Who Bears Firm-Level Risk? Implications for Cash Flow Volatility

Public firms in the United States that provide better insurance against productivity shocks to their workers experience higher cash flow volatility. Difference in intra-firm risk sharing between workers and capital owners accounts for more than 50\% of the variation in firm-level cash flow volatility. I develop a theory in which wages can act either as a hedge or as leverage, depending on the history of the productivity shocks the firm has faced. Heterogeneous roles of workers in the firm are derived by analyzing the dynamic equilibrium wage contracts between risk-neutral owners and risk-averse workers who can leave with a fraction of the accumulated human capital. Owners of the firm will optimally bear more risk when the current value of the firm's human capital is lower than the peak value it has reached. The model successfully explains the joint distribution of cash flow volatility and the wage-output sensitivity. Also, the model produces predictions for the dynamics of cash flow volatility that are consistent with the time series properties of the firm-level data.