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Severance Payments as a Commitment Device

  • Florian Baumann

The present paper analyzes the role of severance payments in optimal labor contracts, employing an efficiency-wage model with two-sided moral hazard. We show how employers commit to job security for their workers by using severance payments, but that in general, employees are not fully compensated for the loss in income in the event of a layoff. By extending the analysis we establish a positive relation between investment in firm-specific training and the probability that a worker dismissed for behavioral reasons receives severance payments, and suggest that a mandatory increase in severance payments may yield a Pareto improvement.

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Article provided by Mohr Siebeck, Tübingen in its journal Journal of Institutional and Theoretical Economics.

Volume (Year): 166 (2010)
Issue (Month): 4 (December)
Pages: 715-734

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Handle: RePEc:mhr:jinste:urn:sici:0932-4569(201012)166:4_715:spaacd_2.0.tx_2-h
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  1. Ichino, Andrea & Polo, Michele & Rettore, Enrico, 2003. "Are judges biased by labor market conditions?," European Economic Review, Elsevier, vol. 47(5), pages 913-944, October.
  2. Kenji Azetsu & Taro Kumagai, 2006. "Severance pay and the accuracy of judgment," Economics Bulletin, AccessEcon, vol. 10(1), pages 1-7.
  3. Burguet, Roberto & Caminal, Ramon, 2008. "Does the market provide sufficient employment protection?," Labour Economics, Elsevier, vol. 15(3), pages 406-422, June.
  4. Fella, Giulio, 2000. "Efficiency wage and efficient redundancy pay," European Economic Review, Elsevier, vol. 44(8), pages 1473-1490, August.
  5. Edward P. Lazear, 1990. "Job Security Provisions and Employment," The Quarterly Journal of Economics, Oxford University Press, vol. 105(3), pages 699-726.
  6. Brander, James A & Spencer, Barbara J, 1989. "Moral Hazard and Limited Liability: Implications for the Theory of the Firm," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(4), pages 833-49, November.
  7. Louis Kaplow & Steven Shavell, 1992. "Accuracy in the Determination of Liability," NBER Working Papers 4203, National Bureau of Economic Research, Inc.
  8. Richard Martin & Steeve Mongrain & Sean Parkinson, 2004. "Severance Payments and Unemployment Insurance: A Commitment Issue," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 6(4), pages 593-606, October.
  9. Booth, Alison & Chatterji, Monojit, 1989. "Redundancy Payments and Firm-Specific Training," Economica, London School of Economics and Political Science, vol. 56(224), pages 505-21, November.
  10. Margarita Katsimi, 2003. "Training, Job Security and Incentive Wages," CESifo Working Paper Series 955, CESifo Group Munich.
  11. repec:ebl:ecbull:v:10:y:2006:i:1:p:1-7 is not listed on IDEAS
  12. Giorgio Brunello, 2006. "Workplace Training and Labour Market Institutions in Europe," CESifo DICE Report, Ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 4(4), pages 33-41, 02.
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