(FORTUNE Magazine) – "Can you not smile?" asked the photographer, seeking a somewhat less ebullient pose. Donald Carty, chairman and CEO of AMR Corp., the parent of American Airlines, shook his head. "I don't do that naturally," he said, grinning.

One might wonder just what Carty has to smile about. He's only 17 months into his tenure in the top job, and already he's encountered more trouble than some CEOs face in a career: an 11-day pilots' sickout that left 600,000 passengers stranded and furious; a Justice Department suit accusing the company of predatory pricing; a sting operation in Miami that charged dozens of American's employees with smuggling what they believed to be grenades and drugs; overwhelming rejection by the flight attendants' union of a tentative contract; and a crash in Little Rock that claimed 11 lives. Passenger complaints are up; the stock is down. "There was a little bit of a honeymoon period," notes Carty. "It wasn't very long."

Yet Carty sees his company on the brink of a major cultural transformation--a transformation that he claims will make American, now the industry's second-biggest carrier, its undisputed leader. The cornerstone of Carty's initiative: having fun.

It's hard to imagine a corporation less likely to embrace the warm and fuzzies. American, based in Fort Worth, has long had rocky labor relations. Even while leading the company to record profits, Robert Crandall, Carty's predecessor and ex-boss, had an infamously autocratic style that earned him the nickname "Fang." An internal survey Carty commissioned last year confirmed what everyone knew: American suffered from a hyperaggressive, top-down culture, where fallible underlings had come to expect abuse from their bosses. And unhappy employees were often surly to passengers.

All this bubbled over in February, nine months after Carty had taken over, when the company pilots' union, skeptical about the CEO's motives for acquiring tiny Reno Air, staged an illegal sickout that crippled the airline. While the integration of Reno wound up creating 150 new American captain's jobs, the pilots had suspected Carty was scheming to replace union members with lower-paid Reno employees. "Our interests were totally allied with the pilots," insists Carty. "But they didn't believe it. They believed we were smart enough to figure out a way to screw 'em."

The sickout, which ended when a Texas judge imposed a huge fine on the union, cost the airline $225 million in earnings. Carty had clearly underestimated the depth of the pilots' bitterness. American captain Rich LaVoy, president of the Allied Pilots Association, claims that Carty had been unwilling to commit to an acceptable timetable for the Reno integration. "There's tremendous pent-up frustration," he says.

The new CEO seems to have learned as much. He now says it will take a year or two of delivering on promises to repair his company's "breach of trust" with its pilots. "The perception of a lot of our employees is that we don't care about them," he says. Meanwhile, he's established a casual dress code, he signs off weekly messages to employees with "have fun," and he's named a customer-service czar who preaches the slogan, "Don't be a jerk!"

All the talk about "fun" emanates from observing Southwest Airlines, the Texas rival where employees earn less but are far happier--and have happier passengers. "They all hug each other and do high-fives when they walk through the terminals," says American vice president Tim Doke. "Our guys don't." Southwest's charismatic CEO Herb Kelleher, who has been known to dress up as Elvis Presley, has much to do with this. It's hard to imagine Carty--a Harvard MBA and a Canadian--aping that. ("No Elvis costumes. They don't come in my size," demurs the 6-foot-4 53-year-old.) But his Jimmy Stewart-ish amiability does contrast sharply with Bob Crandall's Bobby Knight-ish abrasiveness.

There is, of course, more to Carty's plan for remaking American than his niceness initiative. He's sold off noncore businesses, increased domestic flights, and vastly expanded American's feeder network internationally through alliances with other airlines. He also plans to upgrade inflight services. "We're not counting olives anymore," he says, referring to a notorious Crandall initiative to save $80,000 a year by using fewer olives in salads.

After what even Carty acknowledges has been "a pretty ugly year," the CEO is still smiling. "You're turning the Titanic when you turn one of these companies," he says. "They don't turn on a dime. But they do turn. I'm absolutely convinced of that."