Insurance within the firm

versions allowing for rigidities in the form of firing or mobility costs.

9 Conclusions

We began by observing that in the principal-agent model there is a trade-off between earn-
ings incentives and wage insurance against the vagaries of the product market. We offer
empirical evidence on the extent of insurance and incentive provision within the firm, based
on a matched employer-employee data set that spans almost 15 years, from the early 1980s
to the mid-1990s, in Italy.

The main empirical finding is that the provision of incentives is not limited to managers
and executives, the two groups on which the empirical literature has mainly focused. We
document the existence of incentives for all categories of employees, including production
and clerical workers. However, while full insurance is provided against temporary shocks,
lasting disturbances to output are only partially insured.

The sensitivity of workers’ wages to shocks to the firm varies systematically with firm
and worker attributes. In particular, it is a concave function of firm size, it is greater for
firms located within an industrial district, where output is less noisy and information about
workers’ effort is easier to obtain and process, and it is lesser for firms with high overall
performance variability. Our estimates also suggest that the responsiveness to shocks de-
pends on the employee’s position within the firm: managers’ compensation is more reactive
than that of white-collar or blue-collar workers, although estimates are not at all precise.
In addition, workers risk aversion is negatively correlated with such sensitivity, consistent
with the agency model of wage determination.

These findings are sufficiently robust for us to draw a few conclusions. First, all workers
share at least partly the fortunes of their company, to an extent that depends on their
relationship with the firm (i.e., position and tenure), and - more importantly from an
economic and statistical point of view - on their preferences (risk-averse workers self-select
into more secure firms). Second, insurance coverage depends on the nature of the shocks to
the firm: it is complete when temporary but only partial when permanent. This obviously
helps a firm’s adjustment when shocks hit. Let us remark that the distinction made here

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