The Effects of Firm-Level Uncertainty on Firm Employment Decisions

Project overview

It is well known that fluctuations in uncertainty have significant economic consequences. Recent events related to Brexit, the Trade War between US and China and COVID-19, are examples of large and unexpected uncertainty shocks, and in order to predict their aggregate implications, it is important to understand how such shocks might affect the economic decisions of households and firms. 

This project aims to provide novel empirical evidence on the relation between firm-specific uncertainty shocks and firm employment decisions. Given the nature of the question, it is essential to use detailed information about firms and employees. We will use matched employer-employee data from the whole active population of Sweden over almost three two decades – between 1990 and 2017. Worker information will be compared with employer information, for which we have an extensive balance sheet and credit score data. The exceptional quantity and quality of information available in this dataset makes it ideal for our objective.

Besides the availability of high-quality data, another key element of the project is the identification of fluctuations in uncertainty that are exogenous from the point of view of the firm. we will use machine-learning methods (Lasso, elastic net) to estimate the firm-level exposure to fluctuations in commodity prices. We will then use this estimated exposure, together with fluctuations in the volatility of commodities, to construct exogenous measures of firm-specific uncertainty shocks.

Finally, this project will analyze the effect of these shocks on firm decisions. The decisions of interest go beyond the number of employees and focus more on issues regarding the composition of the firm’s labor force in terms of tenure, human capital and age, among others. These decisions also interact with the incentives of employees to acquire general or specific human capital, with potential spillovers that go beyond the firm’s scope. 

Summary, output, and dissemination

Research summary

The researchers performed additional robustness checks of the empirical results, and also developed a stylized model two-period model with uncertainty, heterogeneous workers, and firm hiring and firing decisions, to provide theoretical support to our main empirical results. The model is very stylized and allows for a closed-form solution, and yet is sufficiently rich to analyze the effects of uncertainty on the option value of heterogeneous workers. 

It was discovered that more uncertainty implies an incentive to reduce hiring because initial hiring costs might be wasted if ex post the project is terminated. However, it also increases the option value of firing specialized workers and relocating flexible workers. As a result, the effect of uncertainty shocks on overall hiring and firing decisions is ambiguous. Importantly, the researchers also found that more uncertainty affects the optimal mix of workers, and generates a set of testable predictions. 

1. The model predicts that while more productive workers are fired less frequently on average, both their hiring and firing probability increase more with uncertainty than that of less productive workers.

2. Uncertainty shocks increase the firing probability of specialized workers more than that of flexible workers.

3. An increase in firm-level uncertainty increases relatively more the hiring of workers that are cheaper to hire and train. 

All these predictions are largely confirmed by our empirical analysis. With the completion of additional empirical robustness checks and the theoretical model, the paper is ready to be submitted for publication.

The main additional contribution has been the inclusion in the paper of a stylized model that explains the effects of uncertainty on the option value of heterogenous workers. The researchers extended the empirical analysis to explore and confirm the consistency between the predictions of the model and the empirical evidence.

Publications

How Stimulative are Low Real Interest Rates for Intangible Capital? (With Ander Perez), European Economic Review, Volume 142, February 2022

Income Inequality and Entrepreneurship: Lessons from the 2020 Covid Recession, Latest draft, October 2022 (with Christoph Albert, Beatriz Gonzalez and Victor Martin-Sanchez), Revise and Resubmit, Journal of Banking and Finance

Conference and seminar

Conference

Keynote Speaker at XIV International Scientific Conference of the The Institute of Economic Sciences on “European Economies after Covid-19: Challenges and Implications for the Macroeconomic Policy”, Belgrade, October 2022

Seminar

Invited Seminars: Danish National Bank, University of Kent, 2022