Labor Relations, Endogenous Dividends and the Equilibrium Term Structure of Equity

Abstract

Leading asset pricing models are inconsistent with the recent empirical evidence documenting downward sloping term structures of equity risk and premia. This paper shows that a simple general equilibrium model can accommodate such stylized facts as long as dividends endogenously obtain from a model of labor relations. Unlike standard Walrasian models but in line with the empirical evidence, wages do not equal the marginal product of labor but incorporate an income insurance from shareholders to workers. Such a distributional risk provides a rationale to the counter-cyclical labor share and the high riskiness of owning capital. Fluctuations in the degree of income insurance that workers can exploit within the firm lead to short-term equity risk. Therefore, the model captures simultaneously the negative slope of the term structure of equity and dividends as well as traditional asset pricing facts, such as the equity premium and the excess volatility and their endogenous time-variation.