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Optimal Severance Payment: Theory and Practice

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  • Byeongju Jeong

Abstract

I present a model in which the employment contract includes severance payment as an instrument for achieving optimal separation between the firm and the worker. I show that the privately optimal severance payment from the model can replicate the level and the variation in actual severance payments (and notice periods) across OECD countries. I conduct a policy experiment in which the existing unemployment benefits are financed by a separation tax. Under this policy, the actual severance payments need to change only marginally in order to achieve socially optimal separation.

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Paper provided by The Center for Economic Research and Graduate Education - Economic Institute, Prague in its series CERGE-EI Working Papers with number wp255.

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Date of creation: Apr 2005
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Handle: RePEc:cer:papers:wp255

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  1. Rogerson, Richard & Schindler, Martin, 2002. "The welfare costs of worker displacement," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(6), pages 1213-1234, September.
  2. Alvarez, Fernando & Veracierto, Marcelo, 2001. "Severance payments in an economy with frictions," Journal of Monetary Economics, Elsevier, Elsevier, vol. 47(3), pages 477-498, June.
  3. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 57(3), pages 381-402, July.
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