Labor Leverage, Coordination Failures, and Aggregate Risk

This paper studies an economy where demand spillovers make firms' productiondecisions strategic complements. Firms choose their operating leveragetrading off higher fixed costs for lower variable costs. Operating leveragegoverns firms' exposures to an aggregate labor productivity shock. Inequilibrium, firms exhibit excessive operating leverage as they do notinternalize that an economy with higher aggregate operating leverage is morelikely to fall into a recession following a negative productivity shock.Welfare losses coming from firms' failure to coordinate production areamplified by suboptimal risk-taking, which magnifies the impact ofproductivity shocks onto aggregate output