum set of sustainability issues likely to be material for companies within a given industry.

However, the final determination of materiality is the onus of the company. Related Documents • Airlines Sustainability Accounting Standards

• Industry Working Group Participants

• SASB Conceptual Framework

INDUSTRY LEAD Nashat Moin CONTRIBUTORS Andrew Collins Henrik Cotran Anton Gorodniuk Jerome Lavigne-Delville Himani Phadke Arturo Rodriguez Jean Rogers Gabriella Vozza SASB, Sustainability Accounting Standards Board, the SASB logo, SICS, Sustainable Industry Classification System,

Accounting for a Sustainable Future, and Materiality Map are trademarks and service marks of the Sustainability

Accounting Standards Board

I N D U S T R Y B R I E F | A I R L I N E S

INTRODUCTION

Once a symbol of high social and economic status, air

travel has become a basic transportation service in

developed economies and is increasingly common in

many emerging economies. With this exponential

growth of air travel worldwide, greenhouse gas (GHG)

and other air emissions of airlines at high altitude have

become an acute environmental externality in the

focus of global and local mitigation efforts to combat

climate change. And with intensifying air traffic, the

industry must address increasingly stringent safety

standards to maintain its image of the safest means of

transportation. Moreover, despite a trend towards

privatization, airlines are still directly or indirectly run

by governments in many parts of the world. Fully

privatized airlines struggle to stay profitable with a

highly-unionized workforce, high capital requirements,

and competition from government-sponsored carriers,

and often seek court protection from creditors through

bankruptcy and restructuring. To find economies of

scale, Airlines are in a constant state of consolidation

and increasingly cooperate through alliances, which

limits competition.

Investors would obtain a more holistic and comparable

view of performance with airlines companies reporting

metrics on the material sustainability risks and

opportunities that could affect value in the near- and

long-term in their regulatory filings. This would include

both positive and negative externalities, and the non-

financial forms of capital that the industry relies on for

value creation.

Specifically, performance on the following

sustainability issues will drive competitiveness within

the Airlines industry:

• Improving fuel efficiency of aircraft and

reducing direct greenhouse gas (GHG) emissions

and harmful air pollutants;

• Managing labor relations and ensuring fair

employee treatment;

• Ensuring fair competition practices; and

• Ensuring the highest standards of passenger

and cargo safety by managing the key risk

factors: pilot error and mechanical failure.

In the context of global climate change and rising

economic development in many parts of the world,

regulatory pressure and public expectations will

continue to drive environmental performance,

passenger safety and competitive behavior. Therefore,

management (or mismanagement) of these

sustainability issues has the potential to affect

company valuation through impacts on profits, assets,

liabilities, and cost of capital.

INDUSTRY SUMMARY

The Airlines industry comprises companies that provide

air transportation to passengers for both leisure and

business purposes. This includes commercial full-

service, low-cost, and regional airlines that operate in

the U.S. and internationally. I Most airline companies

also have a cargo segment in their operations from

which they generate two to three percent of revenues

for the U.S.-domiciled airlines. For European, Asian,

and Latin American airlines, nine to 12 percent of

revenue is generated from a cargo segment. Current

I Industry composition is based on the mapping of the Sustainable Industry Classification System (SICSTM) to the Bloomberg Industry Classification System (BICS). A list of representative companies appears in Appendix I.

Sustainability Disclosure Topics

Environment

• Environmental Footprint of Fuel Use

Human Capital

• Labor Relations

Leadership and Governance

• Competitive Behavior

• Accidents & Safety Management

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industry trends indicate that airlines are reducing their

fleet of freighter planes and instead utilizing their

passenger aircraft for cargo transportation. For

example, Air France-KLM transports 72 percent of

freight by passenger planes, which is up from 54

percent in 2007.1

Airline routes and networks are key drivers of

profitability for the industry. Full-service carriers

typically use a hub and spoke model II to design their

routes within the U.S. and internationally. Low-cost

carriers usually offer a smaller number of routes as

well as no-frills service to their customers.2 Regional

carriers typically operate under contract to full-service

carriers, expanding the network of the larger carriers.3

Another tactic used to increase an airline’s network is

the use of alliances. There are three leading alliances:

Star Alliance, Oneworld, and SkyTeam, each with 27,

15, and 20 worldwide members, respectively.

Operating as an alliance allows customers access to

international or otherwise unserved itineraries on

multiple airlines, under one ticket. At the same time,

airlines share some overhead costs and increase their

competitive position in the international market

without having to establish foreign operations.4

The airlines business is global by nature. Four out of

the top five U.S.-domiciled airlines by revenue serve

routes all over the world. Foreign airlines, such as

British Airways and Lufthansa, also operate in the U.S.

Only one of the top five U.S.-domiciled companies,

Southwest Airlines, is a low-cost carrier offering

exclusively domestic travel. Domestic travel relies

heavily on business travelers and demand is driven by

corporate profits and the strength of the business

environment. On the other hand, the majority of

revenue on international flights comes from inbound

international tourism and international trips by U.S.

residents and is driven by consumer discretionary

spending.5

II Using routs from a hub airport to other airports as spokes to connect them via the hub.

The global airlines market is valued at around $615

billion in revenues, with full-service airlines

representing over 80 percent of the revenue. Airline

cargo is the smallest segment with just under $20

billion of global revenue.6 Airline companies listed on

the U.S. exchanges generate over $190 billion in

revenue from the passenger transportation segment. In

2013, the median operating profit margin for U.S.-

listed companies and those primarily traded over-the-

counter (OTC) was 5.2 percent, while the median net

income margin was 2.4 percent. Full-service airlines

tend to have lower margins than their low-cost peers.

Median operating margins of the largest full service

airlines were 2.6 percent and the median net income

margins were 1.3 percent in 2013. In comparison, in

the same year, low-cost carriers were more profitable,

with median margins of 9.8 and 3.7 percent of

operating and net profit margins respectively.7

The industry is mature and concentrated, with the top

four U.S.-domiciled, publicly traded, full-service airlines

(United Continental Holdings, Delta Air Lines,

American Airlines, and Southwest Airlines) holding

more than 75 percent market share in North America

in 2013, up from just under 70 percent in 2012.8

Industry consolidation was one of the main drivers of

the rise in concentration.9 Over the last 12 years six

mergers reduced the number of major carriers from 10

to four to dominate the market. The most recent

mergers and acquisitions include: American Airlines

merging with US Airways in 2013, Southwest

acquiring AirTran Airways in 2011, United merging

with Continental Airlines in 2010, and Delta Air Lines

merging with Northwest Airlines in late 2009. Most of

the companies were overcoming periods of

bankruptcies prior to their mergers.10

The international airlines industry is characterized by

high barriers to entry. This is mostly attributed to strict

government regulations, high capital requirements, as

well as licensing and reporting requirements. There

can be only a limited number of aircraft designated to

operate on each route, determined by airline

agreements involving landing rights. Moreover, volume

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quotasIII on international airline services are imposed

on a country-by-country basis, which may give a

competitive advantage to nationalized airlines.11

Competition in the airline industry is dampened in

some regions through limited airport infrastructure

and airport slots, which can act as a cap on supply and

make it very difficult for emerging companies to gain

new slots. An airport slot is critical to an airline’s

operations and gives the slot owner permission to use

the airport infrastructure necessary to arrive or depart.

The International Air Transportation Association (IATA)

provides a global standard for slot management, but

there are variations throughout the world in how and

to what extent they are applied. The IATA categorizes

airports as Level 1, Level 2, or Level 3 based on the

level of congestion. Level 3 airports are the most

congested and are defined as “airports where the

capacity providers have not developed sufficient

infrastructure or where governments have imposed

conditions that make it impossible to meet demand.”12

At Level 3 airports, slots are allocated to airlines using

several principles, including historical precedents,

whereby airlines that had a slot in the previous year

and utilized it 80 percent of the time can retain that

slot.13 Airlines are able to acquire, retain, and

exchange take-off and landing slots. Due to limited

availability, airport slots are very valuable to airlines.

Therefore, U.K. airlines started recognizing their slots

as assets on balance sheets. For example, BMI British

Midland valued its Heathrow airport slots at £770m.14

The price of fuel is a key driver in the profitability of

the industry. Cost of fuel represented about a third of

total operating expenses in recent years, followed by

wages, with 16 to 19 percent.15 Increasing fuel prices

mean higher costs for airlines, and typically, airlines are

not able to pass the full cost increase onto their

passengers. Therefore, increasing oil prices eat directly

into airline profits. Even with oil prices decreasing in

2013, their volatility in the future will play a critical

role in the stability of the airlines industry.16 Major

airlines employ fuel hedging strategies in order to limit

III Measured in number of seats.

their exposure to such volatility, and nine out of the

top 10 U.S.-based, publicly listed airlines use various

financial instruments to hedge the cost of fuel,

including swap contracts, call options, collars, futures

contracts, and forwards contracts.17 Some companies,

but not all, choose to designate this as hedging activity

for accounting purposes.

In 2007 and 2008, fuel prices soared, while the

economy experienced a downturn. The slowing

economy hit both consumer discretionary spending

and corporate profits, leaving airlines with falling

demand and overcapacity. Coupled with the

fluctuating and mostly increasing fuel costs, this shift

in demand created industry losses. Low-cost airlines

fared better through the downturn and in 2010, the

industry stabilized as a result of cost-cutting measures.

Recent trends show low-cost airlines are slowly eating

into the full-service market share. The market is also

characterized by structural changes in the form of

mergers and acquisitions and bankruptcies.18

Passenger safety is another important factor that drives

performance of airlines. As recent tragedies showed,

some risks may go beyond the airline’s control.

Accidents that led to a loss of many lives made the

industry increase its focus on the safety issue.

LEGISLATIVE AND REGULATORY TRENDS IN THE AIRLINES INDUSTRY

Regulation plays a prominent role in the Airlines

industry. Increasing awareness around climate change

shapes regulations for airlines, due to environmental

externalities related to the nature of their business.

Moreover, continuous evolution towards higher safety

standards puts public and regulatory pressure on the

industry. The following section provides a brief

summary of key regulations and legislative efforts

related to this industry that drive material sustainability

issues.IV

IV This section does not purport to contain a comprehensive review of all regulations related to this industry, but is intended

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The Federal Aviation Administration (FAA) has

authority to regulate and oversee all aspects of

American civil aviation. The agency is broken into four

lines of business: (1) Airports, (2) Air Traffic Control,

(3) Aviation Safety, and (4) Commercial Space

Transportation. FAA requirements cover, among other

things: retirement of older aircraft, security measures,

collision avoidance systems, airborne wind shear

avoidance systems, noise abatement and other

environmental concerns, aircraft operation and safety,

and increased inspections and maintenance procedures

to be conducted on older aircraft.19 The FAA also

regulates the health and wellbeing of pilots and crew

members as they relate to passenger safety. For

example, the agency has introduced requirements on

the frequency and duration of rest periods compared

to flight time for pilots.20 In December 2011, new pilot

fatigue requirements were introduced to significantly

reduce the number of hours on duty.21 The FAA

routinely issues fines or revocations for infractions and

can enact new regulations with positive or negative

cost implications for airlines.22

Another organization whose standards can influence

airline profitability is the United Nations’ International

Civil Aviation Organization (ICAO). The ICAO is

represented by 191 members and develops

international Standards and Recommended Practices

(SARPs) that are further used by member countries to

develop national civil aviation regulations.23 The

ICAO’s Annex 18 sets standards for "Safe Transport of

Dangerous Goods by Air." Air carriers are required to

have inspection and enforcement procedures to ensure

compliance with the Annex 18.24 In addition, in April

2014, the ICAO Dangerous Goods Panel (DGP)

proposed to restrict transportation of lithium metal

batteries to cargo aircraft only. If the proposal is

approved by the ICAO Council, the changes will

become effective starting January 2015.25

The U.S. Department of Transportation (DOT) also

plays an important role in regulating the airline

to highlight some ways in which regulatory trends are impacting the industry.

industry. The DOT is responsible for executing and

enforcing airline consumer rights laws established by

the U.S. Congress. It may also develop regulations

based on more general statutory authority, giving it

broad powers to prescribe regulations, standards, and

procedures related to air travel.26 The DOT is

responsible for the recently enacted Passenger

Protection Rules, which address matters such as

tarmac delays, chronically delayed flights, fee

transparency, and fair treatment of passengers.

Despite efficiency improvements, increasing levels of

GHG emissions due to the growing demand for air

travel have led to a number of environmental

regulations addressing the airline industry’s emissions,

both in the U.S. and internationally.27

In the U.S., the Environmental Protection Agency (EPA)

has oversight of the Airlines industry’s environmental

impacts under both the Clean Air Act and the Clean

Water Act. The Clean Air Act gives the EPA the

authority to determine whether carbon emissions from

aircraft operations endanger society. It also gives the

EPA authority to introduce regulations to address the

issue.28

In 2012, the European Union (E.U.) moved to include

aviation in its emissions trading system (ETS) by

establishing limits on carbon emissions and introducing

allowances and fees on flights to, from, and within the

European Economic Area (EEA). However, resistance

from several countries, including the U.S., caused the

E.U. to postpone the enforcement on international

flights until November 2013 in hopes of creating a

global, market-based solution through the UN’s

ICAO.29 The legislation has since been amended for

the period from 2013 to 2016, and only emissions

from flights within the EEA currently fall under the

E.U.’s ETS. The decision was driven by the ICAO

Assembly agreement in October 2013 to “develop a

global market-based mechanism addressing

international aviation emissions by 2016 and apply it

by 2020.”30

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SUSTAINABILITY-RELATED RISKS AND OPPORTUNITIES

Industry drivers and recent regulations suggest that

traditional value drivers will continue to impact

financial performance. However, intangible assets such

as social, human, and environmental capitals, company

leadership and governance, and the company’s ability

to innovate to address these issues are likely to

increasingly contribute to financial and business value.

Broad industry trends and characteristics are driving

the importance of sustainability performance in the

Airlines industry:

• Energy inputs and externalities from fuel-

intensity of operations: As a fuel-intensive

industry with large direct emissions contributing

to climate change, the Airlines industry is

attracting growing attention from U.S. and

international regulators. At the same time,

increasing energy costs are providing incentives

for efficient fuel management.

• High safety standards: Passengers entrust

their lives to airlines; companies must continue

to maintain high safety standards to retain their

license to operate.

• Dependence on public infrastructure: The

industry’s use of common capitals and public

goods, including airports and airspace, drives

both its sustainability impacts and consequently,

impacts on its value through regulations or

public reaction.

• Industry concentration creates competition

concerns: The Airlines industry experiences

frequent merger and acquisition activity, leading

to consolidation and concerns about

competitive behavior. As described above, the

regulatory and legislative environment

surrounding the Airlines industry emphasizes

the importance of sustainability management

and performance. Specifically, recent trends

suggest a regulatory emphasis on reduction of

environmental impacts and high safety

standards, which will serve to align the interests

of society with those of investors.

The following section provides a brief description of

each sustainability issue that is likely to have material

implications for companies in the Airlines industry. This

includes an explanation of how the issue could impact

valuation and evidence of actual financial impact.

Further information on the nature of the value impact,

based on SASB’s research and analysis, is provided in

Appendix IIA and IIB. Appendix IIA also provides a

summary of the evidence of investor interest in the

issues. This is based on a systematic analysis of

companies’ 10-K and 20-F filings, shareholder

resolutions, and other public documents. It also based

on the results of consultation with experts

participating in an industry-working group convened

by SASB.

A summary of the recommended disclosure framework

and accounting metrics appears in Appendix III. The

complete SASB standards for the industry, including

technical protocols, can be downloaded from

www.sasb.org. Finally, Appendix IV provides an

analysis of the quality of current disclosure on these

issues in SEC filings by the leading companies in the

industry.

ENVIRONMENT

The environmental dimension of sustainability includes

corporate impacts on the environment. This could be

through the use of natural resources as inputs to the

factors of production (e.g., water, minerals,

ecosystems, and biodiversity) or environmental

externalities and harmful releases in the environment,

such as air and water pollution, waste disposal, and

GHG emissions.

The Airlines industry faces risks and opportunities

related to environmental factors, particularly increasing

climate regulations. Regulatory costs associated with

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GHG emissions are threatening the Airlines industry’s

already thin profit margins. However, optimizing fuel

management through technology innovation offers an

opportunity to control costs.

Environmental Footprint of Fuel Use As a result of heavy reliance on oil, the Airlines

industry generates a significant amount of direct GHG

emissions and is subject to potential compliance costs

and risks associated with climate change mitigation

policies. The main sources of GHG emissions for

airlines companies are aircraft fuel use and emissions,

ground equipment, and facility electricity. Aircraft

emissions are the largest contributor to total emissions

from the industry, and fuel management is a critical

part of reducing emissions.

Fuel management addresses both fuel efficiency and

the use of alternative fuels. It offers an effective way

for airlines to increase profits through reduced fuel

costs, while also limiting exposure to volatile fuel

pricing, future regulatory costs, and other

consequences of GHG emissions. Under the Clean Air

Act, the EPA is currently evaluating whether aircraft

emissions endanger society, the results of which could

lead to regulatory measures.31 In September 2014, the

EPA further began determining whether it will regulate

GHG emissions from airlines. The regulations would

lead to increased air travel costs. There is no timeline

set by the agency on when the rules are to be

released.32

Companies can adopt various strategies to reduce the

environmental footprint of their fuel use. The fuel

efficiency of an airline has several drivers, including

aircraft design, route selection, and load factor. Newer

aircrafts are more fuel-efficient, and one report

estimates that every 10 years, the aircrafts being built

are 10 to 15 percent more efficient.33 However,

existing planes can be retrofitted for efficiency. For

example, adding winglets can increase fuel efficiency

by 1.8 percent,34 and replacing an engine on an

existing aircraft can improve efficiency by 15 percent.35

The dynamic of new technology versus retrofits is

important, given that over a third of the world’s airline

fleet is rented.36 It is not entirely clear that either

leasing or owning is better from a fuel efficiency

perspective, but it is important to acknowledge that

having access to the latest technology does have a

beneficial impact on fleet fuel efficiency.

As one of the strategies to minimize GHG emissions,

airlines can seek alternative fuel options. With looming

climate regulations and volatile fuel prices, the Airline

industry began using biofuels on commercial flights in

2011.37 While biofuel flights do emit carbon dioxide—

unlike fossil fuel—biofuel absorbs carbon dioxide

during the growth of the crop, greatly reducing the

lifecycle carbon dioxide emissions. Given the emissions

captured during the production of biofuels, the overall

reduction in emissions is estimated to be 80 percent

when compared to fossil fuels.38

There are various industry initiatives aimed at reducing

environmental externalities created by airlines’

operations. In 2009, the IATA began taking

commitments from airlines to be carbon neutral in all

growth after 2020 and reduce absolute carbon

emissions by 50 percent by 2050.39 In October 2010,

the International Civil Aviation Organization (ICAO)

established an action plan to identify the most

appropriate measures to reduce CO2 emissions from

international civil aviation.40 The resolution focuses on

technology, operations, and infrastructure measures as

the primary means for addressing emissions.41

Company performance in this area can therefore be

analyzed in a cost-beneficial way, internally and

externally, through the following direct or indirect

performance metrics (see Appendix III for metrics with

their full detail):

• Gross global Scope 1 emissions;

• Long- and short-term strategy to manage Scope

1 emissions;

• Total fuel consumed, percentage from

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renewables; and

• Notional amount of fuel hedged, by maturity

date.

Evidence The Airlines industry is a significant contributor to

global GHG emissions, creating regulatory risks for

companies. According to the Carbon Disclosure Project

Transportation Report, the Transportation sector

accounts for 13 percent of global emissions, 13

percent of which come from air transportation.42

Statistics from the Center for Climate and Energy

Solutions (C2ES) indicate similar contribution, with

around 1.5 percent of global GHG coming from

aviation, which includes both passenger airlines and air

freight. U.S. aviation activities account for

approximately 40 percent of these emissions.43 In

absolute values, the Aviation industry in the U.S.

accounted for around 145 Teragrams CO2 equivalent

(Tg CO2e) emissions in 2012, with 114.4 Tg CO2e

coming from commercial aircrafts. Over 99 percent of

these emissions are in the form of carbon dioxide.44

Climate change regulations steadily make it

more costly for airline companies to operate. Even

without U.S. federal regulations or a global treaty on

addressing climate change, there are regulations

specific to certain geographic areas that can impact

the industry, as airlines operate across different

regions globally. In Europe, the Emissions Trading

System (ETS) was launched in 2005 to mitigate climate

change. The ETS covers factories, power stations,

industrial plants, and all flights within the EEA.45

The E.U. came close to including non-European airlines

that serve Europe in the ETS in November 2012—a

move that would reportedly have cost U.S. airlines

$3.1 billion between now and 2020.46 The move was

postponed in the hope that a more agreeable global

market-based solution would come out of the UN

ICAO (see Legislative and Regulatory Trends section).

In response, the ICAO agreed to build a global market-

based mechanism to monitor, report, and verify

aircraft emissions by 2016. However, given that the

UN’s deadline to implement the system is 2020, the

E.U. may not be satisfied and could still require non-

E.U. airlines to comply with their ETS requirements.47

Meanwhile, the IATA, which represents 85 percent of

the world’s airline traffic, is calling for airlines to offset

increased emissions after 2020 by purchasing carbon

credits. In this scenario, it is estimated that the cost to

the industry could be up to 0.5 percent of total

international airline revenue, assuming the cost of

credits to be $4 to $6 per metric ton in 2015.48

In April 2014, Germany fined 61 airlines from several

countries including the U.S. for breaching E.U. ETS

rules and for failing to submit emissions permits to

cover GHG discharges from the flights within the EEA.

The amount of total penalties is close to $3.7 million,

and the fine is the first since aviation was included in

the E.U. carbon market. Under the E.U. law, aircraft

operators failing to surrender the required number of

permits can be fined EUR100 per metric ton of CO2.49

If the E.U. ETS rules extend to flights to and from the

EEA, the financial impact of non-compliance is likely to

increase in the future.

Furthermore, cost of jet fuel is a significant operating

expense for aircraft operators and can put the business

at risk during times of rising or volatile fuel prices. In

2012, the global airline industry spent $207.6 billion

on fuel, which was 31 percent of its operating costs.50

Airlines for America, the largest U.S. airline trade

association, estimates that for every dollar that the

price of jet fuel increases, the U.S. airlines industry

pays an additional $445 million for fuel per year.51

Along with other factors, increasing oil prices led more

than 50 passenger and cargo airlines in the U.S. to file

for bankruptcy between 2000 and 2012.52

To limit their exposure to volatile oil prices, some

companies in the industry use fuel hedging strategies

or even operate their own refineries.53 All of the top

ten U.S.-domiciled companies by revenue acknowledge

in their 2012 annual filings with the SEC that they are

materially impacted by changes in aircraft fuel prices.

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Nine of these 10 companies are using financial

instruments to hedge fuel prices, and they disclose

metrics on the percentage of their fuel use that is

hedged in their filings.

In their fiscal year (FY) 2012 Form 10-K, Republic

Airways describes the extent to which fuel price

volatility impacts their cash flow, stating that “a one

dollar change in price per barrel of crude oil will

increase or decrease our fuel expense by $3.8 million.”

In 2012, $3.8 million represented 0.5 percent of

Republic Airways’ aircraft fuel costs for the year and a

meaningful 7.4 percent of profits.54 For Alaska Airlines

“a $1 per barrel increase in the price of oil equates to

approximately $11 million of additional fuel cost

annually.”55 For United Continental, the increase

would be $94 million annually.56

Fuel management in the form of efficiency

improvements or hedging strategies is therefore critical

for the profitability of companies, like Republic

Airways and others in the Airlines industry. It also

enables companies to lower their GHG emissions, and

therefore, regulatory risks discussed earlier.

Another way for the industry to mitigate GHG

emissions is through the use of biofuels. The largest

hurdle in switching to biofuels is cost, not technology.

Airlines already spend 25 to 35 percent of their

operating costs on jet fuel annually, and that number

would rise substantially by switching to biofuels at

current prices. When Alaska Airlines launched its first

commercial biofuel-powered flight in 2011, it paid six

times the cost of traditional jet fuel. Alaska Airlines

used a 20 percent biofuels blend, made from used

cooking oil, which it estimates reduces GHG emissions

by 10 percent.57

Although the use of biofuel blends can be beneficial,

biofuels themselves can generate negative

externalities. Irrigation for corn production means that

currently, biofuels are actually the most water-

intensive fuel source in the U.S. Water consumption

for biofuels is orders of magnitude greater than for

refining crude oil.58 Crop production for biofuels also

has the potential to distort other markets, such as the

food industry.

Advanced biofuels could reduce water consumption

significantly, but these technologies are yet to be

proven on a commercial scale.59 Short-term costs to

find commercially viable technologies can be

significant, and these are lowering investments in

advanced biofuels. However, investments in R&D for

such technologies could serve to advance airline

companies’ long-term profitability.

Despite the high costs of biofuels compared to

traditional jet fuel, airlines are acting to make aviation

biofuels more commercially viable, due to the

importance of reducing GHG emissions for the

industry. In its 10-K Form for FY2012 United

Continental Holdings, Inc. states that “(t)he Company

is taking various actions to reduce its carbon emissions

through fleet renewal, aircraft retrofits, and actions

that are establishing the foundation for the

commercialization of aviation biofuels.”60 As one of

the actions for the commercialization of aviation

advanced biofuels, United Airlines signed a purchase

agreement with AltAir Fuels to buy 15 million gallons

of lower-carbon, renewable jet fuel over a three-year

period. AltAir Fuels will retrofit part of an existing

petroleum refinery to become a 30 million gallon,

advanced biofuel refinery near Los Angeles. The fuel is

expected to help the company achieve a 50 percent

reduction in GHG emissions on a lifecycle basis. 61

The importance of managing the environmental

footprint of Airlines fuel use is reflected in current SEC

filings of the top companies in the industry.

Companies such as United Continental, Delta,

Southwest, and American Airlines, to name a few,

have started reporting on their fuel management

programs and initiatives, examples of which include

fleet renewal plans, aircraft retrofits, use of aviation

biofuels, programs to reduce fuel usage by ground

support operations, use of technology to modernize air

traffic control systems, and reductions in engine idle

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times, among others.

Value Impact GHG-intensive operations expose airlines to increasing

risk of chronic regulatory compliance costs, with direct

costs already occurring in some markets. In addition,

management of energy efficiency and energy mix

(including renewables) is key to the profitability and

risk profile of airlines. Compliance—expected or

actual—also leads to additional capital expenditures

(CapEx) to renew or retrofit fleets for energy

efficiency, with a potentially significant impact on

profitability and cash flow. At the same time,

investments in fuel-efficient and alternative fuel

engines will result in lower ongoing fuel expenses in

the medium term, improving profitability. As

international and national efforts continue to advance

regulation to reduce total GHG emissions, including in

the Airlines industry, the probability and magnitude of

these impacts are likely to increase in the near to

medium term. The magnitude of these impacts can be

estimated using companies’ Global Scope 1 emissions,

in absolute terms and relative to their peers, factoring

in regions of operations and mitigation efforts

reflected in concrete emissions-reduction targets.

In addition, while the cost of energy consumption is

already captured in financial results, overall energy

consumption indicates airlines’ exposure to possible

future increases in energy prices, resulting from

internalizing the growing environmental and social

impact of energy consumption. Reliance on specific

types of energy also creates operational risks, which

impact long-term profitability and ultimately the risk

profile of the company and its cost of capital. Lastly,

use of renewable energy indicates airlines’ ability to

mitigate their environmental footprint and exposure to

increases in energy costs driven by sustainability

impacts.

HUMAN CAPITAL

Human capital addresses the management of a

company’s human resources (employees and individual

contractors), as a key asset to delivering long-term

value. It includes factors that affect the productivity of

employees, such as employee engagement, diversity,

and incentives and compensation, as well as the

attraction and retention of employees in highly

competitive or constrained markets for specific talent,

skills, or education. It also addresses the management

of labor relations in industries that rely on economies

of scale and compete on the price of products and

services or in industries with legacy pension liabilities

associated with vast workforces. Lastly, it includes the

management of the health and safety of employees

and the ability to create a safety culture for companies

that operate in dangerous working environments.

In the Airlines industry, human capital issues revolve

around the dependence on a large number of workers

who are covered under collective bargaining

agreements. Even though unionization rates have

generally decreased, union participation in the Airlines

industry remains strong. Therefore, management of,

and communication around, issues such as worker pay

and working conditions is critical to prevent costly

worker strikes. Proper personnel training and ensuring

the health and well-being of crew members is critical

to ensuring safety. The issue is covered in the

“Accidents & Safety Management” section of the

brief.

Labor Relations The Airlines industry employs several types of skilled

workers, including pilots, flight attendants, baggage

handlers, maintenance workers, and ticket agents.

Wages were the largest cost component for airlines

until recent increases in fuel prices replaced labor costs

with fuel costs as the largest cost item. Organized

labor plays an important role in the industry as there

are high levels of unionization—some U.S.-listed

airlines have as much as 97 percent union

participation. There are several major airline unions

that govern negotiations, including the U.S. Airline

Pilots Association, Air Line Pilots Association,

Association of Flight Attendants, and the Transport

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Workers Union.62

Unions can protect worker rights and negotiate wages

due to their bargaining power. In countries with strong

labor laws or in industries with union representation,

wages tend to be higher than in the absence of strong

worker laws and enforcement, representing to an

extent better protection of worker rights. Unionization

of key personnel leaves airlines vulnerable to service

shutdowns resulting from strikes if management is

unable to address worker demands, which reduces

industry revenue and disrupts economic activity.

Additionally, collective bargaining may result in higher

labor costs via wage or benefits increases. Some older

U.S. airlines also face larger burdens from legacy

pensions compared with their younger counterparts,

and bankruptcies are a means to reduce these

liabilities. This creates a risk for labor rights if worker

pay or benefits are significantly reduced as a result.

Proper management of, and communication around,

issues such as worker pay and working conditions can

prevent conflicts with workers that could lead to

strikes that can severely impact revenue and create

reputational risk.

Airlines with newer operations in the U.S. have lower

unionization rates or pension liabilities. For companies

with low unionization rates in an industry

characterized by otherwise high union participation, a

short-term view on worker compensation, contract

terms, and working conditions could create a potential

for disruption as workers begin to demand better

standards through increasing unionization or other

actions.

Proper management of, and communication around,

issues such as worker pay and working conditions can

prevent conflicts with workers that could lead to

extended periods of strikes, which can slow or shut

down operations and create reputational risk. Airlines

need a long term perspective on managing workers,

including their pay and benefits, in a way that protects

worker rights and enhances their productivity while

ensuring the financial sustainability of a company’s

operations.

Company performance in this area can therefore be

analyzed, internally and externally, through the

following direct or indirect performance metrics (see

Appendix III for metrics with their full detail):

• Percentage of workers covered by collective-

bargaining agreements; and

• Number and duration of strikes and lockouts.

Evidence Labor unions play a critical role in the global Airlines

industry. Over one-third of all workers in the U.S. air

transportation industry are unionized: in 2013, 37.1

percent of workers were union members and 38.6

percent were covered by collective bargaining

agreements.63 Some airlines, such as China Eastern,

LATAM, Alaska, and Southwest Airlines, report higher

rates of unionization, with rates of between 31 and 97

percent.64 Most major carriers are highly unionized,

while national and regional carriers include a mix of

union and nonunion workplaces.65 In contrast, only 7.5

percent of all U.S. private sector workers were covered

by unions in 2013. In durable goods manufacturing, a

traditional union stronghold, union density fell from

32.1 in 1983 to 10.9 percent in 2013.66

Wages at U.S.-domiciled international and domestic

airlines are estimated to represent 22.1 and 10 percent

of revenue for 2013, respectively.67 Costs are also high

for non-U.S. international airlines. For example, Latin

American airline LATAM reported labor costs as 20

percent of total operating expenses in its FY2013 20-F

filing.68 It is estimated that airline workers covered by

collective bargaining agreements enjoy a wage

premium. Across all airline workers, between 1995 and

2000, union members had a wage premium of about

15 to 25 percent,69 which may account for the

significance of labor costs.

Heavy union participation in the Airlines industry

presents considerable operating risk, if relations

between labor and management are strained. Many of

LATAM’s pilots, flight attendants, mechanics, and

airport personnel are unionized. The company

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recognizes the risks associated with poor labor

relations in its FY2013 20-F form by disclosing that

strikes, walk-outs, or stoppages by these groups could

“severely disrupt our operations and negatively impact

our operating and financial performance, as well as

how our customers perceive us.”70

Airlines have tried to reduce their labor costs through

bankruptcies and mergers. Without early engagement,

unions may limit the ability of companies to quickly

adjust labor expenses and the size of their workforce

in response to competitive pressures or adverse

economic conditions. After the crisis in early 2000s,

several major U.S. carriers entered bankruptcy. Among

the factors responsible were high labor costs, rising

fuel prices, competition from low cost carriers, and low

demand. U.S. Airways entered bankruptcy in 2002 and

2004, United in 2002, Delta and Northwest in 2005. In

2003, American Airlines was able to avoid bankruptcy

after negotiating concessions with unions.71

In 2012, American Airlines was forced to cancel

hundreds of flights when a large number of pilots

called in sick to protest a contract that would reduce

their pay and benefits at the then-bankrupt carrier.72

The possibility of reductions in pay and benefits can

also lead to worker actions that pose difficulties during

merger proceedings. Recently, the likelihood of a flight

attendants’ strike at Piedmont Airlines threatened the

pending merger of its parent company, U.S. Airways,

with American Airlines. Piedmont flight attendants

formed picket lines in June 2013, looking to share in

the success of U.S. Airways. This came in the midst of

U.S. Airways’ bid for approval from federal regulators

for its proposed merger with American Airlines.73 At

the same time, unions can play an important role in

working with management to resolve difficulties in

operations. As part of the same proposed U.S.

Airways-American Airlines merger, U.S. Airways’ union

leaders met with leaders at the Department of Justice

to register their support for the merger as a means to

preserve jobs.74 This case highlights both the positive

and negative impacts of worker actions related to

wages and working conditions for airlines in their

merger activities and operations generally.

Several examples of strikes and near-strikes highlight

the potential material impacts on airlines of poor labor

relations. On June 12, 2010 Spirit Airlines pilots went

on strike for better wages, grounding flights for

thousands of passengers. 75 The pilots claimed that

they had been “working at below market rates and

work rules for years.”76 The airline refunded

passengers’ tickets and gave them $100 toward future

flights. The strike was resolved and pilots went back to

work on June 18, 2010. The resolution included better

pay, retirement benefits, and performance reviews to

acknowledge leadership initiative. The strike is

reported to have cost Spirit Airlines $19 million;

however, the company reported a loss of $2.8 million

in the first six months of 2010.77 The event highlights

the challenges that can result from employee strikes

related to wages and working conditions, and

emphasizes the importance of management

recognizing and addressing worker concerns in a

timely manner, and maintaining good communication

between management and employees. Likewise, pilot

strikes resulted in 160 canceled Avianca flights in

2013. Pilots of the U.S.-listed Colombian airline

claimed that in 2003 they agreed to increase working

hours from 75 to 90 hours a month under the promise

of benefits that did not materialize.78

Value Impact Labor-intensive industries with well-defined

occupations are prone to high rates of unionization, as

employees with similar skills and compensation have

an incentive to resort to collective bargaining in their

negotiations with management. The bargaining power

that comes with unionization leads to higher wages

and other compensation costs, as well as pension

liabilities. This is likely to be particularly material in the

Airlines industry, where median net income margins

are already at 2.4 percent.79 Unionization can also lead

to labor disputes and service disruptions with short-

term impact on revenue and longer-term impact on

reputation and brand value, and ultimately market

share.

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New entrants or disruptors in highly unionized

industries often have a short-term competitive

advantage from low unionization rates and lack of

pension liabilities. However, these companies incur the

risk of a medium-term shift in cost structure as growth

tapers and cost-cutting initiatives drive employees to

collective bargaining. The number of work stoppages

provides a measure of past performance on labor

practices, while the percentage of employees

unionized provides an indication of companies’

exposure to wage cost increases and possible future

labor disputes.

BUSINESS MODEL AND INNOVATION

This dimension of sustainability is concerned with the

impact of environmental and social factors on

innovation and business models. It addresses the

integration of environmental and social factors in the

value creation process of companies, including

resource efficiency and other innovation in the

production process. It also addresses product

innovation and looking at efficiency and responsibility

in the design, use-phase, and disposal of products. It

includes management of environmental and social

impacts on tangible and financial assets—either a

company’s own or those it manages as the fiduciary

for others.

Airline companies rely on innovation to maintain value.

Innovation that contributes to sustainability outcomes

in this industry centers around fuel management and

alternative fuels, which have been addressed in the

disclosure topic “Environmental Footprint of Fuel Use.”

LEADERSHIP AND GOVERNANCE

As applied to sustainability, governance involves the

management of issues that are inherent to the

business model. It also involves issues that are

common practice in the industry, and that are also in

potential conflict with the interest of broader

stakeholder groups (government, community,

customers, and employees) Therefore, these issues

create a potential liability, or worse, a limitation or

removal of license to operate. This includes regulatory

compliance, lobbying, and political contributions. In

addition: risk management, safety management,

supply chain and resource management, conflict of

interest, anticompetitive behavior, and corruption and

bribery. It also includes risk of business complicity with

human rights violations.

For the Airlines industry, leadership and governance

issues arise from the need to manage the safety of

highly complex, sensitive, and global operations,

including accident prevention. Accidents and other

safety incidents affect customers and employees, and

can also lead to significant economic losses in the case

of the cargo segment. The safety of passengers and

cargo is a priority for companies in the industry, and

mismanagement of the issue can have a significant

negative impact on company value.

Competitive Behavior

As described in the industry summary, the Airlines

industry is characterized by low profitability due to

high fixed capital and labor costs, as well as

competition with subsidized national carriers in foreign

markets. This pushes airlines to find economies of scale

through alliances or consolidation, which results in a

highly concentrated market with four players capturing

75 percent of the U.S. markets. The industry is also

characterized by high barriers to entry through limited

landing rights and increasing airport congestions.

Together, these factors can result in anticompetitive

practices that result in higher prices for consumers.

As a result, certain airline industry practices have been

scrutinized by antitrust authorities. These practices

include market concentration, airport slot

management, predatory pricing, and the

anticompetitive effects resulting from airline alliances

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and mergers. Any time a business action is held up in

legal limbo, there is a material risk to investors

stemming from legal fees, reputational risk, costs

associated with a delayed transaction, and limit to

growth by acquisition. Moreover, denied mergers may

press companies to declare bankruptcy.

The oldest and largest airline alliance is the Star

Alliance, originally formed between United and

Lufthansa, which has since been expanded to include

27 airlines worldwide. The other major alliances are

Sky Team and Oneworld, with 20 and 15 member

airlines respectively. Alliances can be controversial and

may have both positive and negative effects on

competitiveness and consumer pricing, and are

therefore heavily scrutinized. University of Illinois

economists found mixed effects on consumer pricing

as a result of alliances, claiming that prices to smaller

regional airports decrease due to alliances, while fares

to large gateway airports increase.80

Another industry dynamic that affects competition is

the availability of airport slots. Limited slots at some

airports effectively cap the supply to that region and

create a barrier to entry for new players. Incumbent

airlines have a dominant position because they are

allowed to maintain any slots they use regularly,

leaving little room for new players. The percentage of

slots held by companies is often considered in high-

profile mergers when evaluating anticompetitive

practices.81

Finally, the issue of competitive behavior revolves

around price-fixing practices within the cargo segment

of the industry. High industry consolidation makes it

easy for airlines to collude. There have been several

high-profile cases of price-fixing involving the cargo

segment of airlines. Major airlines were found to have

colluded on fuel surcharges.

Company performance in this area can be analyzed in

a cost-beneficial way internally and externally through

the following direct or indirect performance metrics

(see Appendix III for metrics with their full detail):

• Amount of legal and regulatory fines and

settlements associated with anticompetitive

practices.

Evidence Continuous consolidation of the industry drove the

number of major airlines from eight to four in the last

five years. Several studies show that mergers of airlines

eventually result in higher ticket prices for consumers.

According to The Wall Street Journal dissected data,

flight prices between some big cities increased by 40

to 50 percent after mergers. Particularly, by the third

quarter of 2012, fares between Chicago and Houston

(hubs of United Airlines and Continental Airlines prior

to the merger) increased by 57 over three years. The

average fares of United Airlines increased by only 16

percent over the same period.82

Ancillary fees (baggage fees and on-board food and

services) are a significant portion of revenue for

airlines. In 2013, United Airlines earned $5.7 billion in

ancillary revenue, the most of any airline globally. In

the same year, the total industry ancillary revenue was

$31.5 billion.83 With current consolidation trends and

the increasing share of the ancillary revenue, airlines

will likely increase fees as competition weakens.

Moreover, in the long term, airlines may reduce

benefits of their loyalty programs. Passengers flying

from non-major cities will be left with no choice of a

carrier, therefore, ‘loyalty’ will not be a decisive

factor.84

As mentioned above, merger and acquisition (M&A)

activity in the industry resulted in high market

consolidation. Even though the recent mergers were

approved, the cases had to go through lengthy reviews

and investigation. In 2013, a civil antitrust lawsuit was

filed by the Department of Justice (DOJ) to challenge

the proposed merger between US Airways and

American Airlines. The DOJ was seeking to

permanently block the $11 billion merger. Federal

courts were examining whether the merger would lead

to less competition in the industry and higher prices

for consumers. Prior to the merger, U.S. Airways held

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55 percent of the slots at Reagan National Airport;

post-merger, that would increase to 69 percent.

However, US Airways and American Airlines’ parent

company, AMR Corporation, argues that there are two

other major airports serving the Washington

metropolitan area, and post-merger, they would only

control 25 percent of aircraft seats in the market. The

news of the government’s antitrust suit caused US

Airways’ stock to fall 13 percent, and bonds of AMR

Corporation also dropped. AMR, which filed for

bankruptcy in November 2011, was using the merger

as a means to complete a reorganization and exit court

protection.85 If the merger was not approved, it could

result in American Airlines declaring bankruptcy.

For the merger to be approved, American Airlines had

to give up 52 round-trip slots at Washington Reagan

Airport and 17 round-trip slots at New York LaGuardia

Airport.86 Subsequently, Southwest Airlines and JetBlue

Airways won most of the slots that became available.87

The investigation of competitive behavior is also

affecting other companies in the industry. In 2011, a

$1.4 billion acquisition of AirTran by Southwest was

under the antitrust investigation. In its 10-K filing for

2012, Southwest Airlines stated: “AirTran is currently

subject to pending antitrust litigation, and if judgment

were to be rendered against AirTran in the litigation,

such judgment would adversely affect the Company’s

operating results.” The litigation is a 2009 class action

suit that accused AirTran of colluding with Delta

airlines in 2008 to fix baggage fees.88 The Southwest-

AirTran case was dismissed by a federal judge.89

Regulatory scrutiny of anticompetitive practices

extends beyond the U.S. and affects airlines’ global

operations. A federal court in Australia fined Emirates,

the UAE based airline, $10.2 million in 2012 for price-

fixing. The court found that the airline had engaged in

cartel conduct with other carriers by fixing prices

associated with fuel and other surcharges in its routes

to Australia. This example exposes that U.S.-listed

airlines are engaged in a global business and can be

held accountable for their actions in any country in

which they operate. The penalty comes from the

Australian Competition & Consumer Commission

(ACCC), which imposed a total of $68 million in fines

to Emirates and the other airlines involved in the

cartel.90

In 2010, the European Commission fined 11 air cargo

carriers, including Air France-KLM and British Airways,

a total of almost €800 million for anticompetitive

practices. The Commission alleged the companies of

forming a cartel and rigging surcharges for fuel and

security between May 2004 and February 2006. Air

France-KLM was hit with the largest fine: almost 43

percent of the total amount, €339.6 million, which

represented €0.91 per fully diluted share. It also

represented 7.3 percent of gross cash reserves on June

30, 2010.91

Value Impact

Perceived and actual anticompetitive practices can lead

to regulatory fines and penalties that increase

extraordinary expenses and contingent liabilities and

negatively affect a company's bottom line. Denial by

federal antitrust authorities to proceed with merger

plans limits the ability of companies to grow by

acquisitions, something of particular importance for

airlines given the maturity of the industry and the

difficulty of growing organically in markets with

incumbents’ landing rights. Market concentration can

lead to increased scrutiny from antitrust authorities

and can impact airlines’ ability to raise prices, with

subsequent impact on revenue. Increased antitrust

oversight can also raise the risk profile of airlines,

raising their cost of capital. Beyond high-publicity

antitrust actions during mergers or otherwise, ongoing

legal and regulatory fines associated with

anticompetitive practices indicate airlines’ ability to

maximize profit while managing a sensitive competitive

environment.

Accidents & Safety Management

Passenger safety is a paramount issue in the Airline

industry, given the nature of air travel and extreme

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situations in which incidents can occur. Although air

travel is one of the safest modes of transport, airlines

are held to very high safety standards, with consumers

expecting completely safe and accident-free

operations. Furthermore, as products transported by

air tend to be high value or perishable goods,

delivering them from point A to point B safely and in a

timely manner is a priority for any carrier. Moreover,

airline accidents may result in significant

environmental and social externalities and require

companies to pay for remediation and compensation

of victims.

Safety incidents or violations of safety regulations can

lead to a chronic impact on reputation. They can also

lead to lower demand from passengers, as well as

cargo shippers. Larger accidents, even if they happen

rarely, can lead to significant and long-term impacts

on reputation and revenue growth.

Proper personnel training, and ensuring the health and

well-being of crew members, is critical to ensuring

safety. Equally, timely and adequate maintenance of

aircrafts can help operators minimize chances of

technical failure and avoid severe regulatory penalties

for non-compliance. The FAA standards for both

aircraft maintenance and pilot scheduling and training

are quite stringent; however, this is a global industry

and airlines that maintain the highest safety standards

throughout their international operations are likely to

experience fewer safety incidents.

The FAA maintains rules regarding pilot scheduling to

ensure pilots have adequate rest when they enter the

cockpit for the duration of their work. The rules cover

the flight duty period,V flight time limitsVI, rest period

minimums, and cumulative fatigue.92 These rules

provide a minimum set of standards, but as the

evidence below suggests, pilot fatigue is a challenging

issue for the industry, with devastating consequences

and requiring careful oversight.

V A period that starts when a pilot reports for duty and ends when he or she reaches the gate at the end of his or her flight. VI The actual time spent operating the aircraft.

Company performance in this area can be analyzed in

a cost-beneficial way internally and externally through

the following direct or indirect performance metrics

(see Appendix III for metrics with their full detail):

• Description of implementation and outcomes of

Safety Management System;

• Number of accidents; and

• Number of governmental enforcement actions

of aviation safety regulations.

Evidence Cultivating the image of a relatively safe means of

transportation, the aviation industry must constantly

strive to maintain the highest standards to ensure

safety of passengers and cargo. In general, accidents in

the industry are rare. But when they occur, they may

have significant social externalities as well as acute

financial impacts on companies. According to IATA,

there were 36.4 million flights in 2013, with 16 fatal

accidents and 210 fatalities globally—a rate of 0.44

fatal accidents per million flights.93 There are several

factors that contribute to accidents in the industry. The

majority of fatal airline accidents are due to pilot error,

accounting for 51 percent of incidents. The next

highest contributor, mechanical failure, accounts for

20 percent of fatal accidents.94This highlights the

importance of rigorous employee training, fleet

maintenance, operational measures, and ensuring that

the pilot and crew are well rested and alert.

Safety incidents and accidents can create burdensome

costs and liabilities for airlines by requiring further

accident prevention measures, remediating actions,

and compensation of victims. The recent crash of an

Asiana Airlines flight while landing at San Francisco

International Airport took three lives and called into

question pilot flying skills and cockpit teamwork. While

investigations are still pending, Asiana has committed

to increasing crew training, and has brought in third-

party consultants to evaluate their program’s

effectiveness.95 Survivors of the crash are suing both

Asiana and Boeing for poor pilot training and aircraft

design.96 Even in the absence of incidents or accidents,

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evidence suggests that violations of safety regulations

can have acute impacts on value through regulatory

penalties. On July 28, 2014, the FAA imposed a $12

million fine against Southwest Airlines for non-

compliance with safety regulations during their aircraft

repairs.97 In 2009, the company was already fined $7.5

million by the FAA for flying planes without critical

safety checks.98 In 2013, American Airlines and three

of its subsidiaries paid $24.9 million to settle FAA

claims of alleged safety violations between 2007 and

2011.99

Among other things, the new FAA rules, which go into

effect in 2014, require a 10-hour minimum rest period

prior to a pilot’s flight duty period, a two-hour

increase over the old rules. The rules also mandate that

a pilot must have an opportunity for eight hours of

uninterrupted sleep within the 10-hour rest period,

and that pilots will be limited to no more than nine

hours of flight time. Pilots will also be limited to 28

working days in a month and will be required to be

given at least 30 consecutive hours free from duty on a

weekly basis, a 25 percent increase over the old

rules.100

As pilot error is the main contributing factor to fatal

airline accidents, ensuring health and well-being of

pilots is crucial for safety management. In May 2009,

Continental Airlines’ regional carrier Gulfstream

received a $1.3 million civil penalty from the FAA for

overworking pilots and breaking aircraft maintenance

rules.101 In the week following the announcement,

Gulfstream’s stock fell 21 percent and eventually

plummeted 51 percent by the end of the year.102 The

FAA investigation began with a complaint filed by a

Gulfstream pilot and was eventually settled in 2010,

with Gulfstream agreeing to pay $550,000.

The fine for Gulfstream came just after the crash of

Continental Flight 3407, which took place in Buffalo,

NY, when the flight experienced an aerodynamic stall

and crashed into a house. All 49 on board the flight

were killed, as well as one person on the ground. The

National Transportation Safety Board (NTSB) released

documents during the hearing that indicated the pilots

made a series of errors leading up to the crash.

Additional testimony at the hearing suggests that the

pilots may have suffered from fatigue (from

commuting from their homes in Florida and Seattle) to

work out of Newark Liberty International Airport.103

Financial impact from fatal accidents goes beyond

substantial regulatory penalties. Following the two

crashes of Malaysian Airlines, the company

experienced “a sharp decline” in weekly bookings.

Damaged reputation and low demand for services

resulted in net loss $97.4 million in the second quarter

of 2014. The company is likely to experience

difficulties in the long-term to gain market confidence

back and increase sales.104

Usually, the most valuable products are transported by

air, when time and safety matter the most. Even

though goods transported by air account for only 0.5

percent of global trade, they represent over 35 percent

by value, which equals approximately $6.8 trillion

annually.105 The loss of valuable cargo as a result of

accidents can therefore have a significant economic

impact.

Cargo may contain hazardous materials, which

substantially increases the risk of transport. Companies

that fail to comply with safety requirements in

transporting hazardous products may be prone to

incidents that could not only result in a loss of cargo,

but in hull losses in extreme cases. There were 144 air

incidents recorded by the FAA from March 20, 1991 to

May 19, 2014 that involved batteries carried as cargo

or baggage.106 In September 2011, an Asiana Airlines

cargo plane crashed into the East China Sea after a fire

on board. The jet was carrying lithium batteries.

Moreover, on September 3, 2010, a UPS plane carrying

more than 81,000 lithium batteries caught on fire and

crashed at a military base shortly after taking off,

killing both pilots.107

Lastly, airlines with a poor safety record are likely to

experience a long-term negative value impact from

increased insurance premiums. For example, following

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the twin tragedy of Malaysian Airlines flights in 2014,

the insurance industry is likely to lose $2 billion. The

prices for all-risk policies that cover liability claims,

compensation payments to passengers, legal fees, and

physical damage to aircraft (not caused by hostile acts)

are expected to rise, according to a Financial Times

report.108

In their SEC filings, airlines recognize the extent of

various material impacts that may follow accidents. For

example, in its Form 10-K, Alaska Air Group states:

“[the company] could experience significant claims

from injured passengers, by-standers and surviving

relatives, as well as costs for the repair or replacement

of a damaged aircraft and its consequential temporary

or permanent loss from service. We maintain liability

insurance in amounts and of the type generally

consistent with industry practice, as do our codeshare

partners and CPA carriers. However, the amount of

such coverage may not be adequate to fully cover all

claims and we may be forced to bear substantial

economic losses from an accident. Substantial claims

resulting from an accident in excess of our related

insurance coverage would harm our business and

financial results.”109

Value Impact Major airline accidents in which passengers are injured

are global news events. Whether incidents occur due

to mechanical failure, human error, or unpredictable

circumstances, they can negatively affect the

reputation of a carrier, with acute and long-term

impacts on revenue and market share. Accidents also

lead to extraordinary expenditures and contingent

liabilities related to compensation of victims and

regulatory sanctions, which have an acute impact on

value. Failure to comply with safety standards can

result in chronic impacts on value through fines and

additional capital requirements to remain in

compliance. Poor safety records can also increase the

risk profile of airlines, resulting in higher insurance

premiums and cost of capital. The number of

accidents—defined broadly to include passenger safety

and mechanical failures—indicate trends in safety

records beyond high-publicity events. Safety

Management Systems (SMS), together with

government regulatory actions, provide a sense of how

companies are proactively managing safety above and

beyond regulatory requirements. Increasing oversight

and enforcement of safety standards around pilot

fatigue is likely to increase the magnitude of these

impacts in the near to medium term.

SASB INDUSTRY WATCH LIST

The following section provides a brief description of

sustainability issues that did not meet SASB’s

materiality threshold at present, but could present a

material issue in the future.

Noise & Light Pollution: The human and

environmental impacts of noise and light from

aircrafts, particularly near airports, continues to be a

topic of concern for communities living near airports.

A recent study by researchers at Harvard School of

Public Health and Boston University School of Public

Health have linked exposure to aircraft noise with

higher hospitalizations for cardiovascular disease. This

is likely due to exposure to noise being related to

stress reactions and increased blood pressure, both of

which are risk factors for cardiovascular disease.

Public health concerns for local residents have played a

role in limiting airport expansions. A German court

banned flights landing at Frankfurt between 11 p.m.

and 5 a.m. as a result of residents protesting excessive

noise. Such restrictions are of material concern to

airlines whose landing slots were scheduled during

those hours. In Frankfurt, the ban was estimated to

cost the cargo arm of Lufthansa €40 million. While

plane engines are getting less noisy, the increase in

flight traffic may still lead to exposure to increased

noise levels. This has led to many airports restricting

maximum decibel levels for individual flight landings

and in aggregate. A lesser understood impact of

increased flight traffic is light pollution. While light

pollution from urban centers is brighter but localized,

light from flights can span larger distances. Artificial

I N D U S T R Y B R I E F | A I R L I N E S | 17

light has an effect on the ecosystem and migratory

animals that use light sources to direct them. Public

concern regarding noise and light pollution from

aviation may lead to regulations that could have a

material impact on airlines in the future.

Pilot Recruitment & Inclusion: Airlines are facing

three important trends that contribute to talent

shortage: (1) increasing federal requirements for

minimum pilot training, (2) reductions in working

hours to diminish fatigue, and (3) higher-than-normal

retirement rates, driven by an aging population of

pilots. These two issues have a compounding effect on

access to talent for companies in this industry.

The Airlines industry is characterized by significant

gender and racial gaps in workforce representation.

According to the U.S. Bureau of Labor Statistics, in

2012, only four percent of the 129,000 aircraft pilots

and flight engineers in the U.S. were women.110 This

trend has been stagnant for over a decade. The gender

gap can be partially explained by a larger pool of men

with backgrounds in the military, where they receive

training. The racial bias in the industry is also

significant. According to the 2012 annual average data

from the U.S. Bureau of Labor Statistics, 93 percent of

the 129,000 aircraft plots and flight engineers were

white. Meanwhile, only 2.7 percent were black or

African-American, 2.5 percent Asian, and 5 percent of

Hispanic or Latino ethnicity. Women have only been

allowed to become fighter pilots since 1993, and are

able to retire after 20 years with the Air Force. As a

result, the industry may soon benefit from a greater

pool of military-trained female pilots.111 Companies

that are among the first to seize this opportunity may

be better positioned in protecting their pilot pipeline,

avoiding talent shortages, and improving their

reputation.

I N D U S T R Y B R I E F | A I R L I N E S | 18

APPENDIX I FIVE REPRESENTATIVE AIRLINES COMPANIESVII

VII This list includes five companies representative of the Airlines industry and its activities. This includes only companies for which the Airlines industry is the primary industry, companies that are U.S.-listed but are not primarily traded Over-the-Counter, and for which at least 20 percent of revenue is generated by activities in this industry, according to the latest information available on Bloomberg Professional Services. Retrieved on July 10, 2014.

COMPANY NAME (TICKER SYMBOL)

United Continental (UAL)

Delta Airlines (DAL)

American Airlines Group (AAL)

Southwest Airlines (LUV)

China Southern Airlines - ADR (ZNH)

I N D U S T R Y B R I E F | A I R L I N E S | 19

APPENDIX IIA EVIDENCE FOR SUSTAINABILITY DISCLOSURE TOPICS

HM: Heat Map, a score out of 100 indicating the relative importance of the topic among SASB’s initial list of 43 generic sustainability issues; asterisks indicate “top issues.” The score is based on the frequency of relevant keywords in documents (i.e., 10-Ks, shareholder resolutions, legal news, news articles, and corporate sustainability reports) that are available on the Bloomberg terminal for the industry’s publicly-listed companies; issues for which keyword frequency is in the top quartile are “top issues.”

IWGs: SASB Industry Working Groups

%: The percentage of IWG participants that found the disclosure topic to likely constitute material information for companies in the industry. (-) denotes that the issue was added after the IWG was convened.

Priority: Average ranking of the issue in terms of importance. One denotes the most important issue. (-) denotes that the issue was added after the IWG was convened.

EI: Evidence of Interest, a subjective assessment based on quantitative and qualitative findings.

EFI: Evidence of Financial Impact, a subjective assessment based on quantitative and qualitative findings.

FLI: Forward Looking Impact, a subjective assessment on the presence of a material forward-looking impact.

Sustainability Disclosure Topics

EVIDENCE OF INTEREST

EVIDENCE OF

FINANCIAL IMPACT

FORWARD-LOOKING IMPACT

HM (1-100)

IWGs EI

Revenues &

Costs

Assets & Liabilities

Cost of Capital

EFI

Probability & Magnitude

Exter- nalities

FLI

% Priority

Environmental Footprint of Fuel Use

97* 100 1 High • • High • • Yes

Labor Relations 60* 86 3 High • • Medium No

Competitive Behavior

80* 91 4 High • • • High No

Accidents & Safety Management

50 73 2 Medium • • • High No

I N D U S T R Y B R I E F | A I R L I N E S | 20

APPENDIX IIB EVIDENCE OF FINANCIAL IMPACT FOR SUSTAINABILITY DISCLOSURE TOPICS

MEDIUM IMPACT H IGH IMPACT

Evidence of

Financial Impact

REVENUE & EXPENSES

ASSETS & LIABILITIES

RISK PROFILE

Revenue

Operating Expenses

Non-operating

Expenses

Assets

Liabilities

Cost of Capital

Industry Divestment

Risk

Market Size

New Markets Pricing Power

COGS

R&D

CapEx

Extra- ordinary Expenses

Tangible Assets

Intangible

Assets

Contingent Liabilities & Provisions

Pension & Other

Liabilities

Environmental Footprint of Fuel Use

•

•

•

Labor Relations •

•

•

•

Competitive Behavior • •

•

• •

Accidents & Safety Management

•

•

• • • • •

•

I N D U S T R Y B R I E F | A I R L I N E S | 21

APPENDIX III SUSTAINABILITY ACCOUNTING METRICS – AIRLINES

TOPIC

ACCOUNTING METRIC

CATEGORY

UNIT OF MEASURE

CODE

Environmental Footprint of Fuel Use

Gross global Scope 1 emissions Quantitative

Metric tons CO2-e

TR0201-01

Description of long-term and short-term strategy or plan to manage Scope 1 emissions, emissions reduction targets, and an analysis of performance against those targets

Discussion and Analysis

n/a TR0201-02

Total fuel consumed, percentage renewable Quantitative Gigajoules, Percentage (%)

TR0201-03

Notional amount of fuel hedged, by maturity date Quantitative Millions of gallons, Year

TR0201-04

Labor Relations Percentage of active workforce covered under collective-bargaining agreements, broken down by U.S. and foreign employees

Quantitative Percentage (%) TR0201-05

Number and duration of strikes and lockoutsviii Quantitative Number, Days TR0201-06

Competitive Behavior

Amount of legal and regulatory fines and settlements associated with anti-competitive practicesix

Quantitative U.S. Dollars ($) TR0201-07

Accidents & Safety Management

Description of implementation and outcomes of Safety Management System

Discussion and Analysis

n/a TR0201-08

Number of accidents Quantitative Number TR0201-09

Number of governmental enforcement actions of aviation safety regulations

Quantitative Number TR0201-10

viii Note to TR0201-06 - Disclosure shall include a description of the root cause of the stoppage, impact on operations, and corrective actions taken. ix Note to TR0201-04 - Disclosure shall include a description of fines and settlements and corrective actions implemented in response to events.

I N D U S T R Y B R I E F | A I R L I N E S | 22

APPENDIX IV: Analysis of SEC Disclosures Airlines

The following graph demonstrates an aggregate assessment of how the top ten U.S.-listed Airline companies by revenue are currently reporting on sustainability topics in the SEC Disclosures.

I N D U S T R Y B R I E F | A I R L I N E S | 23

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