Insurance within the firm

Insurance within the Firm*

Luigi Guiso^      Luigi Pistaferri^      Fabiano Schivardi^

March 2001

Abstract

The full insurance hypothesis states that shocks to the firm’s performance do not
affect workers’ compensation. In principal-agent models with moral hazard, firms trade
off insurance and incentives to induce workers to supply the optimal level of effort.
We use a long panel of matched employer-employee data to test the theoretical pre-
dictions of principal-agent models of wage determination in a general context where
all types of workers, not only CEOs, are present. We allow for both transitory and
permanent shocks to firm performance and find that firms are willing to fully absorb
transitory fluctuations in productivity but insure workers only partially against perma-
nent shocks. Risk-sharing considerations can account for about 10 percent of overall
earnings variability, the remainder originating in idiosyncratic shocks. Finally, we show
that the amount of insurance varies by type of worker and firm in ways that are con-
sistent with principal-agent models but are hard to reconcile with competitive labor
market models, with or without frictions.

Keywords: Insurance, incentive contracts, matched employer-employees data.
JEL Classification: C33, D21, J33, J41.

*This paper is part of the EU-TMR research project “Specialisation versus diversification: the microe-
conomics of regional development and the spatial propagation of macroeconomic shocks in Europe”. The
Italian “Ministero dell’Università e della Ricerca Scientifica” and the “Taube Faculty Research Fund” at the
Stanford Institute for Economic and Policy Research provided financial support. We thank Cris Huneeus,
Marcel Jansen, Tullio Jappelli, Ed Vytlacil, Sevin Yeltekin, and seminar participants in Salerno, Turin, the
Bank of Italy and the 2001 North-American conference of the Econometric Society for useful discussion and
comments on a preliminary draft, and the INPS for supplying us with the data on workers’ compensation.
The views expressed in this paper are our own and do not involve the Bank of Italy or the EU. We are
responsible for all errors.

Wniversità di Sassari, Ente Luigi Einaudi and CEPR.

^Stanford University, SIEPR and CEPR.

⅛esearch Department, Bank of Italy.

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