Insurance Between Firms: The Role of Internal Labor Markets

We investigate how Internal Labor Markets (ILMs) allow complex organizations to accommodate positive and negative shocks calling for costly labor adjustments. Adverse shocks affecting one unit in the organization are shown to increase workers' mobility to other units rather than external firms, with stricter employment protection in the adversely hit unit causing an additional increase in internal mobility. The ILM response to adverse shocks is also stronger when the receiving units in the organization are more productive and have a better financing capacity. We also find that affiliated units faced with positive shocks to their growth opportunities rely on the ILM for new hires, especially managers in the top layers of the organization and other high-skilled workers, thus overcoming human capital bottlenecks that may curb growth. ILMs therefore emerge as a co-insurance mechanism within organizations, allowing them to bypass both firing and hiring frictions, and providing job stability to employees as a by-product.