Risk Sharing Within the Firm: A Primer

62 Pages Posted: 17 Jan 2020

See all articles by Marco Pagano

Marco Pagano

University of Naples Federico II - Department of Economics and Statistics; Centre for Studies in Economics and Finance (CSEF); Einaudi Institute for Economics and Finance (EIEF); Research Institute of Industrial Economics (IFN); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: December 12, 2019

Abstract

Labor income risk is key to the welfare of most people. This paper starts by asking why this risk is mainly insured “within the firm” and not by financial markets, and what restricts the extent of such risk sharing. It identifies four main constraining factors: public unemployment insurance, moral hazard on the workers’ side, limited commitment by firms, and workers’ wage bargaining power. These factors explain three empirical regularities: (i) family firms provide more employment insurance than nonfamily firms; (ii) the former pay lower real wages, and (iii) firms provide less employment insurance where public unemployment benefits are more generous. The paper also explores the connection between risk sharing and firms’ capital structure: highly leveraged firms have more unstable employment, so that greater leverage calls for high wages to compensate employees for job risk; nevertheless, firms may want to lever up strategically in order to offset the bargaining power of labor unions. Hence, the distributional conflict between shareholders and workers may limit risk sharing within the firm. By contrast, bondholders and workers are not necessarily in conflict, as both are harmed by firms’ risk-taking. Finally, firms may also insure employees against the risk due to uncertainty about their own talent, but their capacity to do so is constrained by the fact that, in the presence of labor market competition, talented employees require high wages, making uncertainty about talent uninsurable. Lastly, the paper offers evidence that risk sharing within firms has declined steadily in recent decades and discusses possible explanations.

Suggested Citation

Pagano, Marco, Risk Sharing Within the Firm: A Primer (December 12, 2019). Available at SSRN: https://ssrn.com/abstract=3510275 or http://dx.doi.org/10.2139/ssrn.3510275

Marco Pagano (Contact Author)

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