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Firm and aggregate volatility

US publicly-traded companies have become more volatile over the postwar period (see 1 and 2). This trend has been the result of increased competition in product markets through deregulation, through more intensive innovation activity, and through easier access to capital markets. As a result, market leaders have observed how the probability of falling down of the top quintile in sales or profits within five years has increased by a factor of 7 over the post-war period (see 2).

Since the wages of publicly traded companies are a function of the firm's performance, the higher volatility faced by firms has affected the volatility of wages (see 3). Furthermore, since around 1980, firms have responded to the more volatile environment by making compensations more dependent on the firm performance. As a result, wage volatility has increased very significantly for workers in publicly-traded companies.

The upward trend in the individual volatility of publicly-traded companies contrasts with the decline in the volatility of most macro aggregates such as GDP, investment, consumption and hours worked known as the great moderation. The simultaneity of these two trends is possible because what drives the great moderation is the reduction of the co-movement between the performance of companies (or sectors) in the economy (see 1).

Indeed, sectors where firm volatility has increased by more are also the sectors that have experienced larger drops in their co-movement with the rest of the economy (see 2). This evidence suggests that the great moderation and the increasing turbulence of companies may be connected. One way to rationalize this connection is by recognizing that innovations that lead idiosyncratic firm growth (and turbulence) are distinct from those that lead to aggregate growth (and its volatility). Furthermore, there are reasons to believe that the firms’ return to conducting these two types of innovations are negatively related leading to the opposite trends in volatility at the aggregate and firm level (see 4).


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