A standard assumption in theories of unemployment is that firms are risk-neutral. However, there are several reasons why firms may in fact be risk averse. Some factors that can be invoked are nondiverisified ownership, liquidity limitations or costly financial distress. And even if maximizing profits is the preferred objective of firm owners, the entrustment of firm control to a risk-averse manager whose wages are linked to performance may induce the firm to behave risk-aversely as output may be subject to uncertainty. Moreover, the firms/ incentive schemes may change her attitude towards risk-taking. This may happen when firm owners heavily rely on stock options which arguably have fundamentally changed the incentive landscape in the U.S. in that most managers/ pay is now thought to be convex in stock value (Hall and Liebman (1998), Guay (1999)). Therefore, risk-incentives to managers are greater than they were ever before.
There are other uncertainties a firm may face. Contribution such as Booth, Chen and Zoega (2001) and Booth and Zoega (1999) consider employment dynamics with the effect of quitting on the hiring and training by firms when productivity is uncertain. Chen and Funke (2004) consider the effect on firms decision making in terms of employment and working hours using real option theory. In the light of the above discussion, surprisingly little work has focused on uncertainties and their possible (direct) affect on firm behavior in the form of risk-aversion.
Altering the assumption of risk-neutrality in firm has several implications for the labour market. Important work by Grossman and Hart (1983) shows in the context of a static model that the probability of unemployment is higher when firms are risk averse and it increases as risk-aversion rises. In their model firms have more information than workers and firm risk-aversion creates more unemployment then a Walrasian economy when times are bad as firms attempt to exploit asymmetric information. Similarly, Frank (1990) show that risk-aversion implies firm operate too cautiously at low levels profit levels and as a result the economy can get stuck in an equilibrium recession. While, these paper suggest firm risk-aversion having a negative impact on unemployment levels, we suggest that this may not be the case during transitional dynamics.
We consider a dynamic version of the turnover-training model in the tradition of Hoon and Phelps (1992), Orszag and Zoega (1996, 1995). The firm faces workers turnover uncertainty and is risk-averse in her profit function. In line with turnover-training literature, the firm invests in the training of new workers and uses wages to reduce quitting and hence the costs associated with labour turnover. The firm also has a constant-returns-to-scale technology; an assumption commonly used in this literature. In the presence of firm risk-aversion and uncertainty we show that in the aftermath of a random transitory (or permanent) shock to either productivity or interest rates which drive the economys employment level below its steady-state, a high risk-aversion in firms tends to speed-up adjustment process of employment back to its steady-state. In this sense, risk-aversion serves as a self-adjusting device in that cautious managers steer their firms to regain the pre-shock employment levels, in the case of a temporary shock, in a bid to stay closer to their steady-state profit levels; thereby minimizing fluctuations in profits. This close tracking of the steady-state, however, comes at a cost in the form of altering wages, hiring or losing workers during the period where adjustment is taking place.
The result we obtain is independent of the levels of labour market rigidities characterized by high training cost and low quit rates in our model and extends the literature in three ways: (i) situations where firm risk-averse behavior affect (un)employment dynamics have received little attention but, as we have argued, are clearly appropriate, (ii) we examine the problem in a dynamic framework which generalizes the existing turnover-training models, (iii) anecdotal evidence is discussed that links employment dynamics with corporate governance.
The rest of this paper is organized as follows. In Section 2 we briefly present the related literature. In Section 3 we develop the basic structure of the model and solve for the steady-state. In Section 4 we analyze, using both theory and numerical simulations, the dynamic properties of the model with respect to the firm risk-aversion and the speed of adjustment of unemployment. The model has the empirical implication that the economies with more risk-averse firms are quicker to adjust to various shocks and this is discussed in Section 5. Finally, in Section 6 we present the concluding remarks.
