Lenders as Monitors of Risk Devolution

The COVID-19 pandemic represented the emergence of an enormous, systemic, and largely un-anticipated economic risk. It upended entire industries on a global scale, shuttered millions of businesses by government order, and left millions more struggling to adapt to unforeseen and rapidly changing circumstances. These risks impacted employees of traditional and “gig economy” firms differently. Traditional Coasian firms act as employee risk-pooling mechanisms. However, “gig economy” structures disaggregate these risk pools, eroding the coinsurance function of the firm and discretely devolves significant risk to contingent workers.Unfair allocations of risk can be invisible during times of prosperity. When risks materialise in a crisis, however, the ultimate bearers of those risks become apparent. This presents unique ethical issues when risk is devolved to “smallholders”; poorly diversified individuals whose primary source of income involves leasing their labour or property, either directly or through thinly capitalised companies. The ethical issue is simple: during good times the distribution of risk can be invisible to ordinary people, and sophisticated companies can get away with shifting quite a lot of risk to smallholders. When a crisis emerges, these smallholders go bankrupt or go hungry.However, smallholders have a powerful potential ally in fighting risk devolution: debtholders. Because employee contracts represent an asset of the employing firm, destructive risk-shifting by equity to smallholders represents a form of synthetic leverage that undermines the economic interests of debtholders. This essay argues that smallholder risk devolution presents both ethical and economic concerns for debtholders. In the first part of this essay, I describe the risk-pooling function of a traditional firm and outline how this is eroded by the growing trend of smallholder risk devolution. Next, I argue that finance structures play a key role in incentivising such riskshifting, and that debtholders are well-suited to police smallholder risk devolution because it presents structural risks to the interests of debt. Finally, I suggest mechanisms for debtholder monitoring of risk devolution