Operating Leverage, Coordination Failures, and Systematic Risk
58 Pages Posted: 4 Jun 2018 Last revised: 16 Jun 2019
Date Written: June 2019
We study an economy where demand spillovers make firms' production decisions strategic complements. Firms have access to an increasing returns to scale technology and choose their operating leverage ex ante trading off higher fixed costs for lower variable costs. Operating leverage governs firms exposures to an aggregate labor productivity shock, the only source of uncertainty in the economy. In equilibrium, firms' operating leverage is too high because firms do not internalize that an economy with higher aggregate operating leverage is more likely to fall into a self-fulfilling equilibrium with inefficiently low output after a bad productivity shock. Welfare losses
coming from firms' failure to coordinate production ex post are amplified by suboptimal risk-taking ex ante. Excessive operating leverage contributes to systematic risk by magnifying the impact of productivity shocks onto aggregate output.
Keywords: coordination failure, operating leverage, systematic risk
JEL Classification: D80, D61, D62
Suggested Citation: Suggested Citation