The first definition is rooted in the fact that pursuant to Article 17 of the Convention on International Civil Aviation aircraft have the nationality of the state in which they are registered. U.S. law (14 CFR § 121.153 (a) (1)) requires American air carriers to operate aircraft registered in the United States and most countries have similar laws. Thus when an airline operates an international route, between two countries, having been designated pursuant to a Bilateral Air Transport Agreement any crime that would be committed on board would be prosecuted under the laws of the airline's state. Article 3 (1) of Tokyo Convention declares that "The State of registration [of the aircraft] is competent to exercise jurisdiction over "offenses and acts committed on board." " Therefore the aircraft is truly carrying the flag of its country. The American definition of "U.S.-flag air carrier service" contained in 48 CFR 47.403-1. is based on this first definition. The U.S. requirements under the Fly America Act, are consistent with requiring that Title 18 of the United States Code (U.S. Criminal Law) would protect U.S. government employees on flights to foreign countries.
The second and more broadly used definition of "flag carrier" is a legacy of the time when countries established state-owned airline companies. Governments then took the lead due to the high capital costs of establishing and running airlines. However, not all such airlines were government-owned; Pan Am, TWA, Cathay Pacific, Union de Transports Aériens, Canadian Pacific Air Lines and Olympic Airlines were all privately owned. Most of these were considered to be flag carriers as they were the "main national airline" and often a sign of their country's presence abroad.
The heavily regulated aviation industry also meant aviation rights are often negotiated between governments, denying airlines the right to an open market. These Bilateral Air Transport Agreements similar to the Bermuda I and Bermuda II agreements specify rights awardable only to locally registered airlines, forcing some governments to jump-start airlines to avoid being disadvantaged in the face of foreign competition. Some countries also establish flag carriers such as Israel's El Al or Lebanon's Middle East Airlines for nationalist reasons, or to aid the country's economy, particularly in the area of tourism.
In many cases, governments would directly assist in the growth of their flag carriers typically through subsidies and other fiscal incentives. The establishment of competitors in the form of other locally registered airlines may be prohibited, or heavily regulated to avoid direct competition. Even where privately run airlines may be allowed to be established, the flag carriers may still be accorded priority, especially in the apportionment of aviation rights to local or international markets.
In the last two decades, however, many of these airlines have since been corporatized as a public company or a state-owned enterprise, or completely privatized. The aviation industry has also been gradually deregulated and liberalized, permitting greater freedoms of the air particularly in the United States and in the European Union with the signing of the Open Skies agreement. One of the features of such agreements is the right of a country to designate multiple airlines to serve international routes with the result that there is no single "flag carrier".