Research seminars

Operating Leverage, Risk Taking and Coordination Failures

Finance

Speaker: Matthieu Bouvard
Desautels Faculty of Management

14 June 2018 - S125 - From 2:00 pm to 3:15 pm

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We study an economy with demand spillovers where firms' decisions to produce are strategic complements. Firms have access to an increasing returns to scale technology and choose their operating leverage trading off higher fixed costs for lower variable costs. Operating leverage raises the sensitivity of firms' profits to an aggregate labor productivity shock, thereby magnifying systematic risk. We show that firms take excessive risk as they do not internalize that higher operating leverage increases the likelihood of a coordination failure where output is infficiently depressed across the economy. More generally, our analysis suggests that individual risk-taking decisions aggregate into excessive output volatility in the presence of strategic complementarities among agents.

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