Risk Shifting and Reliability in Labor Markets

Abstract

This paper analyzes the allocation of risk which is associated with variations in the value of aggregate output in a context of differences in worker and firm attitudes to risk. The analysis emphasizes two factors—limited firm risk-absorbing capacity and worker unreliability—which make it infeasible for risk-neutral firms to relieve risk-averse workers of all risk. The main ideas are that the limitation on current wage payments imposed by the value of current output implies that firms generally cannot guarantee their workers a stable consumption stream and that firms generally earn rents in their risk-absorbing role. In addition, differences among workers in their reputation for reliability, which relate to their behavior when the value of output is high, produce differences in the terms at which they can obtain consumption when the value of output is low. Specifically, workers of unproven reliability obtain less consumption in bad states of nature and, unless they plan to be unreliable, have lower current expected utility than workers of proven reliability. Those workers who earn reputations for reliability tend to be those who are relatively more risk averse and those who belong to groups which have a relatively good record for reliability.