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Financial Market Development and the Rise in Firm Level Uncertainty

This Paper posits that firms can choose the degree of risk inherent to their technological/ marketing/organizational strategies. Financial market development, by improving risk sharing between owners of listed firms, increases the willingness of these firms to take risky bets. This in turn increases firm level uncertainty in sales, employment and profits. In equilibrium, this effect diffuses to non-listed firms, a group not directly involved in risk sharing. The effect is larger when competition increases, and when labour market institutions are flexible. This Paper thus provides a finance-based, instead of technology-based, rationale for the increase of firm level uncertainty that has recently been documented in France and the US. We then use the French stock market reforms of the late 1980s to test our predictions, using listed firms as the treated group and privately held firms as a control group. Consistent with our model’s testable predictions, we find that (1) for listed firms, firm sales volatility has increased markedly after the reforms; and (2) this effect is stronger where product market competition is the strongest. Such evidence holds in front of various robustness checks. In particular, we seek to control for the exposure to international competition and the adoption of new technologies, two forces that may have affected our treatment and control groups differently.