Labor Leverage, Coordination Failures, and Aggregate Risk

Abstract

This paper studies an economy where demand spillovers make firms' production
decisions strategic complements. Firms choose their operating leverage
trading off higher fixed costs for lower variable costs. Operating leverage
governs firms' exposures to an aggregate labor productivity shock. In
equilibrium, firms exhibit excessive operating leverage as they do not
internalize that an economy with higher aggregate operating leverage is more
likely to fall into a recession following a negative productivity shock.
Welfare losses coming from firms' failure to coordinate production are
amplified by suboptimal risk-taking, which magnifies the impact of
productivity shocks onto aggregate output.

Keywords: coordination failure, operating leverage, systematic risk

JEL Classification: D80, D61, D62