Capital Share Dynamics When Firms Insure Workers

• Author: MINDY Z. XIAOLAN,BARNEY HARTMAN‐GLASER,HANNO LUSTIG
• DOI: http://doi.org/10.1111/jofi.12773
• Published date: 01 August 2019
• Date: 01 August 2019

THE JOURNAL OF FINANCE •VOL. LXXIV, NO. 4 •AUGUST 2019

Capital Share Dynamics When Firms

Insure Workers

BARNEY HARTMAN-GLASER, HANNO LUSTIG, and MINDY Z. XIAOLAN∗

ABSTRACT

Although the aggregate capital share of U.S. firms has increased, capital share at

the firm-level has decreased. This divergence is due to mega-firms that produce

a larger output share without a proportionate increase in labor compensation. We

develop a model in which firms insure workers against firm-specific shocks, with

more productive firms allocating more rents to shareholders, while less productive

firms endogenously exit. Increasing firm-level risk delays exit and increases the mea-

sure of mega-firms, raising (lowering) the aggregate (average) capital share. An in-

crease in the level of rents magnifies this effect. We present evidence that supports

this mechanism.

OVER THE LAST SEVERAL DECADES, publicly traded U.S. firms have experienced

large increases in the firm-specific volatility of both firm-level cash flows and

returns (see, for example, Campbell et al. (2001), Comin and Philippon (2005),

Xiaolan (2014), Bloom (2014), and Herskovic et al. (2016)). At the same time, the

share of total value added (VA)that accrues to the owners of these firms (i.e., the

aggregate capital share) has also increased (see, for example, Karabarbounis

and Neiman (2014) and Piketty and Zucman (2014)). We find that the aggregate

factor shares are largely determined by the firm-level factor shares of the

largest U.S. firms in the right tail of the size distribution. These mega-firms

∗Barney Hartman-Glaser is with the Anderson School of Management, University of California,

Los Angeles. Hanno Lustig is with the Graduate School of Business, Stanford University and the

National Bureau of Economic Research. Mindy Z. Xiaolan is with the McCombs School of Business,

University of Texas, Austin. We received detailed feedback from Hengjie Ai, Andy Atkeson, Alti

Aydo ˘

gan, Frederico Belo, Jonathan Berk, Peter DeMarzo, Sebastian DiTella, Andres Donangelo,

Darrell Duffie, Bernard Dumas, Andrea Eisfeldt, Mike Elsby (discussant), Bob Hall, Lars Hansen,

Ben Hebert, Chad Jones, Pat Kehoe, Matthias Kehrig (discussant), Arvind Krishnamurthy, Pablo

Kurlat, Ed Lazear, Brent Neiman (discussant), Dimitris Papanikolaou (discussant), Monika Pi-

azzesi, Luigi Pistaferri, Larry Schmidt, Martin Schneider, Andy Skrypacz, and Chris Tonetti. The

authors acknowledge comments received from seminar participants at Insead, the Stanford GSB,

UT Austin, Universite de Lausanne and EPFL, the Carlson School at the University of Minnesota,

the Federal Reserve Bank of Atlanta, the Federal Reserve Bank of New York, the Capital Mar-

kets group at the NBER Summer Institute, NBER EFG, SITE, UCLA, the Duke/UNC Corporate

Finance Conference, the 2016 Labor and Finance group meeting, and the UW-Madison Junior

Conference. We thank Jangwoo Lee and Tim Park for excellent research assistance. All errors are

our own. We have read the Journal of Finance disclosure policy and have no conflicts of interest

to disclose.

DOI: 10.1111/jofi.12773

1707

1708 The Journal of Finance R

Figure 1. Aggregate capital share of total value added for public firms. The figure

presents the aggregate capital share for all firms in the Compustat public firms database. The

aggregate capital share is given as icapital incomeidivided by ivalue addedifor each year,

where capital income is operating income before depreciation (OIBDP), and value added is capital

income plus labor expenses. (Source: Compustat/CRSP Merged Fundamentals Annual (1960 to

2014).) (Color figure can be viewed at wileyonlinelibrary.com)

have experienced substantial increases in their capital share even though the

capital share of the average U.S. firm has decreased.

The U.S. economy’s aggregate factor share dynamics are well understood, but

its firm-level factor share dynamics are not. Between 1960 and 2010, the U.S.

labor share of total output in the nonfarm business sector of the U.S. economy

shrank by 15% (this phenomenon does not appear to be limited to the United

States; see, for example, Karabarbounis and Neiman (2014)). Figure 1plots the

capital share over time for the universe of U.S. publicly traded firms. As can be

seen, the aggregate capital share for these firms has increased from 40% to 60%

since 1980. In this plot, capital share is measured as the ratio of capital income

to valued added, where capital income is operating income before depreciation

(OIBDP) and VA is operating income plus labor expenses.1Our key empirical

contribution is to show that the increase in the capital share is concentrated

among the largest publicly traded firms in the United States. Figure 2plots the

relationship between firm size and the ratio of capital income to sales, which

captures the capital share of profits. In 1970, there was essentially no relation

between firm size and the capital-income-to-sales ratio, but by 2010, this ratio

had strongly increased in size. This shift caused the average and aggregate

capital shares to diverge, with the equal-weighted average capital share of

publicly traded companies declining since the 1980s. The United Kingdom

and continental Europe have experienced similar divergences between the

1Weimpute labor expenses for the Compustat sample using the method developed by Donangelo

(2016).

Capital Share Dynamics When Firms Insure Workers 1709

Figure 2. Firm-level capital income-to-sales ratio by size. This figure presents the relation

between the ratio of capital income (OIBDP) to sales and firm size for all firms in the Compustat

public firms database. Firm size is measured as total assets. Each point represents the within-

bin average of the ratio after grouping firms into 20 size bins. (Source: Compustat/CRSP Merged

Fundamentals Annual (1960 to 2014).) (Color figure can be viewed at wileyonlinelibrary.com)

aggregate and average factor shares over this period, as well as similar

increases in idiosyncratic risk. Japan, in contrast, has experienced neither.

Recently, scholars have documented similar findings in a different sample of

U.S. firms. In particular, Kehrig and Vincent(2017) find similar evidence using

establishment-level data in the manufacturing industry. In work preceded by

ours, Autor et al. (2017) employ census data and attribute the decrease in labor

share to the low labor share of the largest firms. This result is consistent with

our earlier findings, but Autor et al. (2017) abstract from the equally important

changes in factor shares in the left tail of the size distribution.

We develop an equilibrium model that links our observations on volatility and

factor shares and provides novel implications for national income accounting.

When shareholders insure workers against idiosyncratic risk, capital shares

vary substantially across firms, with the largest and most productive firms

having the highest capital share. In our model, changes in the size distribution

of firms triggered by changes in firm-level risk have first-order implications

for the aggregate and average capital shares in two ways. First, in our model,

an increase in idiosyncratic volatility coupled with an increase in economic

rents can quantitatively explain the shift in both the aggregate and the av-

erage capital share. Second, consistent with our model, U.S. industries that

saw larger increases in idiosyncratic volatility experienced larger drops in the

average firm-level capital share. We document similar findings for the United

Kingdom, Europe, and, to a lesser extent, Japan.

Shareholders of publicly traded firms can decrease idiosyncratic firm-specific

risk through diversification, while risk-averse workers cannot. It is therefore