Severance Payments and Unemployment Insurance: A Commitment Issue

Abstract

In the event of a job termination, many workers receive severance payments from their employer, in addition to publicly provided unemployment insurance (UI). In the absence of a third party enforcer, contracts featuring severance payments must be supported by an implicit self-enforcing contract. Workers believe employers will make severance payments only if it is in their best interest ex post. If firms discount the future deeply, they will reduce the severance payment they offer, in order to relax their incentive constraint. Workers are forced to bear risk, and too many workers are laid off. We show that a well-designed public UI system can correct these distortions.

Lobbying and dismissal dispute resolution systems

“…4) Moving beyond the economic analysis of courts and litigation, our contribution is related to the political economy of employment protection legislation (e. g., Saint-Paul (2002), Bruegemann (2007), Neugart (2008), Boeri et al (2012)). The evasion of dismissal protection regulations has been investigated theoretically by Martin et al (2004) and Baumann and Friehe (2012) and in empirical studies by Almeida and Carneiro (2009) among others. Additionally, the role of courts in the enforcement of employment protection legislation has been looked at by Ichino et al (2003), Galdón-Sánchez and Güell (2003), Stähler (2008), Huang et al (2009), Goerke and Pannenberg (2010), Fraisse (2010), and Berger and Neugart (2012), inter alia.…”

On the evasion of employment protection legislation

“…4 There has been research done on illegal means of avoiding labor market institutions: however, it has focused on different aspects than we do in the current paper. For example, several contributions analyze default of firms with respect to severance payments (see, e.g., GaldonSanchez and Güell, 2003, Martin et al, 2004, Azetsu and Kumagai, 2006, Stähler, 2008, and Besancenot and Vranceanu, 2009). Starting with Ashenfelter and Smith (1979), a rich literature on noncompliance with minimum wage laws and the consequences for employment levels has developed (see, e.g., the very recent contributions by Danziger (2009Danziger ( , 2010 and Basu et al (2010)).…”

Severance Payments as a Commitment Device

“…incentive exists for the employer to rename a redundancy as a disciplinary dismissal because of shirking or to simply default on severance pay (see GALDON-SANCHEZ AND GÜELL [2003], and MARTIN, MONGRAIN, AND PARKINSON [2004]). We assume that the probability of receiving a severance payment is at least as high in the event of a real redundancy as in the case of a dismissal for behavioral reasons.…”