Operating Leverage, Coordination Failures, and Systematic Risk

58 Pages Posted: 4 Jun 2018 Last revised: 16 Jun 2019

See all articles by Matthieu Bouvard

Matthieu Bouvard

McGill University - Desautels Faculty of Management

Adolfo de Motta

McGill University - Desautels Faculty of Management

Date Written: June 2019

Abstract

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

Bouvard, Matthieu and de Motta, Adolfo, Operating Leverage, Coordination Failures, and Systematic Risk (June 2019). Paris December 2018 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=3189575 or http://dx.doi.org/10.2139/ssrn.3189575

Matthieu Bouvard (Contact Author)

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

Adolfo De Motta

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

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